What is economics? Why is it important to define clearly what is economics?
Economics as Phenomenon
Historically, economics originated from the consideration by philosophers of human activities as social phenomenon, to be studied like physics as natural phenomenon (Mirowski, 1989). The assumption is: there are natural laws of economics equivalent to the natural laws of physics. Economics, when considered as knowledge from discoveries about social phenomenon of humans, did not require precise definition; it only required a scoping of human activities under study.
For example, Marshall (1890, p.1) defines economics as "a study of mankind in the ordinary business of life", particularly "connected with the attainment and with the use of the material requisites of wellbeing". The view of economics as social phenomenon persists to today and explains many other misconceptions in economics, which will be subjects for future posts on this blog.
Economics as Purpose
Economic knowledge has two senses: a collection of knowledge of individual economists and a consensual knowledge of most economists.
To most people, consensual economic knowledge has a purpose in the same way that knowledge of natural sciences has a purpose. Consensual economic knowledge is used by business and government to make and justify decisions on how money is spent and how resources are allocated for production and consumption. The accepted knowledge used in this practical way, is the economic paradigm regarded as core knowledge captured in basic economics textbooks.
There is a wider knowledge of individual economists, outside orthodox economics, known collectively as heterodox economics or pluralism, which is a varied collection of alternative, and often conflicting, ideas. By definition, heterodox economics has little practical relevance in the real world because it is rarely used by consensus, or only some of it is used by a relatively small minority of people. Most rules, laws or economic policies which affect our lives in a democratic society are derived from the economic paradigm of the orthodoxy.
Most criticisms of orthodox economics by the heterodoxy are concentrated on the “unrealistic” assumptions or the lack of sophistication of its models, thus largely missing the point of purpose (Friedman, 1952). Orthodox economics serves a useful purpose which heterodox economics does not. The key question is not whether orthodox economics is objectively more “right”, or not, compared to its alternatives, but rather whether orthodox economics is sufficiently useful or fit-for-purpose.
Not Fit- for-Purpose
The economic knowledge which is actually used is orthodox economics or the economic paradigm, which is often referred to simply as “economics” on this blog. It is this economics which policy makers have found deficient in the recent global financial crisis, when President Trichet of the European Central Bank lamented (2010):
“Macro models failed to predict the crisis and seemed incapable of explaining what was happening to the economy in a convincing manner. As a policy-maker during the crisis, I found the available models of limited help. In fact, I would go further: in the face of the crisis, we felt abandoned by conventional tools.”
Hence economics has failed to be useful, according to public expectations, where it is needed most. The failure to anticipate, understand or ameliorate the global financial crisis is one of the most significant failures of economics. For this failure, the whole economic profession, including all economists in education, business and government, have to take collective blame. But particular blame should go to academic economists, because they are responsible collectively for propagating, through textbooks, the unscientific knowledge which has led to erroneous decisions and policies, the consequences of which will continue adversely to affect our lives for years to come.
Economics has been so narrowly defined by academics that it is not fit-for-purpose. The global financial crisis is merely one dramatic example of how economics is not fit-for-purpose, because orthodox economics assumes endogenous crises do not exist and therefore it has little knowledge of them (Sy, 2012). For example, the orthodox assumption of efficient markets denies the existence of asset bubbles. Without a theoretical concept of asset bubbles, Greenspan (2002) pleaded that “it was very difficult to definitively identify a bubble until after the fact--that is, when its bursting confirmed its existence”.
Importantly, the current economic paradigm either neglects many important economic issues or treats them in an inconsistent or incoherent manner, because they are assumed, without justification, to be non-existent or unimportant. A lack of attention to these issues will become apparent only when new crises strike the economy in unexpected ways. Surely it is desirable to have an economic paradigm which is capable of evaluating economic issues, real or apparent, in a coherent and scientific manner, without simply dismissing them out-of-hand.
In other words, the consensual core knowledge of economics or the economic paradigm is not fit-for-purpose, because it is unscientific and has an unacceptably narrow scope.
Definition of Economics
It is therefore important to redefine economics in a way which is fit-for-purpose in meeting expectations of its use and is capable of accommodating a broad range of economic concepts, with minimal preconceived limitations. We suggest the following definition:
Economics is the knowledge obtained from the study of how human needs and wants are met in an uncertain world of finite resources.
The key words in this definition are “human”, “uncertain” and "finite", which make economics both challenging and interesting. The precise meanings of these words are critical to the new concept of economics proposed here. Economics is knowledge of humans, for human use, and developed by humans. The implication that economics is essentially about humans is both radical and profound compared to the existing mechanistic conception of economics.
Humans are in the process of evolving biologically and socially in their knowledge and consciousness and in their needs and wants. In particular, humans invent new products and technologies and create new economic institutions to satisfy and manage new and changing needs and wants. Marshall (1890) stated in the first sentence of his textbook, “Economic conditions are constantly changing, and each generation looks at its own problems in its own way”.
Many economic innovations are motivated by human needs to manage uncertainty and limited resources, without which economics may be trivially simple and uninteresting. Human innovations themselves create uncertainty, from which the consequences of change are unpredictable. The essence of economics as a phenomenon is both dynamic and uncertain, and the purpose of economics is to develop the knowledge of, for, and by humans to manage their environment with limited resources. Many significant economic problems would not exist if resources were infinite.
Importantly, humans, unlike unthinking objects of physics, have the capacity to use the developed knowledge to change the economic phenomenon they study and of which they are a part.
Scope of Economics
In future posts we will explain why much of economics, both orthodox and heterodox, is not economics at all, according to our definition. The greatest economic instability and stagnation since the Great Depression have not brought forth, in the past five years, any genuinely new ideas. The reason is that the origin and possible endogenous cause of the crisis (Sy, 2012) are defined as outside the scope of the economic paradigm itself, which is a synthesis of neoclassical and Keynesian economics; both parts have this and other serious limitations.
The fond hope is that the economic paradigm, with the ignorance of its own destabilizing impact, will survive as being adequate when economic “normalization” eventually occurs. The longer “normalization” takes to occur, the more inadequate the economic paradigm will appear and the greater the damage will have been done by unscientific government interventions.
A new economic paradigm with a broadened scope is required to be “fit-for-purpose” in addressing the urgent economic problems of our age. Many of the problems are man-made disasters which are important to understand and address because they are, by definition, preventable or solvable. It suffices here to list a few examples:
- The recent economic crisis was caused by failures in both the market and government, and it is ongoing.
- The economic ignorance of money is bringing the global monetary system to the edge of collapse.
- There is a need to study the balance between economic growth and finite resources, fairness and income inequality, regulation and innovation, technology and employment, etc.
The purpose of economics is to address these issues; they are substantially man-made and they should not be defined out of existence by the economic paradigm, as is currently the case. The objective of this blog is to lay the foundation for a scientific economic paradigm fit for the purpose of economics, as the world expects.
In summary our ultimate goal is to create a scientific economic paradigm for our new definition of economics with a new set of objectives, assumptions and methods, which will be tested constantly against experience. Hopefully, the new economic knowledge will be useful and fit-for-purpose in addressing human needs and wants in an uncertain world of finite resources.
I enjoyed reading your blog. As you might expect, I sympathise with much of it. I have three comments (which relate to all of your posts so far):
a) You observe: “Few other schools of economics scrutinize the macroeconomic data as much as the econometric branch of mainstream economics. This creates a scientific appearance for mainstream economics, elevates its status and enhances its influence.” You are right. But as you and I know, when the signal-to-noise ratio in econometrics is very low (as it often is), then econometrics on its own can refute little or nothing (see my ‘Doubtful Significance’, 2012). The apparent refutations are based on “untestable assumptions” – or “prejudices”, as Rudolf Kalman calls them. The scientific appearance is really a gloss.
b) Your observations on pluralism are interesting. You are right that pluralism was a problem in the past and that it can increase confusion. Despite that, I feel pluralism has an important role to play. Why do I say that? Compare three visions of the economics discipline:
1) The mainstream reigns, the facts that would refute the mainstream are ignored and pluralism is suppressed – not because it is wrong, but because it is unorthodox. Result: apparent unity, but unity around bad theories. Dangerous!
2) Pluralism reigns, but heterodox economists are no better than the mainstream at using evidence to refute false theories. Result: chaos and confusion!
3) Pluralism reigns and economists learn to take refutation seriously. Result: a workable theory may emerge from pluralism.
I suppose I am dreaming of vision (3): pluralism + refutation = good science!
c) How are we to increase the rate at which bad theories are rejected? I think we shall have to move on beyond Friedman’s ‘positive economics’ argument that the test of a theory is how well it predicts, not whether it is based on plausible assumptions. If we could test predictive power over an unrestricted domain then that would indeed allow us to refute bad theories. But we can’t, and a lot of bad theories can survive in the very restricted domain available to us. I think it is reasonable to refute a theory if it is based on implausible assumptions, because no such theory could predict accurately over an unrestricted domain of tests.
Thank you for your interesting comments.
a) Your work on "Doubtful Significance" (Swann, 2012) is important in showing that most econometric works are not even statistically significant, let alone economically significant. Econometrics has not produced substantive insight about economics, not even its most central piece in the Phillips Curve (Phillips, 1958). From my own research experience, your idea of using the data from case studies leads to more significant statistics and more scientifically valid conclusions.
b) Pluralism does not need special endorsement if it means being open minded about new or different ideas. But there is a second sense in the pluralism movement (Fullbrook, 2008) which seems to be about peaceful co-existence of all ideas, to be accorded equal or similar status and funding.
Pluralism in the first sense already exists and there is chaos and confusion (your case 2) because there is no refutation. Pluralism in the second sense (not yet a reality) would create even more chaos and confusion.
Refutation destroys pluralism, certainly in the second sense. Refutation would reduce chaos and confusion in the first sense. Mainstream economics has been refuted already by evidence, so we need alternative ideas, which is pluralism in the first sense. I agree with your vision (case 3) where I would interpret: good science = a scientific economic paradigm.
There are many misconceptions about science by economists. For example, there is no pluralism in physics, because for any given situation there is usually only one accepted theory. Getting rid of pluralism is a driving force for theoretical progress in physics. This may be a topic for a future post.
c) Predictions are more general than forecasts, which are events specific to time and place. I think forecasts are impossible in economics, but predictions are possible. Predictions are important to science because they drive investigations and provide prestige if they are met. For example, the predicted existence of the Higgs boson from a gap in the standard theory of elementary particles provided enormous prestige when its existence was verified.
In a recent post, I refuted Keynesian economics by showing that its basic tenet on consumption demand is clearly and simply inconsistent with the facts of observation.
Plurality in your first sense plus active refutation is essentially the same as Linus Pauling's celebrated maxim (here quoted from Francis Crick): "If you want to have good ideas you must have many ideas. Most of them will be wrong, and what you have to learn is which ones to throw away."
Agree with Crick, Peter. Having wrong ideas is part of the scientific process. They could be constructive, so long as we remember why they have been thrown away and do not waste resources on the same wrong ideas, unless or until the reason for their rejection becomes invalid (e.g. due to new evidence or understanding).
Let me first say that ideally I too envision Swann's case 3 above. Refutation need not destroy pluralism. It leads to rejection of wrong or invalid ideas, but it also pulls investigation into new questions, which tends to generate new ideas.
I think that you are right to reject a mechanistic conception of human beings. There are glimmers of the recognition that humans are not purely mechanistic in nature - that''s where I think some of the value in heterodox economics lies. Still, if we take behavioral economics as an example, it may be on its way toward a different, but equally "mechanical" vision of humanity. For example, see Philip Pilkington's post on "Naked Capitalism" (http://www.nakedcapitalism.com/2014/01/philip-pilkington-behavioral-economics-victorian-moralising.html)
Bill Black has said much the same thing as you regarding econometrics as applied to the banking sector. I have read others who point out additional shortcomings, such as McCloskey and Ziliak, "The Cult of Statistical Significance" (http://www.deirdremccloskey.com/articles/stats/preface_ziliak.php) Econometrics can give a scientific feel to a non-scientific endeavor. All I would say is that the idea of "fit for purpose" while valid, may not apply in economics. "Fit for Purpose" implies a scientific purpose - one which should allow an unbiased investigation of the collision of theories with facts, and the emergence of new ideas when old ones are not sufficient any more. There is a real question whether economics in whatever form has served to promote ideology i.e. Marxism and its tie to central planing, and the marginal productivity theory of distribution of J.B. Clark being used to justify the vast inequalities of wealth and income we can currently observe.
This ties into moral claims about "moral" economic systems, and about virtuous moral behavior within a given economy. It might be virtuous to "save" but this is only possible in a market setting if someone else is being 'non-virtuous' by spending. Whatever Keynes' other shortcomings, he at least had this one spot on as it is a variant of the fallacy of composition.
We are left with the realization that economics as currently practiced may not be scientific in the naturalistic sense, but this leaves aside the question of whether a naturalistic approach is applicable. Because this is not settled, it becomes that much more difficult to build a "scientific" approach to economics.
I now have two papers to read - the one on Keynes which I said I would read about three months ago, and "Endogenous Crises and the Economic Paradigm." I would like to apologize for not getting back you as quickly as I thought I would regarding Keynes.
Jeff, Your comments are much appreciated.
Economics is riddled with many deep fallacies. Pilkington's attack on Kahneman is justified on the basis that reductionism of human behavior is a fallacy. Much of economics is based on the machine fallacy, which is the belief that the economy can be operated predictably like a machine (once human behavior is "worked out"). This fallacy originates from the erroneous imitation of physics. The science of humans cannot be the same as the science of natural objects.
McCloskey's work is loose and tedious. I do not disagree with much of his/her criticism about statistics, though many of its arguments are undisciplined and digressive. My meaning of "fit for purpose" of an economic paradigm stipulates the capacity of the framework to discuss and evaluate any properly expressed economic theory, whatever its origin. The neoclassical economic paradigm is inadequate because it cannot possibly discuss in a coherent way the endogenous origin of economic crisis.
Economics is about humans and hence it is impossible to avoid the impact of value and ideology in economic theory. This aspect of human value does not prevent the application of the scientific method to economics. All that science requires is a clear statement of assumptions underlying what are the values of a particular economic system. For example, the values associated with capitalism or socialism can be explicitly articulated in economic theory. Different economic systems reflect different values. Value systems are pluralist, but not the method of studying and evaluating them.
The discussion on saving in the historical literature is badly confused. I'll discuss this more in the research paper I'm writing. It is simply untrue that for someone to save someone else has to spend. There are many such fallacies in economics which can be demonstrated as such, both by logic and by empirical evidence. Economists have accepted a lot of nonsense without proof.
I have touched on these fallacies in my paper on Keynesian economic collapse. I'll wait until you've read that paper to comment further. In fact, I'm writing the above-mentioned follow-on paper which relates saving or its opposite (capital consumption), to economic growth.
I have already partially answered your question about a scientific approach to economics in the post; What is Science? My next post on Methodology will provide more details on how it is done.