Where Economics Went Wrong

In a recent article, Lars Peter Hansen argues that the commonly used phrase “evidence-based policy” is misleading. He quotes Alfred Marshall in 1885:

The most reckless and treacherous of all theorists is he who professes to let facts and figures speak for themselves, who keeps in the background the part he has played, perhaps unconsciously, in selecting and grouping them.

The idea that public policy can be created using only objective scientific facts is prevalent in economics. Milton Friedman predicted the science of economics would eventually be able to definitively answer whether raising the minimum wage is good policy. Half a century later, hundreds of empirical economics papers purport to scientifically measure the effect of minimum wages, yet the policy debate rages on.

In their new book Where Economics Went Wrong, David Colander and Craig Freedman argue economics viewed purely as a scientific endeavor cannot answer policy questions. Instead, economists should return to their classical liberal roots and recognize economics as an art involving non-scientific judgment.

How Economics Got Here

Colander and Freedman characterize the evolution of economics during the 20th century as a gradual abandonment of classical liberal methodology. But what does it mean to follow a classical liberal methodology?

One exemplar of classical liberalism is Adam Smith. Smith taught and wrote books on moral philosophy, jurisprudence, and rhetoric in addition to economics. The Wealth of Nations is largely a work of history. Classical liberals took a holistic, self-aware approach to political economy. Data, math, and objective science alone do not lead directly to policy solutions. The tools of modern science need to be supplemented with fuzzier types of evidence, moral sensibilities, and judgments in order to say anything important.

In contrast, economics students today are taught more game theory, math, and statistics and less moral philosophy, history, literature, and institutional insight. Modern economics obsesses over proving mathematical theorems or obtaining statistically significant “results” from data.

As Alex Tabarrok put it,

I went into economics to prove capitalism was great but ended up proving if Σ is a compact, convex, nonempty subset of a finite-dimensional Euclidean space, & r : Σ ⇒ Σ a correspondence from Σ to Σ & if r(σ) is nonempty, convex and has a closed graph. Then r has a fixed point.

First-year economics graduate students today spend a lot of time worrying about fixed point theorems.

According to Colander and Freedman, during the 20th century, economists came to see their mission as discovering objective scientific facts that lead directly to policy conclusions. If we could just gather the right data or prove the right theorem, the correct answer to questions like the minimum wage would be evident:

Our concern in this book is not focused on which policy view is correct. Instead our interest lies in the manner in which the debate about those policy views should be conducted. Should it be primarily a debate about science, formal models, and statistical tests of empirical evidence? Or should it be primarily a debate about sensibilities and judgments that are informed, but not determined, by science? Our argument is that Classical Liberal support for the market was a precept upon which good economists could disagree. It was not a fundamental conclusion based on economic science. Although science and theory can provide some guidance about policy, resolution of such debates is not to be found in theory, but rather in vigorous "argumentation for the sake of heaven," a term that designates a process of cordial argumentation that attempts to seek out the best estimate of truth that is possible. It is not argumentation that focuses primarily on winning policy debates.

Classical liberalism does not close the door on discussion and disagreement. There is no modernist proof or objective scientific evidence that alone constitutes the end of the conversation.

Avoid the False Pretense of Knowledge

If we cannot create public policy solely out of objective, scientific facts, are we doomed to inaction? Of course not. As Hansen says:

Prudent and smart decisions don’t require full knowledge. They require that you assess the uncertainty and figure out its potential consequences. The uncertainty doesn’t mean that you simply cross your arms, close your eyes, and do nothing while you wait for complete certainty. In economics, you will be waiting a long time.

I have loaded much into the term “prudent,” however. Designing activist policy prescriptions on the basis of a false pretense of knowledge can indeed be harmful.

If modern economists actually practiced what they preached about modernist scientific methodology, they would never be able to make recommendations about public policy. To say anything of practical importance requires judgments and sensibilities beyond strict modernist science. Being aware and open about our nonscientific precepts allows the classical liberal discussion to continue and economics to advance.