Useful Economics

So Many Critics of Economics Miss What It Gets Right

At this point, blanket critiques of the economics discipline have been standardized to a refrain is getting stale.  Simply calling for humility and methodological diversity accomplishes little. A more constructive tone would be preferable.

Here’s what economics get right:

1). some theories that really work → can makes testable predictions that apply to other situations

a) auction theory, (relies on individual rationality), which predicts how buyers will bid for things like online ads or spectrum rights

e.g. Google auctions its advertisement space with a setup known as a generalized second-price auction (developed relatively recently by economists such as Hal Varian), which is based on game theory  →  predicting which types of auctions most reliably lead to profitable trades  →  crucial to the profits of online-services companies

b)  matching theory, (basically an algorithm for central planning), which started from game theory, with impact on resource allocation , has main practical application on entry level labor markets, and also has made it a lot easier to get an organ transplant

e.g. 2 new and influential applications in practice: School Choice + Kidney Exchange

c) random-utility discrete choice theory, (neoclassical), which is used in everything from marketing to transportation planning to disaster preparedness

e.g. In 1972, San Francisco introduced a new train. While the authorities predicted that 15% of area commuters would use the system, economist McFadden predicted that usage would be only 6.3%, very close to actual number 6.2%.  ←  the models were “random-utility discrete choice models”, the extensions of simple utility theory which have been applied in a huge number of areas (product development, pricing decisions, marketing, energy usage and environmental-impact studies)

d)  gravity models of trade, which have proven very successful at predicting the flow of international trade

== one of the most robust empirical finding in economics: bilateral trade between two countries is proportional to size, measured by GDP, and inversely proportional to the geographic distance between them.

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=>> prove that anyone who claims that econ theories will never be reliable, because they deal with human beings instead of atoms, is simply incorrect.

(however, most of useful theories are from micro economics, while macro economics that attracts more public attention is still looking for its first big success in predicting booms and busts, which is certainly a doom if they insist. The difference is what I have argued that the 2 systems observed are very different on their systematic characteristics and element robustness.)

 

2). economics is becoming a lot more empirical → focusing more on examining the data than on constructing yet more theories (Hamermesh (2013), and more recent research using machine-learning techniques)

スクリーンショット 2017-07-16 21.39.59

Without empirical support, we can’t really be confident that a theory is a good framework for thinking about the world.

(Some economists claim that the main point is to learn how to pick models into the right place. However, we will definitely find it hard to do this if we refuse to reject any of them and claim none of them are wrong but fits some specific situation. One situation is what noah said in How should theory and evidence relate to each other?, some economists, especially a lot of young, smart economists, “do empirical work, observe the results, and then make one structural model per paper to “explain” the empirical result they just found. These models are generally never used or seen again.” Another situation is what I have seen in today’s doctoral program, all the young students begin their paper from ‘I construct a model’, which is just a pro-forma model-making of the older “theory generation” (who are always their advisers).
=> economists in general are extremely reluctant to toss out any theories at all. econ needs to get more comfortable with the idea of killing theories. The final part of this blog has an excellent conclusion.)

2.1). empirical economics is becoming more directly and immediately relevant to policy matters, partly due to the “credibility revolution”

The quasi-experimental economics evaluates the results of policy experiments (Seattle’s recent minimum wage hike / European countries’ acceptance of refugees).
== Instead of relying on complex theory or unrealistic assumptions, quasi-experimental studies give immediate clear answers and find believable estimates of the effects about the results of government action
=> That won’t make economic theory obsolete, but it vastly increases the speed with which economists can give policy makers reliable feedback.

Drawbacks:
a) Quasi-experiments only give us local understanding of the world, not the kind of global understanding that we’d need for really big bold policy moves. In the long run, being able to deeply understand the economy will require working structural models)
b) Quasi-experiments usually must be found by luck rather than purposefully implemented, and even the ones that are purposefully implemented (lotteries, RCTs) are limited in the set of things they can study.
(e.g., studies pretty conclusively show that the minimum wage doesn’t destroy many jobs in the short run, but the idea that minimum wage constrains job growth over the long run is much harder to study using quasi-experiments.)

Update 2017/09/08

Is there really an empirical turn in economics?

 

3). free-market ideology is no longer the case.

= today’s star economists likely to fall on the left side of the political spectrum + economists in general are more pro-government than the general public on most issues

スクリーンショット 2017-07-16 21.53.56

When pop economists still use simplistic old ideas to justify laissez-faire policies, economists just don’t look very ideological anymore, replaced by nuance, moderation and complexity.

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Though “some economists still defend the idea that economic theory doesn’t need to make predictions in order to be useful, and instead merely has to give people a framework for thinking about the world”, I would prefer the following statement

“academics are working hard to make econ more scientific — to create reliable, applicable theories, to gather and understand new data, to provide rapid, useful feedback to policy makers, and to gain a more balanced and refined understanding of the economy.”

 

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