Monday, March 05, 2007

It's More Important to Understand Than to Predict

Mark Thoma on his Blog, Economist’s View, 3 March discusses the dilemma that, allegedly, economics is not very good for forecasting (“Forecasting Recessions”) (at
He comments on the article by Daniel Gross in the New York Times: “The Forecast for the Forecasters Is Dismal” that kicked the discussion off and comments in his reply:

“The second use of models is to understand how the world works and this is, I hope, an area where we have done a bit better (though I expect that statement will be challenged). Even if we can't predict the future of the economy very well, that doesn't mean we can't use our understanding of the economy to design policies and institutions to minimize economic fluctuations.”

You must read the article by Daniel Gross, Mark Thoma’s studied reply and then trawl through the 32 comments on Thoma’s post, to get a flavour of what they are arguing about.

This is an interesting discussion (and quite a robust one at times). I would like to add a slightly different perspective as to what economics can do and what it cannot, for this goes to the heart of what Adam Smith was about in mid-18th-century Britain, and what was different from his approach in how political economy developed in the 19th century and beyond. I should add that I agree in principle with Mark Thoma’s assessment in the piece I quoted above, but with the caveat that I think neoclassical economics has not done very well in explaining what its policies should be for what has happened.

Modern neoclassical economics makes claims for the gold standard of it being a ‘hard’ science, similar to the natural sciences, compared to the softer social sciences. Its claims rest largely on its axiomatic foundations, using rationality in pursuit of self-interest as it passport to mathematical precision (Home economicus).

Adam Smith went about his task differently (though he was adept at mathematics according to reputable contemporary sources – professors of mathematics who conversed with him). He took a backward looking perspective of how society had evolved from hunting through shepherding and farming to commerce, and sought to explain that evolution up to limits of the contemporary knowledge of his day. Wealth Of Nations can be seen as a report of his inquiry into what wealth (‘riches’ in French) was and what caused wealth to grow, and what inhibited it from growing. He did not write a textbook, or a set of tools; he wrote a detailed account of what his inquiries showed.

Looking backwards, he did not predict the future; his mission was to explain how Europe evolved to where its component parts were in the second-half of the 18th century. He was not in the prediction business; but was in the explanation business. And this produced many policy recommendations, related to his fairly crude model of economic growth derived from his examination of the past growth of the economies for which he found data. Even his data was often indirect, as Samuel Fleischacker reminds us (‘On Adam Smith’s Wealth of Nations: a philosophical companion, Princeton).

The majority of modern economists do not study history, not even the history of economic theories, and having nothing to say about the past, or how the economies they study arrived where they are, they almost inevitably end up studying the future, or at least proclaiming their ability to do so. That they fail miserably in what they claim to be able to do (and some of them get paid enormous sums from corporations and get tremendous prestige from governments for taking jobs as forecasting advisors) is remarkable, given the historic results of their forecasts. Few if any do better than anybody could do by tossing a coin; sometimes a few of them ‘guess’ right, and win a prize; mostly they ‘guess’ wrong.

Admittedly, it’s better to be approximately right than absolutely wrong, but mostly they manage to be both approximately and absolutely wrong. The odd correct forecast is not proof of the ability of the discipline to forecast; as we are often reminded by mathematical economists, anecdote is not data. But history is data; it happened, sometimes many times, over and over again. If only the bright minds among economists had continued Smith’s example and sought to explain ‘why’ and ‘how’ it happened they way it did, given the many other ways economies could have evolved (using ‘dead-ends’ and disasters as the human parameters that limit the workable options), and society did it unaided, undirected and uncontrolled to the positions it now occupies among the many others it could have become, and economic science (allied to the other sciences, hard and soft) might be further along the road to understanding what is going on.

Be clear, economics can do no more than understand what has been and is going on. It cannot predict future states; it can discuss possibilities, but cannot say when this or that state will materialise, or whether it will. The more certain that people are who claim they know the future (e.g., the causes of climate change phenomenon), the less their credibility.

That’s my considered judgement from my study of Adam Smith and his contemporaries, and most of those who followed.


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