Last year the Queen (Elizabeth II) visited the London School of Economics and took the opportunity to ask why nobody saw the financial crisis coming. Actually many people saw it coming, at least in principle if not the timing, and the Austrians have emerged with some credit because they provided a good explanation after the event, even if nobody took any notice beforehand.
You could draw a long bow and say that the classical/Austrian Hutt saw something coming when he read The General Theory, hot off the press, while his book Economists and the Public was in galleys. He managed to insert some brief comments in his own book, including the prediction that “The General Theory would have a quite unparallelled influence by reason of what I judged to be its demerits as a contribution to thought.”
As to the answer in 1993, this can be found in a book by Thomas Mayer, Truth Versus Precision in Economics, Edward Elgar, 1993. This is a detailed critique of the systemic failure in teaching economics along the lines that a major criterion of quality is mathematical rigor, and the leakage of that criterion out of “formal” economics (where he thought it might be defensible) into “empirical” economics and especially econometrics where it is not. Closely related to that is/was a deplorable lack of attention to practical/policy problems, and indeed rather little attention to theories in a broad sense, due to the focus on mathematical modellingbased on a specific data set rather than testing theories which is what scientists are supposed to do, at least some of the time.
This was going on despite widespread dissatisfaction among both students and faculty, but it seems that the Titanic of measuring, modelling and econometrics could not be easily diverted in its course. Of course that dissatisfaction has found expression in the vigorous and noisy movement of Heterdox Economics but this seems unlikely to make a difference any time soon, which is just as well because the Heterodox are no more helpful than the Autistic Economists who they abominate.
There was enough concern for the American Economics Association in 1988 to set up a commission on graduate education. According to Mayer a major concern of the Commission was the production of idiots savants. (That is the language of the Heterodox! Rather surprising in an official report of the AEA). He quoted the report’s concern with:
The extent to which graduate education in economics may have become too removed from real economic problems…the screening process poses substantial barriers to students who find elementary topology difficult but few barriers for students who cannot handle elementary undergraduate applied exercises in economics…The Commission’s fear is that graduate programs may be turning out a generation with too many idiots savants, skilled in technique but innocent of real economic issues.
One of the Commissioners, Alan Blinder wrote, regarding the findings:
Both students and faculty find economics obsessed with technique over substance…The impression I carried away from the many macro and micro theory exams the Commission examined is that they tested mathematical puzzle-solving ability, not substantive knowledge about economics…Only 14 per cent of the students report that their core courses put substantial emphasis on applying economic theory to real-world problems. This strikes me as a devastating critique.
That looks like a reasonable answer to the Queen. Blame the idiots savants! (The term idiot savant comes from the French for “learned idiot” or “knowledgeable idiot”)
A few links on the book. Summary. Publishers blurb. Abe books catalogue, I must have got the last affordable copy on the planet (second hand, out of Salford Uni Library).
Sounds like global warming climate modellers who refuse to accept that their models are not tools for prediction, and refuse to test them, yet still claim to be scientists
WhaleHunt Fun
22 Aug 12 at 9:40 pm
I have friends in engineering who say the same of their discipline, and it is definitely true in mine. Science and engineering are in a bad way in the west.
WhaleHunt Fun
22 Aug 12 at 9:43 pm
When engineers venture into the real world I think they tend to be careful because there are real costs if their structures fall down.
Poor Old Rafe
22 Aug 12 at 9:47 pm
Agreed. But there are real costs when economists get things wrong, but so often there is weaseling away and an explanation that it would have been worse if not for my having saved you.
WhaleHunt Fun
22 Aug 12 at 9:51 pm
Am enjoying Open Society and its Enemies. Fascinating to see the origins of so much of todays thought. In awe of whoever the guy was who read it in a weekend; must not have had anything else on.
Bit difficult with a six year old underfoot. Still, what are nights for?
Driftforge
22 Aug 12 at 10:02 pm
If you saw the financial crisis coming, would you tell anyone before or after you had finished trading on your own account and rebalancing your portfolio?
If someone told you that they see a financial crisis coming, but had not traded on their own account to rebalance their portfolios, would you believe them?
Central to the efficient markets hypothesis is the movement of financial prices are random and unpredictable.
• No one knows what will happen next, and there will be large and fast up and down movements in asset prices when new information arrives.
• Share price movements were like random walks – investors can never predict what new information might arise to change a share’s price.
Fama (1965) showed that distributions of stock returns are fat-tailed: there are far more outliers than would be expected from normal distributions – a fact reconfirmed in subsequent market episodes, including the recent crisis that displeased her Majesty. Academics in finance have been aware of the fat tails phenomenon in asset returns for about 50 years.
It’s tough to make predictions, especially about the future said Yogi Berra
Jim Rose
22 Aug 12 at 10:44 pm
Yeah well I saw a finance academic quip to a conference that the market didn’t stuff up, only the participants of the market.
Academics and finance analysts alike found that hard to swallow, that the whole could be exonerated but the parts could be guilty in toto.
Economics needs a more rigourous conceptual and mathematical outlook.
Very few graduates could design or go onto teach a new educational framwork like that.
I’m not strong enough mathematically I believe, but it has never hindered me at work.
However, I have never used a disequilibrium model, which I find highly realistic, unless adjustments are immediate and always correct.
Part of the problem is the theoretically and conceptual valid Austrians prefer to play some stupid game where nothing is validated empirically. I personally like a priorism. Now what if we have to measure the costs of regulation if the opponent is ideologically opposed to praxeology and laissez faire?
.
22 Aug 12 at 10:59 pm
As a non-economist, I think the answer to Her Majesty is : because the properties of the macroeconomic process are such that the crises are poorly predictable. Sounds like a tautology, I know. But it is similar to trying to predict a tornado. This is quite common for crises (catastrophs) of different nature. Just like trying to predict when a bubble will burst.
Boris
23 Aug 12 at 2:20 am
While Leigh Sales does a typical ABC feral attack on the opposition leader and says that nothing BHP quoted for their withdrawal from the big project in SA relates to the carbon tax or the mining surtax, this crisis was also very predictable.
One of the elephantine reasons is FWA – giving too much power back to the unions. BHP’s operations in QLD have been quite severely impacted, and when they say “financial reasons” now, it,s a mixture of all the dumb things the government has done plus market conditions.
Blogstrop
23 Aug 12 at 6:34 am
dot and Boris, the notion that the future is unpredictable comes from the fact that the future is the future. there are many unknowns in the future which may result in large, rapid adjustments when these unknowns become known.
Jim Rose
23 Aug 12 at 6:42 am
Mayer has the cart before the horse. From the Economist:
In praise of misfits
The idiot savants are being graduated because they are the ones who are attracted to spreadsheetville and work single mindedly on all those boring figures. Sort of like the opposite of Prince Harry.
Geeks like money too (speaking from personal experience). Modern finance and economics has led to a rise in salaries to juicy levels. You can buy a lot of clocks for a giant vampire squid modeller’s salary.
Bruce
23 Aug 12 at 7:18 am
People are sheep. Those who climb the pole are some of the most conformist. They tend to believe in some pantheon of gods above their pay grade: Murdoch, Greenspan, Buffet, Lay, Green, et al. They have no comprehension of the lacuna.
Big Jim
23 Aug 12 at 8:07 am
Mathematics is a symbolic language compressing thoughts into numerically manipulatable variables and factors.
The danger lies in using it as an end in itself to find oneself in a mathematical cul de sac that appears to be real but in reality isn’t. Most of science has stalled in this cul de sac at present, mainly because of the Platonic effect – that all who are stalled in the cul de sac agree that this “MUST” be reality.
In this sense the Austrians remain on the main thoroughfares while the Keynesians remain stalled in their virtual economies.
Louis Hissink
23 Aug 12 at 8:27 am
Friedman, Fama and Cootner argued that asset markets will select for rational investors, and that because of this selection, assets will eventually be priced efficiently. suppose traders use a variety of portfolio rules. traders whose rules are not rational will lose their money to those who do act as if they are rational.
According to Fama`A superior analyst is one whose gains over many periods of time are consistently greater than those of the market.’
If any group of traders was consistently better than average in forecasting stock prices, they would accumulate wealth and give their forecasts will carry greater and greater weight.
Alchian (1950) was aware of this too: ‘The pertinent requirement-positive profits through relative efficiency’. Positive profits accrue to those who are better than their actual competitors, even if the participants are ignorant, intelligent, skilful, etc.
The crucial element is as in a race, ‘the award goes to the relatively fastest, even if all the competitors loaf.’ the relatively fastest will in fact be profit maximizers, and so market selection will lead to the survival only of profit maximizing firms.
selection will tend to permit the survival of only those firms that either through good luck or great skill have managed to optimize their position and earn the normal profits necessary for survival.
Jim Rose
23 Aug 12 at 6:46 pm