Streetwise Professor

May 17, 2014

The Dangers of Doing the History of Economic Thought by Watching YouTube

Filed under: Economics,History,Politics — The Professor @ 7:42 pm

In the continuous process of Bayesian updating, my estimation of Noah Smith’s sensibility went up when I read his post on high frequency trading: he too recognized the ambiguous effects of informed trading. But my estimation plunged today when I read this. The piece comparing economists new and old is silly, superficial, and truth be told, embarrassingly ignorant.

Smith’s basic thesis is that economists of the 60s and 70s were “policy scientists”, theoretical rather than empirical, and ideological rather than practical, with that ideology being pro-market and anti-government: conservative, in a word. In contrast, modern economists are engineers focused on predicting human behavior rather than trying to influence policy, relentlessly empirical rather than theoretical, and due to their more practical grounding, less ideological, more skeptical of markets, and more supportive of government intervention.

All of which is tripe, of course.

Smith’s exemplar of the 60s-70s economist is Milton Friedman. Smith’s views of Friedman are apparently based on YouTube videos: he refers to those, but not to one piece of Friedman’s professional work. If he had paid the slightest attention to that work, he would have realized that his characterization is completely at odds with reality.

Friedman was all about using economics to explain human behavior and the consequences of the interactions between individuals in market settings. He was, first and foremost, a scientist.

Yes, Friedman did theory. But as his famous (and controversial) essay “The Methodology of Positive Economics” demonstrates, he viewed empirical evidence as the ultimate arbiter: theories were only as good as the empirical validity of their predictions. The objective of theory is to explain practical things. What’s more, Friedman practiced what he preached. He did empirical work. Lots of it. His PhD thesis, on the income from professional practice, was empirical. His most important and influential work, A Monetary History of the United States, 888 pages (!) of empirical work, done back when empirical work was a true labor.

Moreover, Friedman’s theoretical efforts spawned massive amounts of empirical research, precisely as he desired. The most notable example of this is his work on the theory of the consumption function, which was motivated by the empirical failures of the Keynesian consumption theory.

Nor was Friedman alone. The great Gary Becker just passed away. Becker was all about using economic theory to explain an incredible range of human behavior. He made practical predictions that are as amazing and empirically valid as those of auction theory and random utility discrete choice which Smith cites with approval as representative of modern economics.

In fact, the 1960s and 1970s were a period during which neoclassical economics was developed and applied extensively to produce tremendous insights on a broad range of human behavior, including family and fertility, crime, and myriad other subjects.  It was first and foremost about explaining human behavior. To the extent these explanations had policy implications, some economists were not shy about pointing them out. But that was a side-effect of the main thrust of their inquiries.

And believe it or not, these basic microeconomic tools are still amazingly powerful today.

Indeed, part of the reason that these theories were powerful is that they showed the flaws in numerous policies. Anti-trust and regulation immediately come to mind.

In other words, many economists of this earlier generation-and most notably Friedman-were all about understanding and solving real-world problems. This is not something that came to economics in the last decade or two. Noah Smith grossly mischaracterizes, and arguably slanders, the giants on whose shoulders he stands.

Such is the danger of doing the history of economic thought based on YouTube videos.

Smith notes that a larger fraction of published research today is empirical. Friedman would not be surprised. As Smith notes, the  price of empirical research relative to theoretical research  has gone down due to computation costs and the availability of data sets, and any good price theorist would predict that this will lead to substitution towards empirical work.

There is a corollary to this. The value of the marginal regression will fall to its marginal cost. As that cost has gone to zero, so has the value of the marginal piece of empirical research.

Insofar as the politics and ideology of economics is concerned, to say that economics was  a “conservative science” in the middle of the 20th century is beyond delusional. In what alternate universe?

In the 60s and 70s in particular, economists were broadly in favor of government intervention: this had been true since the 1930s. This was the golden age of Market Failure Economics. In macro, Keynesian fine tuning reigned supreme. To say otherwise is completely ahistorical.

Friedman and other avowedly pro-market economists were the exception, rather than the rule.

There was a shift among economists towards more pro-market, anti-government attitudes in the late-70s and early-80s due to the marked empirical failure of Keynesian economics in macro, the theoretical and empirical work on the actual causes and effects of regulation, and Coase’s logical evisceration of the Pigouvian market failure paradigm. To the extent that the pendulum has swung back it is due to the financial crisis, just as the shift to pro-intervention among economists in the 30s and 40s reflected the impact of the Great Depression.

Smith remarks that the  most well known current public economist, Krugman, is liberal, whereas the most well-known public economist of the 60s and 70s was Friedman, a conservative. But here again Smith is making a fundamental error. Yes, Friedman was a public figure in the earlier era, but there were many more economists on the left that played the role of public intellectual: Paul Samuelson is the most notable of these. Friedman was again the exception. What is remarkable is that these other economists have faded from view, whereas Friedman lives on, as the YouTube vids that Smith mentions attest. Who will remember Krugman 40 years from now? I am betting that Friedman will be better known in 40 years than Krugman will be. For myriad reasons, professional and personal.

Smith’s biggest blind spot-and the above shows that there are many-relates to government, and specifically government failure. He mentions how information economics has identified additional sources of market failure. But he utterly neglects to mention how some economists-including many from that earlier generation-have identified how private arrangements can mitigate these problems, and completely overlooks the fact that government may not be able to ameliorate these failures, and may create failures of its own. (And by saying “may” I am being overgenerous.)

Again, an awareness of the insights of some of those “policy scientists” whom Smith denigrates would disabuse him of this error. Coase in particular comes to mind. He emphasized that any analysis of policy could not end with the identification of a market failure: that was at best a beginning. Any analysis has to make comparisons between real world alternatives, rather than conjuring a magical government solution. I would further note that Coase was relentlessly empirical. “The Theory of Social Cost” grew out of an analysis of how the Federal Trade Commission actually worked.

Smith characterizes modern economists as more practical and less ideological than those of an earlier generation. And lo!, they are also liberal and favorably disposed to government intervention.

Smith is probably right about the political leanings of modern economists, and the basis for those views. So much the worse for modern economics.

But he can only make favorable comparisons between the current generation and Milton Friedman and others of an earlier generation by completely distorting the professional work of Friedman and his contemporaries. Smith probably does this out of ignorance, but that is no excuse. Smith doesn’t know what he doesn’t know, and this leads him to denigrate unfairly the legacy of the earlier generation and exaggerate the virtues of his own.

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  1. Noah’s ruminations on the history of economic thought display a stunning lack of self-awareness. He’s badly in need of an internal editing filter that would run a minimum number of self-reflection checks.

    Comment by Anon — May 17, 2014 @ 8:59 pm

  2. Noah, along with Krugnuts, Stiglitz, DeLong and even Landsburg, are in dire need of reminding that:

    ““The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

    ― Friedrich von Hayek

    Comment by Methinks — May 18, 2014 @ 7:33 am

  3. > “even Landsburg”

    That’s a big question. Care to explain how come you put Landsburg in that list?

    Comment by Ivan — May 18, 2014 @ 7:49 am

  4. SWP,I’m out of the loop in your world of economics, academia, etc., so I don’t know this guy’s true impact. Just from the little I read while poking around this guy’s website, I find him to be a completely shallow thinker. Is he actually taken seriously out there? He seems like a typical progressive crank more than anything.

    Comment by Howard Roark — May 18, 2014 @ 8:26 am

  5. @Howard-good to hear from you. I would characterize him as a very green economist, recent U Michigan PhD, who hasn’t had time to establish a professional record but who has obtained a lot of influence-including influence in the profession-via Twitter (17.4K followers) and his blog. Quite a few other more established economists who have blogs link to him frequently. The particular piece that I slam has received a lot of attention, some of it favorable. It is for these reasons that I thought it worth an hour to slap it around a little.

    The history of economic thought is not a part of the curriculum in most PhD programs now, and plays a very marginal role in the profession. George Stigler was perhaps the last great mainstream economist who wrote extensively on the topic. That said, it is ridiculous that someone who purports to write seriously on the relatively recent history of economic thought is so obviously ignorant of the subject, but either doesn’t care or thinks he knows. (Of those two alternatives, hard to know which is worse.)

    The ProfessorComment by The Professor — May 18, 2014 @ 12:10 pm

  6. “But open and actual Econ 101 textbook – say, Greg Mankiw’s `Principles of Economics’ – and you’ll find a whole host of reasons why markets fail.”

    “A 2005 survey by economists Dan Klein and Charlotta Stern found that most economists favor government intervention in the economy in a wide range of areas, including income redistribution, minimum wage laws, environmental regulation, anti-discrimination laws, and others (and that was before the financial crisis!). They also found that economists are more likely to vote Democratic than Republican by a margin of 5 to 2. But even the Republican-voting economists tended to favor some amount of government intervention in all of these areas.”

    That’s strange, because if Mr. Smith would have gone to Chapter 2 of Mankiw’s text he would find a series of survey questions which directly refute the idea that “most economist favor government intervention in the economy in a wide range of areas.” Indeed, there is an 80%-90%+ consensus on the detrimental effects of rent controls, the minimum wage and deficit spending among other things. Surely, Mr. Smith would be aware of this chapter if he himself pointed us to Mankiw’s text, yet he chose to report only the findings of a survey which support his thesis. Is it just me or is this flirting with intellectual dishonesty?

    Comment by The Inked Economist — May 18, 2014 @ 2:38 pm

  7. @Ivan,

    Landsburg, who knows absolutely nothing about intermediation in financial markets and trading in general, has decided that HFT is social waste. He wants to implement regulations that slow down trading. Pure idiocy. I was as surprised as you. However, Steve does have a history of going off the rails sometimes. It’s all on his blog.

    Comment by Methinks — May 18, 2014 @ 3:51 pm

  8. @Streetwise Professor

    “The history of economic thought is not a part of the curriculum in most PhD programs now”

    And that is a very sad fact. In part this is why professional economists repeat the same mistakes over and over. Quite frankly, academic economists, with a few exceptions, are a sad lot. I’m sure you’ve had your share of frustrations in the academy.

    Comment by Methinks — May 18, 2014 @ 3:57 pm

  9. Your criticism brings to mind this post by John Taylor:

    I’m a fresh PhD too, but I wouldn’t spout off to 17k people about history of thought with only a YouTube education on the topic. Sounds like our friend is too big for his britches.

    Comment by Levi Russell — May 18, 2014 @ 9:47 pm

  10. The Krugman book’s ratio of government failure to market failure mentions is 0.00. I’m shocked! Shocked!

    The ProfessorComment by The Professor — May 19, 2014 @ 11:45 am

  11. Very sad. Krugnuts used to be an actual economist.

    Comment by Methinks — May 19, 2014 @ 5:36 pm

  12. @Methinks. Particularly sad because in Pop Internationalism Krugman actually discussed government failure at some length. But since he has become purely a polemicist, propagandist, and prog partisan, the concept of government failure has been consigned to the memory hole.

    The ProfessorComment by The Professor — May 19, 2014 @ 6:32 pm

  13. great piece

    Comment by Jeffrey Carter (@pointsnfigures) — May 21, 2014 @ 5:40 am

  14. I couldn’t imagine calling the 1960s either an era of theoretical economics or an era dominated by conservative economists. JFK brought so many Harvard men (read: “liberals”) into his administration that Harvard was called the “fourth branch of government”. They increased spending and decided that they could use fiscal policy to fine tune the economy. (Remember the income surtax in the Johnson administration?) The Phillips curve was taught as fact. DRI built a computer model that they thought could be used to run the US economy. A friend of mine did his PhD at Minnesota about adding a few equations to that model. (He learned the error of his ways later.) A few years later, all ended poorly and we entered the 1970s with stagflation. How can an economist be so ignorant of the dominance of liberal, or central planning, economics of the 1960s and 70s and the destruction it wrought?

    Comment by Highgamma — May 21, 2014 @ 1:47 pm

  15. @Highgamma. You are spot on. Chicago was always scornful of the Cambridge-DC conveyor belt. Big Model Macro was such a joke. This is exactly what Friedman, and then Lucas, destroyed. But what really destroyed it was stagflation, as you note. Friedman & Lucas explained why BMM missed that.

    Sadly, this episode has been largely consigned to the Memory Hole. The ignorance you mention is epidemic, a few old f*cks like me excepted. And I’m not in macro, so it’s not like it matters.

    The ProfessorComment by The Professor — May 21, 2014 @ 2:32 pm

  16. You know what is really amazing, and depressing? The Fed *still* relies on the Phillips Curve. Unbelievable.

    The ProfessorComment by The Professor — May 21, 2014 @ 4:56 pm

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