The problem of economics

There are a few problems that I have with economics. Keep in mind that I am not an economist. I am a pure mathematician (meaning that I study maths abstractly and for its own sake, as opposed to applied mathematics, which is the study of how to use pure maths to describe the empirical world), but I am familiar with empirical science (more specifically, physics). So, take that background into account, for good and bad, with what I will now say.

Economists use silly variables when analysing real economies.

Or perhaps ‘silly’ is the wrong word. However, the point remains that many statements by economists, especially when they are talking as political pundits, are incredibly misleading, because the variables which they use tell only a small part of the picture. For example, one could look at the Dow Jones to see how the economy is doing, and say that if the DJ is up, the economy is up. Similar statements can be made with the GNP or GDP. However, just because these numbers are up does not mean that the ordinary member of society is better off. The DJ could go up, but perhaps the majority of people actually lost money.

There are attempts to analyse the income inequality in a society, such as the Gini index. Unfortunately, these are rarely discussed by political pundits. The general assumption seems to be that if the economy is larger, it is automatically better, even if most people are suffering.

Another example of a silly variable would be unemployment. Under Obama, unemployment went down significantly, which sounds impressive, until it is observed that a person only counts as ‘unemployed’ if they have only been out of work for a fairly short time. Thus, people who have spent many months looking for a job are not considered unemployed. In other words, the ‘operative definition’ of unemployment which was used for this statistic is not a good one; it does not catch all the people we would normally consider unemployed (i.e. all the people who want a job but do not have one).

Economic models suck

Economic models invariably suck, although some are better than others. There are several reasons for this.

One of the first is that they rely upon assumptions which are, at best, unproven, and at worst, ridiculous. To give an example that is not strictly economic, but which is related: I received my phD in maths a few years ago, but continue to collaborate with my advisor. He told me a side project he started, trying to figure out the ‘optimal grading system,’ to encourage students to study. This sounds like a fine idea, but when he started telling me details, his system relied on the assumption that 1. higher GPA correlates with higher salary after graduation (it might, but does anyone really know how it correlates?), and that 2. students would be motivated by the ‘future value of current study time,’ meaning their motivation to study would be that more studying would mean a higher grade meaning mroe money in the future – and that they would be able to approximately calculate this! Now, many students may not be motivated by money. Many students, even if they are motivated by money, are likely to have no idea what the ‘future value of current study time’ might be, and even if they did, they might ignore it, because students (like most humans) are not entirely rational. If all of your friends are going out to party, you’re probably going to go along, future value of study time be damned.

This example was not strictly about economics, but it a sense it was, if we think of the grades as an economic good. When we look at models of the real economy, however, we find similar wild assumption running rampant. An example is the Laffer curve (Laffer, Arthur. “The Laffer Curve: Past, Present, and Future”. The Heritage Foundation.). The Laffer curve descrives the revenue that a government will receive in taxes as a function of the tax rate. Here is the problem: there is not just one Laffer curve! Any nonnegative curve which is 0 at 0% and 0 at 100% qualifies as a Laffer curve. What shape the curve has, where its maximum might lie, these are not known. So if an economist wants to figure out where the maximum revenue is, first she has to invent a Laffer curve and justify it. But there is no consensus as to what a realistic Laffer curve might be.

Economics is too complex to model

The economy is probably not a chaotic system like the weather (in normal systems, small changes to initial conditions result in small changes to the outcome: throwing a ball a little harder makes it go a little further; in chaotic systems, a small change can result in a drastically different outcome, as if throwing the ball a little harder suddenly made it go a completely different distance). But it is still complicated, with many variables, many of which are probably in practice impossible to determine. (As an aside: the Jurassic Park scene describing chaos theory was wrong on many levels, including physics: the first drop of water might go down the hand in a random direction, but it will leave a trail of moisture. The second drop will follow this trail, due to surface tension).

Thus, any economic model that can be used in practice is going to suffer from vast oversimplification. And in fact, it may be inherently indeterministic anyway, depending upon one’s philosophical outlook.

We see the lack of ability to model economics repeatedly. Although many economists are fairly good at making predictions in some cases (this is how people make money in stocks), they can miss something as big as the 2008 housing bubble.

Economics is probably a little better than I have painted it here. However, popularized economics certainly is not.

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