Is economics an empirical science ?

Tyler Cowen[1] lists a number of economic propositions which he formerly believed, but has abandoned in the light of contrary evidence. Most of these propositions were elements of the economic orthodoxy of the 1980s and 1990s, variously referred to as Thatcherism, neoliberalism, the Washington consensus and, in Australia, economic rationalism. They include the efficacy of monetary targeting, the beneficence of free capital movements and the desirability of privatisation in transition economies.

Following in the same spirit, I thought I’d list a couple of propositions on which I’ve changed my mind in the face of empirical evidence. These are elements of the Keynesian orthodoxy of the 1950s and 1960s, on which I was trained. Following Cowen, I’ll list them as false claims I used to believe

* There is a long-run trade-off between unemployment and inflation

* Keynesian fiscal policy is a powerful and reliable instrument for stabilising aggregate demand

On both these issues, I’ve come to accept that Milton Friedman was largely right, and his Keynesian opponents largely wrong.

On the first, I think Friedman’s victory was total, although the supposed implication that there exists a “natural rate” of unemployment at which inflation remains stable has proved equally unreliable.

On the second, Friedman was absolutely right in talking about “long and variable lags” and rejecting the idea that it is possible to “fine-tune” the economy. This doesn’t mean that fiscal policy is of no value. In particular, the fact that budgets naturally go into deficit when the economy turns down provides a measure of automatic stabilisation. And when a deep recession lasts for more than, say, a year, there’s time to bring discretionary fiscal policy into play. The suggestion, by Nick Gruen and others, of some form of independent body to manage discretionary fiscal policy, analogous to that of the Reserve Bank in monetary policy, has a lot of appeal for me. Still, this is a long way from the kind of mechanical Keynesianism I was taught a few decades ago.

Combining my concessions and Tyler Cowen’s, it’s evident that there is some process of convergence in the beliefs of economists, though with a lot of oscillation. The breakdown of Keynesian economic management during the crisis of the 1970s, and the general ‘fiscal crisis of the state’ that occurred at the same time, validated many of the criticisms made by Friedman and others of the Keynesian and social-democratic orthodoxy of the postwar period. But it produced an overreaction, most notably in the extreme claims made by advocates of rational expectations macroeconomics, but also in overblown claims about the merits of privatisation and deregulation. These have gradually lost favour as their empirical weakness has been exposed by events.

fn1. Jason Soon has also noted this piece

29 thoughts on “Is economics an empirical science ?

  1. I can’t pretend, as an arts/humanities scholar, to offer as much knowledge as some of your regulars. After dabbling with a bit of economics and economic history in my degree, I abandoned much interest in it after Friedmanism took hold.

    I didn’t have much faith in a system that transparently favoured the rich and powerful. Even that was a bit unfair. Many modern economists would say that it was misused by the powers that be. Still, the fact remains that beyond Galbraith and Kenneth Davidson, most economists could not grab my attention.

    I am encouraged, John, that you can recognize the limits and flaws in Keynesianism. I have had trouble shaking them off myself because of the humanism inherent in it. I think it takes real courage and open enquiry to realize something you’d believed in strongly had flaws.

    I’d like to see that sort of openness in the advocates of the new system. Such as, are we in a position to measure the benefits and costs of privatisation against state entities? Is competition or ‘the market’ necessarily the most desirable thing in all circumstances?

    Should we be taking human nature more into account when considering some of these models? eg, the allocation of resources (eg Bond acquiring Nine;Pay TV licence bidding) will not necessarily go to the most efficient but often to the most reckless.

    I think also of Marxism/communism in this regard. The farming collectives seemed like a more efficient way of allocating resources, but the system went so much against human nature wanting to grow his/her own product from owned land, that they became a liability.

    What happened to Savings and Loans societies in the 80s in the USA seems to me a strong argument against unfettered deregulation. And with the State Banks here, you could argue that prudential regulation would’ve been more effective than ‘disciplines of the marketplace’ which is where Federal Treasury wanted to go.

    I’m not sure if it is a science. However, like science there ought to be a continuum of learning.
    What seemed to occur here in the 80s and 90s (still?) was that everything, including our history was tossed out as irrelevant to the new system. That struck me as anti-learning.

    There ought to be ways of threading all systems together. In this respect literature is useful.

    When I reread Dickens’ “Hard Times” a few years ago, I was startled by the resemblance between the ‘men of facts’ of the 1850s and the economic rationalists of today. Trying to get people to conform to economic, social or political theory seems to be the wrong way of doing things.

  2. JQ,
    I think to say the Keynesian times of the 70′ is a bit misleading.
    My reading of most of Keynes particularly The general Theory would have had him criticising Governments for runing deficits in the good times when he would have expected them to run surpluses.

    totally agree on your two main points.

  3. I’m not that sure there is no tradeoff between inflation and unemployment at all. Akerlof, Dickens and Perry have a paper in which they present a model in which there is a tradeoff between inflation and unemployment at very low levels of inflation, making zero inflation bad policy. I think their idea makes sense. While this is far from the beliefs of dinosaur Keynsianism, it still goes against what Friedman wrote.

  4. It is nice to see the proposal to try to develop independent fiscal policy institutions, along the lines of monetary policy institutions staying on the radar screen. Alan Blinder mentioned it a few weeks ago at a conference of the Federal Reserve in Boston (including mention of its Australian incarnation via the BCA Paper). It got a similar mention in a major think piece by CESifo commissioned by the OECD recently. This was reported by Alan Kay in the Financial Times at (email me for either or both papers). The OECD also showed some interest in the BCA paper when it was first published and written up in The Economist. And the book ‘Imagining Australia’ which was only launched on the weekend mentions it as one of four proposals to “strengthen our institutions and the macro economy”. (I think an extract was in this Weekend’s Australian, but I don’t have the link).

    Pleased to see you like it John, I didn’t know if you would. Those who instinctively favour active fiscal policy often see constraints on fiscal policy (in the name of fiscal responsibility) as constraints on flexibility. The debate on fiscal flexibility itself is often seen as one between those arguing for fiscal responsibility and those arguing for fiscal flexibility – which is usually code for fiscal expansion. The dichotomy is silly of course, and the idea of developing our fiscal institutions along the lines of monetary policy is based on the idea that fiscal responsibility is a precondition for fiscal flexibility. Clearly party politics has difficulty delivering this, and so the idea is to build out institutions as we have with monetary policy – where we have improved our management of a very similar tradeoff. Ideally more independence in monetary policy improves monetary responsibility, and in purchasing credibility enhances flexibility.

  5. Quick comment on convergence in economics… I’m not sure if it’s true. I agree that there is convergence on ideas that have been out and debated for a while… but this is countered by the growth of new ideas in economics. Much like any market, it seems that there is a constant battle between the incentives towards equilibrium and new innovation – making sure we’re in a constant state of evolving disequilibrium.

    No point me listing what I’ve changed my mind on – would be too long. My views have moved from nationalism, protectionism and rabid social conservativism to being an international free trading near-anarchist! 🙂

  6. Prof Q,

    This is perhaps a bit OTT, but I always think your best blogging is when you write about economics. Within Ozplogistan, that’s where your comparative advantage lies (not making any judgements on absolute advantage!). More economic commentary please!


  7. “Consensus can be reached on specific issues, but consensus for a research area as a whole is equivalent to stagnation, irrelevance and death.”

    – Robert E. Lucas, Jr, March 1993.

  8. re George;’s Lucas quote
    we have enough disagreements as it is among economists. if we can’t reach consensus on some issues we might as well give up the game and move into the English department.
    does the quote mean that physics, chemistry and biology are stagnant, irrelevant and dead?

  9. I don’t like the idea of an unaccountable fiscal policy board, raising and lowering taxes. Tax policy has immediate and direct distributional consequences. In fact, the level and pattern of taxation is part of society’s revealed preference in social welfare functions. Consequently, tax policy ought never to be a matter for unaccountable technocrats.

    You might argue that the fiscal policy board would only have control at the margins – for example by raising and lowering a special ‘economic management levy’, with the bulk of the tax system outside their purview. This gets rid of some of the problem, but at the cost of rendering the board nugatory – any government can easily (and in inflationary times, almost invisibly) offset the board’s policy with their own preferred policy.

  10. DD, Firstly, the board is only ever likely to have any influence at the margin. Its hard to see it doing anything else unless the government is hugely irresponsible. If so, is it appropriate not to have some constitutional constraints on the wrecking of a country’s fiscal institutions by one generation? Would we have the same attitude to monetary institutions?

    Presumably you wouldn’t have a problem with a board with advisory power only – leading to the question of where one draws the line. What about a board that set the stance of fiscal policy – by raising or lowering taxes across the board – subject to being overruled by the Govt or the Parliament of the day.

  11. Oops. The last post was less self serving than intended. My browser told me I was posting a comment on Brad Delong’s weblog! Or I thought it was. Of course had I used an alias, this vigorous agreement with myself would have been more convincing! Having used my own name, I have to confess.

  12. Stupid is as stupid does.

    My momma thought some feller Keynes said we were all slaves to the ideas of some economist of yesteryear ‘n all … or something like that.

    When you play football you play in the position where you can do your best. Convergence is not an option, unless you’re going to tackle someone with a team mate. But if you’re tacklin’, you’re not taking the ball forward. That’s also why there is only every one quarterback on a side, one Picasso, and one Jesus. Someone crazy-brave like.

    Who is today’s Jesus quarterback? They won’t be known, by acclaim, until tomorrow or the next Nobel Prize. Until then, we all have to live with today’s economic soothsayers.

    I sometimes think we have a religion here rather than a profession. There’s a power of faith in ideas and a great deal of fear of empiricism. Is it all simply sand castles in the mind, washed away on the next tide of rational economic opinion?

    Economics should be a quest for the truth by all people, not a closed talking shop subject to bounded rationality.

    The truth shall set y’all free.

  13. Sorry, I thought the empiricism was the point. Does the world behave more predictably if the levers are pulled according to certain coherent propositions?

    Isn’t the claim about economics that there is an internal mathematics which works to explain the real world? Consistently functioning quantitative terms?

    Otherwise it is just history, sociology and the operation of power.

  14. John:

    The naïve trade-off theory has been ritually demolished in undergraduate textbooks for twenty-five years, but I’m not sure who actually subscribed to it or for how long. Keynes of course never advanced anything of the kind, and nor did Phillips himself. Samuelson and Solow made some conjectures about it in about 1960, but a 1972 survey of the terrain by James Tobin, the archetypal post-war Keynesian, is all about complexities and doubts.

    You write as though there were agreement that there is an identifiable, threshold unemployment rate – call it full employment, the natural rate or whatever – below which inflation is set off, and that the crucial point of disagreement is just whether this inflation will be stable or accelerating. But this is hardly the case. The crucial questions have always been: What is full employment? How can we identify the lowest sustainable rate? What institutional structures contribute to inflation, and how can these be modified to get more people permanently in work?

    Inertial or self-fuelling inflation is of course an important phenomenon, but it’s ridiculous to suggest that the question of how big its role is has been a major fault line in macroeconomic thinking. As for Friedman, he certainly deserves credit for putting a spotlight on expectations. But he performed an equally important disservice by infecting macroeconomics with the natural rate fixation.

    I know you want to show the world that you are capable of admitting error, but you already did that more than adequately in that famous post repudiating your life-long insistence on leniency towards career criminals and standover men. A man who braves the wrath of Neddy Smith doesn’t need to prove his valour by beating up straw Keynesians.

  15. James, I think your history is pretty much right. The naive trade-off theory was only dominant from the mid-60s to the early 70s.

    But that was when I first learnt economics, so I had the trade-off taught as established fact, and experienced its demolition with full force.

  16. If I am following this correctly a fiscal policy unit would have some reserve power to request that the government of the day raise taxes or lower expenditure to ensure that the knife edge of government stimulation of growth doesn’t lead to inflation albeit a blunt instrument working at the edges/ providing a check and balance to government dreams of grandeur.

    Now it’s my understanding that without the additional spending/taxing by government the economy would inevitably go into a tailspin as capital accumulated in the hands of fewer and fewer and consequently became less and less productive.(feel free to criticise this simplistic notion)

    I grew up in Canberra which of course made me a committed DURD Marxist. These days I’m much more radical.

    I’d happily settle for a free market if it could be shown to be sustainable, but fiscal policy units notwithstanding, free markets seem to be plagued by boom bust cycles and they are posited upon the existence of infinite growth of consumption which makes little sense in a finite world.

    Innovation is usually put forward as the raison d’etre of free markets leading to growth from new inventions etc. But this begs the question as to the limits to growth, especially to reproductive (renewable) resources. Whilst innovation has bought some transitory benefits in the areas of agriculture (we’ve learnt how to mine soil), the distribution of wealth is becoming more not less equal which is being exacerbated by the increasing pressure of population on finite sources of arable land etc. etc.

    I don’t think that the supply of oil is half as much a problem as the supply of food, firewood , and water for instance.

    The problem with economics IMHO is that it is still in thrall to a ‘Marxist’ conception of production as the be all and end all of economic activity.

    I agree that we need to corral and balance the energy of the free market with instutions without limiting the freedom of individuals to make an independent living.

    If we want to think sustainably about this we should be thinking about how our children benefit from our wealth. But in my experience the wealth of a childs parents is not the sole or even main arbiter of a childs wealth or happiness.

    What matters more is how people spend their time.

    Thinking about time and reproduction may seem to be too theoretical a way of discussing ecomic management but it is still amenable to empirical argument.

    Germaine Greer once made the observation that in the Mughal Empire land was owned by farmers and the general populace as an individual asset that could be traded at will but title still reside in the Crown(the Emporer). But the landowner in return was required to give the Emporer 2 days work a year. As she observed, the system worked for hundreds of years by providing labour to carry out public works etc. When the British conquered India they immediately put a monetary value on the land and within a few years the system had collapsed and the public value that it provided was lost forever.

  17. I marked a batch of 2nd year University essays in June in which the students had to critically examine the proposition that competitive contracting out of public sector services always leads to better results at lower cost than in-house provision, with reference to real-world cases.

    The interesting thing is that all those students who did what the essay question asked, and looked at a range of actual cases, concluded that the hypothesis was falsified by at least some cases.

    Some of the students obviously came at the problem under the influence of contemporary neo-liberal orthodoxy, but nonetheless were obliged by consideration of the facts to concede that there were limit cases where contracting out would not work, even though they continued to assert a general preference for it. Other students whose predispositions were social-democratic or further left had great fun discussing cases beyond the limit cases. All of these students did the essay very well and most Distinctions or High Distinctions.

    There were two particularly bad essays, which basically did not examine the hypothesis in relation to real world cases. These students thought that it was sufficient to show that the hypothesis was deducible from neo-liberal premises which were assumed to be axiomatic. One did not consider real-world cases at all, whilst the other only briefly descended from the abstract to the concrete for a distressingly ill-informed reference to Queensland’s ambulance levy. What was most striking about both these essays was the students’ apparent inability to even imagine that neo-liberal assumptions might be wrong, or that an hypothesis derived from them needed to be tested empirically to determine its validity.

    Then again, an hegemonic ideology, by definition, is one which people cannot even imagine being wrong.

  18. Thanks for that, Paul. I feared that what you have outlined might have been the case upon examination (re outsourcing).

    I guess the most encouraging thing is that most students were able to look beyond the dogma for empirical evidence.

  19. Economics is most definitely not an empirically verifiable and falsifiable science although some bits of it may be scientifically useful.

    How could it be when its basic premises are hopelessly reductionist in the bad sense of the word – they reduce the complexity of reality to a crude soup of vague assumptions.

    Take the three tenets of classical economic theory: land, labour and capital. What’s wrong with this picture? It’s left out the complex dimension of human motivation. No economy exists or functions without human motivation. And what about the realm of ideas as factors of production? The invention of various machines and techniques that make the other factors work together – these come from ideas (history, culture) and are often not accounted for in the monetary system.

  20. John wrote:
    “But that was when I first learnt economics, so I had the trade-off taught as established fact, and experienced its demolition with full force.”

    Pretty much confirms Deidre/Donald McCloskey’s observation:

    “The ‘theory’ [taught in economics departments] is focused on proof, a quite unscientific obsession taken from the Math Deptment (not from the Physics or Engineering departments). It is puerile. What is worse, it becomes obsolete quickly — not because of scientific advances but because of scientific fashions. The half-life of the so-called ‘theory’ you .. suffer through in the first year [of graduate school] is five years in macro and a maximum of ten in micro.”

  21. “does the quote mean that physics, chemistry and biology are stagnant, irrelevant and dead?”

    While I don’t know enough about chemistry, there are quite some controversies in biology and physics.

    On the McCloskey quote: I’m not that knowledgable of macro but it seems that game theory and general equilibrium theory have survived for a little bit longer than ten years. McCloskeys own example, linear programming models of production, are still the basis of the theory of the firm in general equilibrium theory. For some strange reason McCloskey thinks partial eqilibrium analysis works, but general equilibrium analysis doesn’t. Nevermind the conflict wth logic.

  22. When my bunsen-burning friends seek to taunt me by claiming that economics is not a “real” science, my flip response is “Of course not! It would be a waste of scarce, high value resources to restrict economists to analysing that narrow range of matters that can be assessed using scientific procedures alone.”

  23. Micheal
    Maybe there should be three classifications in Economics:
    Classical for those concepts which have stood the test of time, and then the the other two, (nameless of course, because of their shameful performance) for those which fall within McCloskey’s diatribe.

  24. I’m not sure Keynes was in favour of running budget deficits in times of economic boom. I thought he proposed “pump priming” in times of recession or high unemployment, not the opposite. I think it is a myth, partly the result of careless (yet well-meaning) Keynesian fiscal policies, and attempts by right-wing and neoclassical economists to characterise Keynesian economics as undisciplined. In any case, governments must have sensible policies and should avoid getting caught up in ideological questions of efficiency or the free market. Privatisation and deregulation might make sense from the point of view of increasing efficiency (and this in itself is, I think, dubious) but disregards the sound reasons for public ownership and a regulated financial system, namely that they are in the interests of the public in that they act as a lever on the activities of the private sector in what are vital economic matters.

  25. I’m not sure Keynes was in favour of running budget deficits in times of economic boom. I thought he proposed “pump priming” in times of recession or high unemployment, not the opposite. I think it is a myth, partly the result of careless (yet well-meaning) Keynesian fiscal policies, and attempts by right-wing and neoclassical economists to characterise Keynesian economics as undisciplined. In any case, governments must have sensible policies and should avoid getting caught up in ideological questions of efficiency or the free market. Privatisation and deregulation might make sense from the point of view of increasing efficiency (and this in itself is, I think, dubious) but disregards the sound reasons for public ownership and a regulated financial system, namely that they are in the interests of the public in that they act as a lever on the activities of the private sector in what are vital economic matters.

  26. Is Economics an Empirical Science?
    From 1987 till 1989 I drank beer full time only to stop for the occasional exam. When this indolent life ended I found I had graduated from Uni with

  27. Negative gearing is not the problem
    In today’s AFR John Quiggin argues that one source of savings from which Mark Latham could pay for policy initiatives would be the abolition of negative gearing. In passing John also blames negative gearing in part for the housing boom….

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