An interesting test to appreciate how academic methods would fare was conducted Spyros Makridakis. He made people forecast in real life and then judged their accuracy. The last test was held in 1999. Makridakis, with the assistance of one Michele Hibon, reached the conclusion that ‘statistically sophisticated’ or complex methods do not necessarily provide more accurate forecasts than simpler ones.
Like a few previous blogs on this page have led me to conclude, the outcome of this simple study seeks to grossly undermine what mathematical economics seems to be about. For the sake of clarity, what is this critique? It follows that economics falls short of being able to efficiently carry out its key function of forecasting; this is primarily thought to be due to the inability of econometrics to capture the dynamism of a modern society.
However, as an apt reply to the previous post of the ‘impairments’ of economics, it is perhaps necessary to reflect on some particularly unqualified strand of thinking surrounding the issue. After all, the studies of economics have been built around a basic narrative of how we think and are not meant to be taken as a directive for action.
The first renowned example to touch upon is the Lucas critique (after the economics Robert Lucas) which voices that forecast may not be always accurate the way we see it due to reactionary events that follow an asserted prediction. It is said the perhaps forecasters create feedback which cancels their effect. To quote Taleb on this, ‘Let’s say economists predict inflation; in response to these expectations the Federal Reserve acts to lower inflation.’ So you cannot judge forecast accuracy in economics as with other areas of study as the world is far to complex for this discipline. One way to apply this right now, today, can be the topic of a looming U.S. recession in the coming two years by way of the bond-yield inversion. Forecasters say, concerning similar past sequential events, that this inversion signposts a lack of confidence in the economy and thus threatens a collapse. But we may think, upon acknowledging this news, financial institutions may adapt. In any which way they may pursue a course of action, such as hiring more analysts to innovate for the firm, that would impossible for an expert beforehand to see. Granted, there may be a flaw in this thinking; it assumes that all such predictions will have this reactionary response, thus derailing the prediction, but this is not the case for some 90% of predictions. Hence, this may seem like a ‘mere excuse’ for these failures, but nonetheless, it can contextualise the basis upon which one may argue economic flaws are beyond the study’s call.
As claimed by Keen in his book ‘Debunking Economics’, he reminds us that economics is often compared to meteorology; in that it shares a fundamental raison d’être to understand a complex system. I agree. Where he diverts from realistic statements, however, is in adding that the economy would exist with or without economics, just as the climate would exist with or without weather forecasts. A popularly foregone thought in such writers is that economics is a social discipline and so what we believe about economics does have an invisible impact on human society. Consequently, as far I as can see, any critic of economics must remind themselves that in the absence of such a science, society would collapse much more profoundly than at the hands of a mistaken prediction.
One argument celebrated by those yearning to debunk economics is that it misunderstands human nature. As I have referred to several timed, economics wrongly predicates its study on the assumption of human rationality. However, we may reply, in fact, by asking what are we actually like. To say that we are self-interested hedonistic creatures are becoming ever-increasingly naive and ignorant. After all, society nowadays is drawn to being communitarian about issues that are disproportionately affecting some geographical locations more than others, namely climate change. To an extent, the human tendency to unite as a society is well assumed in economics, for example when it suggests we all act likewise to one another in economic transactions. Thus, this view of a utilitarian, individual – pleasure-seeking society does not seem to be so coherent with the society since utility can be seen as less subjective; it seems economic theory is, in fact, closer than ever before to mimicking the interactions of our world.
As a concluding statement, it needs to be clarified that economics, in its entirety, is an abstract theory. After all, any development in economics would be the complex long-sighted outcome of changes in psychology and mathematical methods. This short paper has, on top of looking at reasons why economic forecasting may be as bad as it, sought to contradict some unqualified critiques of the subject. The biggest failure factor for economics is humans. As seen already, we have a love for certainty which plagues our interpretation of the complex laws presented; thus, critiquing the theory may not be as worthwhile as developing an understanding of how the theory pans out. Who knows? This basic approach to human rationality may be a far better representation of us in the distant future.
Economics Relate 