Perhaps one of the more important benefits of the financial collapse and the economic depression is that it is forcing economists to re-examine their profession. Well, OK, some economists. And maybe not so much "examine" as just plain old internecine warfare.
Of which we get a good overview from Robert on The Angry Bear, who discusses the battle between "fresh water" (think Chicago) and "salt water" (think anything other than Chicago) macroeconomics.
Roughly Fresh water economists consider general equilibrium models with complete markets and symmetric information to be decent approximations to reality. Unless they are specifically studying bounded rationality they assume rational expectations, that everyone knows and has always known every conceivable conditional probability. I’ve only met one economists who claims to believe that people actually do have rational expectations (and I suspect he was joking). However, the fresh water view is that it usually must be assumed that people have rational expectations.
Over near the Great Lakes there is considerable investigation of models in which the market outcome is Pareto efficient, that is, it is asserted that recessions are optimal and that, if they could be prevented, it would be a mistake to prevent them.
Salt water macroeconomics is basically everything else with huge differences between people who attempt to conduct useful empirical research without using formal economic theory and people who note the fundamental theoretical importance of incomplete markets and of asymmetric information and of imperfect competition (as in everything you think you know about general equilibrium theory is known to be false if markets are incomplete or there is asymmetric information or there is imperfect competition – Market outcomes are generically constrained Pareto inefficient which means that everyone can be made better off by regulations imposed by regulators who don’t know anything not known to market participants who also just restrict economic activity and don’t introduce innovations like, say, unemployment insurance).
Leading fresh water macroeconomists include Robert Lucas, Ed Prescott Thomas Sargent, Lars Hansen, John Cochrane, Larry Jones, Robert Barro (mostly), and Kevin Murphy (usually). Leading salt water economists include Paul Samuelson, Edmund Malinvaud, Jacques Dreze, Joseph Stiglitz, Robert Solow, Paul Krugman, Andrei Shliefer, Olivier Blanchard, George Akerlof, Robert Hall, Ben Bernankle, N. Gregory Mankiw, Christina Romer, David Romer and, and Lawrence Summers. Brad DeLong is also a salt water economist and he is very very smart, but last I knew, he was a little too far out there to be really a member of the economists club. I can’t classify Paul Romer.
Now, this gives me some big problems, there is no way I am willing to put Mankiw on the same side of the room as Krugman. I don't claim to be an economist; I have no desire to be an economist; I just want to make people like Mankiw (who I have always thought of as a radical free marketer in the Chicago mold) either learn something about how us mere mortals have to struggle to make ends meet, or stfu. And it certainly says something that Brad DeLong is not considered a "member of the economists club." Too much interaction with the masses, perhaps?
Robert then observes that there has been a truce between the two bodies of water since the 1980s, even though the fresh water school holds the other body of water in complete contempt. All this Robert has crossed out, with an update stating that the truce has been broken, with a link to Krugman's recent post blasting the Chicago school for having imposed a "dark ages" on economics. More from Krugman, later, but first, the last paragraphs from Robert:
As far as I can tell, fresh water economists have some respect for some thinkers other than fresh water economists. I think they have rather a favorable view of mathematicians and Physicists. I think it would be useful of mathematicians and physicists to look into fresh water macro and express an opinion. On the other hand, in principle they have great respect for general equilibrium theory, but they don’t listen to general equilibrium theorists at all. Top general equilibrium theorists are all at least left of center politically, the closest David Cass could come to naming an exception is Ed Prescott who, he said, uses general equilibrium theory and studies examples (snort).
Finally I have a view of how people can devote so much effort to working out the implications of assumptions which almost no ordinary people would find other than nonsensical if they understood them. Fresh water economics uses difficult mathematical tools. Students in fresh water graduate programs have to learn a huge amount of math very fast. It is not possible to do so if one doesn't set aside all doubt as to the validity of the approach. Once the huge investment has been made it is psychologically difficult to decide that it was wasted. Hence the school gets new disciples by forcing students to follow extremely difficult courses. Last I hear very few graduate students at U Minnesota came from the USA. Undergrads over there know what the program is like. If my information is not out of date, innocents from abroad are the new blood of fresh water economics.
In A Dark Age of macroeconomics (wonkish), Krugman dismantles the economists who came out declaring that stimulus spending does no good because it crowds out private investment. After going through the macro-economic details showing where these stimulus critics go wrong, Krugman concludes;
So how is it possible that distinguished professors believe otherwise?
The answer, I think, is that we’re living in a Dark Age of macroeconomics. Remember, what defined the Dark Ages wasn’t the fact that they were primitive — the Bronze Age was primitive, too. What made the Dark Ages dark was the fact that so much knowledge had been lost, that so much known to the Greeks and Romans had been forgotten by the barbarian kingdoms that followed.
And that’s what seems to have happened to macroeconomics in much of the economics profession. The knowledge that S=I doesn’t imply the Treasury view — the general understanding that macroeconomics is more than supply and demand plus the quantity equation — somehow got lost in much of the profession. I’m tempted to go on and say something about being overrun by barbarians in the grip of an obscurantist faith, but I guess I won’t. Oh wait, I guess I just did.
Ouch. That's gotta hurt.
One final note. Yesterday Stirling Newberry wrote Fundamental Formalisms, in which he posits that there are actually four "formalisms" of economic knowledge: micro-, macro-, meso-, and mega-economics, "with the discipline of econometrics linking them." I won't claim to understand it all, but Newberry has been so consistently correct in his financial and economic prognosis so far ahead of the curve, that I believe it's always worthwhile to try and think through what he is attempting to explain.
The reason for going through this intellectual difficulty is entirely pragmatic: present pushing of strategic calculations into micro-economic terms, and forcing macro-economic policy to meet an illusory micro- equilibrium - more or less, cooking the books - with an unsustainable mega-trend line - more or less, ignoring that we can't pollute and drill for ever - is what lead to our current crisis. The failure to correctly compute and account for strategic equilibria has caused two of our most important financial meltdowns.
I suspect that like DeLong, Newberry is not accepted in the club, but I don't think there are many economists who regularly keep in view fundamental phsyical economic considerations such as "we can't pollute and drill for ever" to inform their larger world-view. (And the failure to keep this view is a big problem - fatal flaw, even - in formal economics, imho.)
On the cults of economics
"Fresh water economics uses difficult mathematical tools. Students in fresh water graduate programs have to learn a huge amount of math very fast. It is not possible to do so if one doesn't set aside all doubt as to the validity of the approach. Once the huge investment has been made it is psychologically difficult to decide that it was wasted."
This part I have firsthand experience with and it is very true, but the flip side may be even more important; namely, those students who are capable of doing the math but do not accept the basic assumptions, soon realize that they will have no future in the profession, and drop out. This leaves only the true believers behind -- and there is a great deal of money to be made by being a -shill- er, true believer.
BTW, Stirling Newberry is a composer. I am not sure that he has any formal training in economics at all; but his ideas are very interesting and he is a terrific writer. Don't forget, it was musicians who cracked the Japanese code in WW2!
what is with this math bashing????
Ya all, for full disclosure I happen to have an additional degree in mathematics and I have no idea why people are trying to bash a very useful branch of science.
Of course one can learn "fast amounts of math" and question the validity of the model. In fact, if they have had any real analysis, that's the whole damn point of mathematical proofs. The fact the Chicago school suffers from bad math, isn't objectively weighing their models does not mean math is bad.
In fact Stiglitz, Krugman, et. al, are using the same mathematics when arguing fundamentals and they are saying, in a nutshell, these guys are ignoring major assumptions.
But dealing with bounded conditions, quantities of unknowns etc. is all well known in mathematics and possible.
I postulate that economics undergraduates do not have enough mathematics and hence one gets inaccurate or flawed models.
I will take this Angry Bear post.
The fatal flaw in this post is the author believes the Ricardo model predicts some win-win equilibrium. This is false. So he attacks Ricardo model without understand the underlying mathematics behind it.
I am starting to think because others do not understand advanced mathematical concepts, proofs, modeling, probability and stochastic processes that somehow people are promoting an idea that all economic models based on mathematics are bad. Well, that's simply not the case.
it's not math bashing.
It's assumption bashing. You might be able to generate some elegant math from an earth-centered universe, but graduate physics students might not want to go into a career that requires that assumption.
raw data, statistical mean, i.e. assumptions
if they are not clearly stating them or using conditions when assumptions are incorrect....that too is bad math.
But I think people need to clarify the fact that there are three major components to a systems model.
Bad data (input in) = bad data (output out)
for software people this is garbage in = garbage out.
I pointed to Samuelson's paper just an example. In all seriousness...all he did was play around with some assumptions, some "input data" scenarios and came out with his result showing offshore outsourcing (or global wage arbitrage) is not always good for the more industrialized, stronger economy.
But it's really the same fundamental mathematical model...it's just that Mankiw/Bhagwati choose to ignore some critical data assumptions.
Ah, but I am a softwear person
And I recognize there are really two forms of input:
1. Model instructions
Or to put it in OOPS terms that any Macintosh user will recognize, the code fork and the data fork.
Bad input (garbage) on EITHER fork will yield garbage out.
I suspect strongly that the Chicago folks have corrupted both forks.
Maximum jobs, not maximum profits.
Wow, did you read my mind or something:
That has been my exact experience. I was a grad student 12 years ago and that is a big reason why I dropped out. Well, I was also a lazy, second-rate student who was unprepared for the rigors of graduate school. But then, if I hadn't felt the outright hostility of the orthodox (and mostly "fresh water) faculty and actually believed in what I was doing (I felt like an atheist in divinity school, it's something that's irreconcilable) I might have actually put in the effort.
"....under Capitalism, man exploits man. Under Communism it's just the opposite..."
---John Kenneth Galbraith
What he is referring to is a paper, and now they are in blogging wars on how Fema did not follow basic macro economic precepts, laws.
He is not blasting neoclassical or macro economics, he is using it in his argument.
Mankiw.....suffers from bad math. He believe outsourcing is good and with math, this is with the mathematics.
New York Times explaining in layman's terms.
Paul Samuelson's paper, Where Ricardo and Mill Rebut and Conﬁrm Arguments of Mainstream
Economists Supporting Globalization directly refutes Mankiw (in addition to Bhagwati)
the mathematics are spattered throughout but in a nutshell he says when the outsourced country has productivity gains through innovation that is enough to cause the other country to cut production, that 2nd country will lose in trade equilibrium.
i.e. not a win-win and it's some pretty simple math too. Samuelson is just using the model and plugging in a few scenarios.