Wednesday, October 29, 2008

Economics Needs a Scientific Revolution

Continuing my argument on why economics isn't physics (or in the earlier case, why economics will never be like physics), this is such a delicious essay written by Jean-Philippe Bouchaud, head of research of Capital Fund Management and a physics professor at cole Polytechnique in France. The essay appeared in the Oct. 30 issue of Nature.

In the essay, he argued that economists have somehow adopted assumptions into axioms. He illustrated this in a number of ways. I'm trying very hard not to quote almost the whole essay, because it is THAT good, but I'll quote the very pertinent paragraphs that should be of interest:

Classical economics is built on very strong assumptions that quickly become axioms: the rationality of economic agents (the premise that every economic agent, be that a person or a company, acts to maximize his profits), the 'invisible hand' (that agents, in the pursuit of their own profit, are led to do what is best for society as a whole) and market efficiency (that market prices faithfully reflect all known information about assets), for example. An economist once told me, to my bewilderment: "These concepts are so strong that they supersede any empirical observation." As economist Robert Nelson argued in his book, Economics as Religion (Pennsylvania State Univ. Press, 2002), the marketplace has been deified.

Physicists, on the other hand, have learned to be suspicious of axioms. If empirical observation is incompatible with a model, the model must be trashed or amended, even if it is conceptually beautiful or mathematically convenient. So many accepted ideas have been proven wrong in the history of physics that physicists have grown to be critical and queasy about their own models.

Unfortunately, such healthy scientific revolutions have not yet taken hold in economics, where ideas have solidified into dogmas. These are perpetuated through the education system: students don't question formulas they can use without thinking. Although numerous physicists have been recruited by financial institutions over the past few decades, they seem to have forgotten the methodology of the natural sciences as they absorbed and regurgitated the existing economic lore.


Try to read the whole essay if you have the chance. It should cause blood to boil among a group of people that shall remain nameless. :)

Zz.

6 comments:

Ben Lillie said...

And perhaps the revolution is on the way.

Pedro J. said...

¿What about the great physical principles?. For example conservation of energy happens because you asume your laws of motion are the same today than tomorrow. Yo can not probe that. You just asume that and work out consequences. And you discover that way lot of interesting thing as the existence of neutrinos.

I was educated as a physics and I do not see that distance with economics. Yes, the world of finances is complex. But did you really pretend to explain all the details using physical law. No, just the basics. So economics.

ZapperZ said...

We accept them because (i) IT WORKS! (ii) we haven't found a situation when it doesn't.

If and when it doesn't work anymore, we will revise it. That's one of the points made in that article, isn't it?

Zz.

Anonymous said...

Fantastic find, really well put together article. I'm not really sure what the big fascination is with people trying to relate fields (such as economics) with science. Even when science (particularly physics) differs so much with these social sciences on their so called "scientific method".

Peter Morgan said...

Interesting paper. When I was on my wife's coat-tails at IAS in Princeton, I had a number of interesting conversations with a game-theorist. He put the problems in that discipline in the same territory, that assumptions about players were much too limited. He was, with others, progressively introducing changes to the models, but it was taking years to do. As I understood it, the existing axioms were understandable, simple (in a mathematical sense), and led to more-or-less tractable models. Alternatives are all too easily complex enough that they are not comprehensible. Even if a modified set of axioms is capable of modeling more situations, it doesn't necessarily help us understand and usefully modify the macroeconomic or game-playing world.

In Physics, the Wightman axioms and the Haag-Kastler axioms for QFT have no nontrivial models in Minkowski space. After 50 years, revision is perhaps in order, but what revision will work, and be as beautiful and have other pragmatic merits? It's very easy for new classes of models that don't help us understand the Physics to be rightly derided as ad-hoc. QFT has in practice developed as an almost axiom-free zone for over 50 years, but no-one feels entirely comfortable with the renormalization situation, even if it is empirically effective, and many of us would be happier with a new axiomatic basis. What a replacement might be, however, is a hard question. I imagine that the relationship between computer programs sitting in bank computers and the mathematics of academic economics is comparably vague, and it's clear that attempts to modify the axiomatic basis have been just as slow and difficult.

The measurement problem can similarly be thought to be a problem with the applicability of the 80-year-old axioms of quantum theory to real experimental apparatus, but we haven't yet found a productive way of changing them. Axioms can't be wrong, of course, but their usefulness as a constraint on acceptable models may be questionable. Pragmatically, just as for QFT, Physicists can construct and understand effective models for experimental apparatus, but, as only one example, just what is the role of reduction of the wave function, if any, and why does almost everyone have a different idea about it?

Thanks again, Zz.

Mike Darevsky said...

I was working for years in the area of fundamental and applied physics and was intrigued by the article “Economics needs a scientific revolution” by physicist Jean-Philippe Bouchaud.

On the surface, the idea to create more realistic (like in physics!) and pragmatic economical models looks very appealing. However, in reality it will not work because of very simple reason – physics deals with still nature while economics deals with relationships between us, humans. Thus to create any working economical model, we have to understand ourselves on the first place. The history of medicine (psychiatry, for example) clearly shows that we really don’t know ourselves well enough to build any “realistic and pragmatic models”.

However, there is a solution to many if not all of our economical and other problems. I’d suggest reading what Michael Laitman has to say about it. Just check this link: http://www.laitman.com/2008/11/economics-needs-a-scientific-revolution/
to learn more about alternative solutions.



Mike