The Great Divide in Economics

Kudos to Mark Thoma, a professor of economics at the University of Oregon, for an article suggesting that there needs to be more interaction between researchers and practitioners.  He writes:

When I was trying to figure out if there was a housing bubble or not, the academic economists I had come to trust said no, the fundamentals explain this. Sometimes this was backed by econometric analysis. But many people outside of academics, or at least a few, said there was a bubble. This was often backed by logic, intuition, and simple charts rather than sophisticated econometrics based upon theoretical constructs. For the most part, I dismissed the people I should have listened to, especially if it contradicted what the academics were saying. Most of all, I relied too much on the experts in the academic community instead of listening to all the evidence and then thinking for myself.

One of the reasons I didn’t listen is that until I started blogging, I was pretty arrogant about academic economists. As far as I was concerned, pretty much, academic economists knew more about everything related to economics than anyone else. But one thing I’ve learned from the wide array of voices in the blogosphere is that I was wrong. Academic economists have a lot to learn if they are willing to listen.

If only some Modern Portfolio Theorists were as honest and open-minded as Dr. Thoma!  The best point he makes, I think, is about listening to all of the evidence and then thinking for yourself.  There’s plenty of blame to go the other way too.  Practitioners have sometimes been all too eager to accept and implement academic theories, even when they make very little sense or have been based on incredibly suspect assumptions that do not obtain in the real world.  Other practitioners are arrogant and dismiss the idea that academics know anything at all, something that is also not true. 

There’s always something to learn from people in other fields.  Daniel Kahneman and Amos Tversky were psychologists studying decision-making processes—until someone connected the dots and realized that market participants make decisions with uncertain outcomes all the time.  Many years later, psychologist Daniel Kahneman ended up with a Nobel Prize in Economics.

There is particularly a lot to learn in finance if academics and practitioners would interact more and actually listen to one another.  Both Warren Buffett and George Soros have written about problems they perceive with the Efficient Markets Hypothesis, yet some academics dismiss their billions of dollars extracted from the market as some kind of lucky coin-flipping.  Even a rudimentary knowledge of statistics and the law of large numbers would tell you that someone who has made thousands of trades a year over four decades and has ended up with billions of dollars in profits (like George Soros) is not just lucky!

Good theory-making always derives from observation: examine data to see what is happening and then construct a theory to explain why it is happening the way it is.  If you can figure out why, you can extrapolate and test your hypothesis.  (The budget debate is a great example of bad theories—everyone has an idealogy, but no one is citing past historical examples or data.  Open-minded economists and business people with common sense are more likely to do the right thing than political idealogues.)  More interaction might lead to better theories, and better theories would lead to better policy-making for all of us.

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