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Psychic octopus 7 Rational expectations 0

12 July 2010

Well-done Paul the Psychic Octopus! The soothsaying cephalopod maintained his 100% record by tipping Spain to win the World Cup last night. England fans can take comfort from the fact that Paul was born in the Sea Life Centre in Weymouth before his record-breaking transfer to Sea Life Oberhausen in Germany.

There’s little comfort for other experts though. At the end of the day, you’re only as good as your last prediction, and it turned out to be a disappointing tournament for the highly-paid stars of UBS and the other big names of financial forecasting Brian Keeley reported on here.

None of them spotted the winner. None of them spotted the Great Recession either. In that, they were like most economists, apart from the ones who always forecast shocks and crises, knowing they’ll be right sooner or later (there were 195 stock-market crashes and 84 depressions between 1860 and 2006).

They did get it right about football ruining money though. When France were eliminated, shares in French broadcaster TF1 who’d bought the retransmission rights plunged on the Paris stock exchange.

Can a profession that seems more comfortable describing what has happened than in predicting what will happen be called a science? In fact, using the ability to predict the behaviour of large systems as the criterion would exclude disciplines such as weather forecasting, which is like economics in many ways.

Einstein summed up the difficulty of meteorology and other fluid dynamics studies when he remarked that before he died, he hoped somebody would explain quantum mechanics to him, and that after he died, he hoped God would explain turbulence. In one sense though, it doesn’t matter if you can’t forecast the evolution of turbulent flow.

Aircraft designers, for instance, don’t have to predict when a plane will meet extreme turbulence – but they do have to make sure it won’t disintegrate. A similar attitude could be applied to economics – try to understand the basic mechanisms and at least give useful strategies for avoiding disaster.

For economists, this means developing models to describe how systems work. To do this, in common with other social sciences, economics has borrowed many of its concepts and tools from the physical sciences (the notions of flow, masses and reactions, for example) although the “hard” sciences have usually moved on to a new paradigm long before the sociologists and economists.

Has economics come up with anything worthy of the insights of other fields? When challenged by mathematician Stanislaw Ulam to name one social science proposition that was both true and non-trivial, Paul Samuelson nominated comparative advantage, arguing “That this idea is logically true need not be argued before a mathematician; that it is not trivial is attested by the thousands of important and intelligent men who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them”.

At least some of the scepticism about economics arises when a doctrine, tool or method is used to explain much more than its intellectual underpinnings can bear, as when it is assumed that economic agents act rationally.

On the other hand, applying strict economic analysis to a subject not usually treated in this way can be highly entertaining. Adam Smith’s “invisible hand” inspires Peter Leeson’s wonderful title The Invisible Hook: The Hidden Economics of Pirates. Leeson explains, among other things, why working conditions on 18th century pirate ships were immensely superior to those on merchant and naval vessels. And why we should see that Long John Silver’s peg leg was a negative externality with obvious implications for his labour market utility. Arr.

One Response leave one →
  1. Jeff Biset permalink
    July 12, 2010

    well, looks like economic analysis is like sports commentary: they find some very good reasons for one team to have won ….afterwards and whatever the result.
    The key word is ” predictable” but never (or almost) predicted.

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