The economic turmoil in the world today, seven years after the great financial crash of 2008, has once again thrown the spotlight on the economics profession. After failing to foresee the crisis, economists seem to be struggling to find a way out of the morass in which the global economy has landed. As several commentators have argued, this period of economic crisis is also a crisis of economics itself.

However, the crisis is also an opportunity to step back and ask what has gone wrong with economics, and if there are changes that can bring the discipline closer to reality and allow its practitioners to find more effective answers to economic problems.

At a recent debate on the role of history and math in economics at the London School of Economics, Keynesian economist Robert Skidelsky and heterodox Cambridge University economist Ha-Joon Chang persuasively argued that the neglect of economic history is one of the major failings of modern economics.

Greater attention to economic history would have made economists recognize the many mistakes of economists and policymakers throughout the course of history, and made everyone aware of the unresolved debates and plurality of views within the discipline, the duo argued.

As Skidelsky pointed out, the applicability of particular economic models depends upon context, and economic and social history can offer valuable lessons on whether a particular economic prescription is likely to work in a given situation. Nobel-winning economist Robert Solow made a similar argument in a 1985 paper on the role of economic history, suggesting that a careful reading of economic history can offer the economist a sense of the different kinds of social arrangements and their interactions with economic behaviour.

“If the proper choice of a model depends on the institutional context—and it should—then economic history performs the nice function of widening the range of observation available to the theorist," wrote Solow. “Economic theory can only gain from being taught something about the range of possibilities in human societies. Few things should be more interesting to a civilised economic theorist than the opportunity to observe the interplay between social institutions and economic behaviour over time and place."

The old masters of economics and their analysis of historical economic events can offer valuable lessons for modern-day practitioners, as the Reserve Bank of India pointed out in its latest financial stability report. The ideas of forgotten economists such as Hyman Minsky, who analysed the ebb and tide of business cycles, and Alvin Hansen, who wrote about the Great Depression, are beginning to appear relevant again.

As an earlier Economics Express column pointed out, the neglect of its own plural legacy began since the 1970s with the rise of a new orthodoxy of market fundamentalism, based on the idea of extremely rational agents who processed information perfectly. The level of dissent and debate in the profession fell dramatically, and the heterodox tradition of economics was quietly buried.

The elegant mathematics of the rational expectations model led many mainstream economists to believe that it was “the model" that could explain all economic reality. Old theories and prior history were seen as superfluous till the crash of 2008 proved them wrong.

History is, however, not the only important discipline that economists neglect, it turns out. A 2015 paper by researchers Marion Fourcade, Etienne Ollion and Yann Algan uses bibliometric data to show that economists are the most insular of all social scientists. In its quest to become the physics of the social sciences, the profession seems to have rewarded knowledge of mathematics much more than the knowledge of other social sciences, even though insights from those disciplines have a direct bearing on the subjects of economic enquiry.

The specialization of knowledge has made most social sciences insular, but the insularity of economics is markedly higher than any other discipline, Fourcade and her co-authors show. They point out that “articles in the American Political Science Review cite the top 25 economics journals more than five times as often as the articles in the American Economic Review cite the top 25 political science journals". The asymmetry is even starker with regard to the American Sociological Review.

“From the vantage point of sociologists, geographers, historians, political scientists, or even psychologists, economists often resemble colonists settling on their land—an image reinforced by some economists’ proud claims of ‘economic imperialism’," Fourcade and her co-authors wrote. “Lured by the prospect of a productive crop, economists are swift to probe the new grounds. They may ask for guidance upon arrival, even partner-up with the locals (with whom they now often share the same data). But they are unlikely to learn much from them, as they often prefer to deploy their own techniques. And in some cases, the purpose has been simply to set the other disciplines straight. Under the influence, notably, of Chicago price theory, the dominant economic paradigm has successfully conquered a segment of political science, law, accounting, and (for a while) sociology under the label of rational choice theory—thus explaining, in part, the directionality of the citation patterns observed above."

Opinion surveys seem to point to the same trend: other social scientists and even business school professors value interdisciplinarity far more than economists. Fourcade and her co-authors show that citations in top economics journals are not just less interdisciplinary but also tend to be more concentrated.

They identify two key reasons behind such concentration: the homogeneity of economics training (including the use of standard textbooks) which aids group-think, and the dominance of a few elite economics departments, which publish the top economics journals, and which provide an overwhelmingly large share of contributors to those journals.

Such levels of concentration and control can have a pernicious impact in a discipline where top journal editors exert enormous influence because of the nature of the publication process, as Chicago University economist Luigi Zingales (who co-wrote the book Saving Capitalism from the Capitalists with Raghuram Rajan) pointed out in a 2013 research paper.

Young contributors, especially if they are untenured faculty, can easily give in to the suggestions of a persuasive editor, slanting the discourse on a certain subject. All it takes to propagate certain ideas in the profession is to capture a few top editors, suggested Zingales.

“The lack of bias in the publication process depends crucially upon the lack of bias of the editors or, at least, the diversity of biases of the editors across major journals, since there are multiple outlets and thus an author can shop around," wrote Zingales. “Unlike in law, though, the search process is impaired by the prohibition to submit the same paper to multiple outlets contemporaneously. Combined with the relatively long review time and the multiple rounds required, this process gives quite a bit of power to the editor to massage papers in the direction they prefer. If an assistant professor who is going up for review soon is asked at the last round of a long review process to modify slightly the conclusions to make them more palatable to a certain audience, would he refuse? Probably not. Not only does this action bias the conclusions of one paper, but it projects a perception that to publish in that journal one has to reach the ‘right conclusions’. Hence, researchers who want to publish in that journal would start tilting their conclusions in the right direction. In equilibrium, the editor does not have to exercise any arm-twisting, because all the distortion takes place before the first submission and is done voluntarily by the researchers to reduce the risk of seeing their paper rejected."

The economic crisis has, however, emboldened many of the critics and dissenters within the profession to challenge the status quo vigorously. As this column noted earlier, there is a vibrant student movement that has challenged the way economics is taught and researched in major universities. The dissenters have challenged the narrowing of the economics curriculum over the past few decades, and demanded that alternative ways of thinking about economic ideas should form part of the mainstream. So should interdisciplinary approaches involving the study of sociology, history, politics and anthropology, they contend.

A new research paper by Karla Hoff of the World Bank and Nobel-winning economist Joseph Stiglitz shows how insights from other social sciences can enrich economic modelling, and bring it closer to reality. Hoff and Stiglitz point out that our view of the world and the economy changes dramatically once we start relaxing the unrealistic assumptions of conventional economics, and take into account the insights of psychology, sociology and anthropology while making alternative models.

A strand of behavioural economics has already led to changes in how economists understand choices of individuals by showing that the context of the moment of decision-making influences choices when the context is apparently irrelevant to the choice being made. Social factors such as peer pressure, which were not considered as relevant in standard models, have been found to be of paramount importance in empirical studies.

Extending this argument further, and drawing on the work of sociologists and psychologists, Hoff and Stiglitz argue that “the social context not only primes individuals, eliciting one kind of behaviour or another, but that in a fundamental sense it shapes them—how they think and what they want". Preferences that are considered given and exogenous in a standard economic model have to be treated as endogenous to bring our models closer to reality, they argue. Citing the example of empirical studies on bankers, they show how cultural norms in the banking industry may “programme" bankers to act in selfish and even dishonest ways.

“Because how we perceive the world affects what we do, it affects in a deep sense who we are," Hoff and Stiglitz write. “However, standard economics is built on the assumption that individuals are architects of their social worlds, but that the social worlds do not shape cognition or preferences—how individuals think or what they want. The core model in standard economics also assumes that individuals have unlimited powers of objective perception and reasoning. All individuals exposed to the same data and experiences would come to the same conclusions. The rational expectations model goes even further. It makes sufficiently stringent assumptions that, with enough dialogue, all individuals would come to hold the same beliefs—there would be common knowledge. In contrast, cultural psychologists and sociologists take it for granted that society is partly ‘inside us’: socioeconomic factors affect the mental models that influence how we process information."

Hoff and Stiglitz argue that the psychologists and sociologists have got it right, and provide empirical examples to show that the social environment can shape cognition and behaviour, which in turn shapes social outcomes. “Just as economists have had to come to terms with the fact that individuals act in ways that are markedly different from those predicted by the rational actor model, economists will have to come to terms with the fact that preferences and cognition are shaped by those surrounding us, and that these social interactions may be as important determinants of economic outcomes as the variables upon which economists have traditionally focused," they write.

Hoff’s and Stiglitz’s approach of modelling hitherto neglected but important social determinants of preferences such as culture and their acknowledgement of the role of history in shaping our current choices marks an important step in trying to change economics and economic modelling.

Yet, the crisis in economics demands more than just better models of the world. In his latest book, Economics Rules: The Rights and Wrongs of the Dismal Science, Harvard economist Dani Rodrik argues that one of the cardinal sins of many economists has been to pretend that the model they use is “the model" to explain all economic phenomena. Echoing Solow, Rodrik argues that unlike the natural sciences, there are no universal laws of economics: it is a collection of models, and depending on context, one model or another may be put to use.

Extending Rodrik’s argument, one may point out that many economists may be mistaken in thinking that their way of doing economics is “the way" of studying economic systems. While models are useful for their parsimony, they are often of limited use for the same reason: they lack richness, and are poor abstractions of reality.

Critics of economic modelling do not advocate abandoning mathematical economics altogether, just as critics of rational agent-based modelling do not suggest that there is no rationality involved in making economic decisions. Rather, many like Chang of Cambridge University argue that economics needs to take advantage of other methods of enquiry used in other social sciences, such as case studies, oral histories, archival research, ethnographies and other qualitative approaches to supplement and to better inform economic theorizing and policymaking.

Such an approach will allow economists to draw upon a richer repository of knowledge, make them pay greater attention to important contextual factors and perhaps also make them more careful while making policy recommendations.

As Chang points out, economists not only owe it to themselves but also to the world to learn from history and minimize “live experiments with people". Whether it be the horrors of totalitarian state-led command-and-control systems under communism, or the “big-bang" transition back to capitalism, or the pains of structural adjustment programmes inflicted by multilateral lenders upon many powerless developing economies, millions of people have suffered at the hands of economists wearing blinkers.

A catholicity of approaches, attention to economic history and greater engagement with (rather than colonization of) the other social sciences may help produce a finer, more sceptical, and more useful generation of economists in the years to come.

Economics Express runs weekly, and features interesting reads from the world of economics and finance.

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