Thursday, September 15, 2011

Economics As a Science

Scientists come up with an idea of how the world works, compare it with real evidence of how the world works, and then if the idea about how the world works fits the evidence well enough, then they publish a paper explaining their idea and why they think it is a reasonable description of how the world works.  For instance: my wife did her senior thesis looking at the role of a particular gene is involved in the leg development of a particular bug.  Her idea about how the world works was that this gene was needed, and she tested it by blocking expression of the gene, and observing that the legs did not develop.  An economist would say that her model of how the world works looked like this:

She thinks this is a reasonable model, because when you block the step in red, you don't get leg development. This is also how economics is supposed to work, and it is how it generally does work.  The model is usually a little more complicated than this, because there are a lot more moving pieces. Still, the model could be as simple as this:
Which with only a little bit of math and thought gives us this:

This is the model of supply and demand, it has a TON of evidence behind it, and it is the idea that prices shift until there is as much supply as demand. This is called markets "clearing" (because there is nothing left unsold), and it is the basic model that economists fall back on to underly everything.  It is to economics what F=MA is to physics.

Further, we can understand a lot of the world of economics by using variations of this on this idea, so much so that its easy to get the idea that we really understand what is going on here.  But there is a catch.  Like F=MA, this is true, almost.  Just like F=MA does not explain everything in the universe (F=MA stops working when you have really big and fast objects), models based on markets clearing also fail in particularly weird cases.  Like recessions. Specifically, the market clearing explanation of recessions, the Real Business Cycle theory, does not include real, involuntary, unemployment.  Seriously, the wikipedia page linked literally does not mention unemployment.

And so we are left with two major camps of economics:  the ones that base all of their work off of the assumption that markets clear, and the ones that relax the market clearing assumption, and come up with a model of how the world works that explains our current experience.  The ones who did the former can be found in the pages of the Wall St. Journal, and the ones who did the latter trace their conceptual roots to Keynes.

With unemployment running at 9.1%, I think we can agree that the evidence pretty profoundly discredits the market clearing models, which leaves us with only one major group of models about how the economy works, and they all say some variation of: "Stimulus, for God's sake the government needs to borrow and spend!"  If you are against stimulus, I challenge you to carefully lay out an explanation of how we get unemployment.  I'm not saying an exact description of the world, I'm just saying a sort of story, like the bubbles for supply and demand, that explains why we have unemployment.  As an example, here's mine:

No comments:

Post a Comment