In 2013 the Nobel Memorial Prize in Economic Sciences was awarded to three American professors: Eugene Fama and Lars Hansen of Chicago University and Robert Shiller of Yale. They were jointly recognised for “laying the foundation for the current understanding of asset prices”, according to the Royal Swedish Academy of Sciences, which selects the winners.
With the global stock market turmoil of the last decade, it appears confusing that asset prices can be understood. In 2012 the prize was awarded for a series of “systematic laboratory experiments”, amounting to “an outstanding example of economic engineering” and the 2011 prize recognised deeply obscure research into “macroeconomic stability” at a time when the global economy was on a knife-edge. None of these reasons sound like economics. This leads to the question as to whether economics is a science
Economics requires the analysis of economic, commercial and financial life that requires a solid grounding in theory and numeracy, but also requires knowledge of politics, history, sociology and the study of human behaviour.
In the sciences of physics, chemistry and medicine, Nobel recipients have been rewarded for work that claim to have established “certainties”, made “findings” and discovered “relationships”. None of which are possible in economics where markets are volatile, trade wars simmer and the demographics impact results. Economic data is a guide to policy which means economic phenomena are less solid in outcome since economics is judged by what it can produce, making it more like engineering than physics.
Practical and theoretical
Economists must engage with the pressing issues of our day in a practical, rather than just a theoretical manner. Fama’s “efficient market hypothesis”, is seen as the fundamental principle of what economists call “finance theory” stating that share values are extremely difficult to predict in the short-run, given that all new information is quickly incorporated into prices. It makes sense that share prices reflect all available information, but they also reflect rumours, supposition, herd-instinct, prejudice, arrogance, pessimism and many other immeasurable qualitative factors, including occasional madness, which Fama largely ignores. The problem is that once the focus is on economic policy, politics and political posturing gets the public attention rather than the theory.
Fama, together with Hansen’s finance theories may be popular because they say what the financial services industry wants it to say. If financial asset prices are entirely rational, then it’s impossible to beat the market. Better, then, for ordinary investors who want to own shares to put their money in unit trusts and tracker funds, paying charges to the industry for doing so. Fama’s “leave it to the professionals” message has been used over many years to create an intellectual climate that discourages the kind of small-scale and activist investment that engenders accountability and promotes good corporate governance.
The 2013 Nobel prize winner for economics, Robert Shiller is a critic of the finance theory proposed by Fama and Hansen. Shiller is an economist who does his research and then has the courage to say the unpleasant truth. The ingenious Case-Shiller house price index he helped to develop predicted the last US housing collapse for example. Shiller has stated that “Critics of economic sciences sometimes refer to the development of a ‘pseudoscience’ of economics, arguing that it uses the trappings of science, like dense mathematics, but only for show.
Economics is more vulnerable than the physical sciences to models whose validity will never be clear, because the necessity for approximation is much stronger than in the physical sciences, especially given that the models describe people rather than magnetic resonances or fundamental particles. People can just change their minds and behave completely differently. They even have neuroses and identity problems, complex phenomena that the field of behavioural economics is finding relevant to understanding economic outcomes.
Yet economics has an important quantitative side that cannot be ignored. The challenge has been to combine its mathematical insights with the kinds of adjustments that are needed to make its models fit the economy’s complex human element. The research findings of the 2013 winners don’t agree with each other, which is the opposite of what “science” is, yet economics is a science because it can be approached scientifically, and its theories tested. In contrast, many economists are not scientists because they are too politically polarized to view their findings objectively.
The advance of behavioural economics is not fundamentally in conflict with mathematical economics, though it may be in conflict with some currently fashionable mathematical economic models. While economics presents its own methodological problems, the basic challenges facing researchers are not fundamentally different from those faced by researchers in other fields. As economics develops, it will broaden its collection of methods and sources of evidence, the science will become stronger, and charlatans will be exposed.