Three flavours of economic error

There’s a nice part in Keynes’ 1926 essay, The End of Laissez-faire, in which he points out that people often get in a muddle when they criticise capitalism.

He writes that people mix up two very different critiques of capitalism: a moral distaste for the idea that money-making should be the driving logic of society, and a technical critique of capitalism as an unstable and inefficient system.

Keynes says the first step in any productive debate about capitalism is to be clear which of these two critiques we’re discussing. “We need by an effort of the mind to elucidate our own feelings.” Only then can we have a useful conversation.[1]

In the last few years it’s become increasingly popular to criticise economics for the hold it has over public policy and I’ve noticed that these debates can get muddled too. I think Keynes’ advice — to distinguish more precisely between the different critiques we’re making — could be helpful. We need to specify the ways in which economics errs and talk about each one in turn.

As a starter for ten, I think three types of error can be levelled at economics, each of which requires a different solution.

Errors, like icecream, can be usefully distinguished.

First, there are what I’ll call chronic infections. These are long-standing errors of thinking that should never have taken hold so deeply in economics, and the persistence of which says something troubling about the health of the discipline.

Chronic infections are the focus of this recent essay from Tom Bergin.[2] Bergin explores the trouble with ‘blackboard economics’, a term that refers to the tendency among some economists to rely more on theory than fact. He recounts how, in the late twentieth century, economics drifted uncomfortably close to being a religion rather than a science as leading economists seemed to bend facts to fit their theories rather than the way around. Today, a new generation of empirical economists is working to correct this drift, using experiments and data to bring economics closer to the real world.

Bergin uses the minimum wage as an example to illustrate the troubling power of dogma in economics. The example is awkward for economics because it saw an error — the belief that minimum wages cause unemployment — persist for decades at the heart of the discipline despite being unsupported by evidence.

What I find most interesting here isn’t so much the minimum wage itself — this debate was settled years ago among anyone sensible — but the question of what such a persistent infection tells us about the health of economics. A healthy academic discipline should identify and reject an error in the way a healthy immune system rejects a virus. So a lingering error is a worrying sign, symptomatic of ill-health in the body economic — and indeed that’s exactly what the latest economic research is now confirming. There’s growing evidence that economics suffers from markers of ill-health like publication bias and groupthink. And it’s also clear that the discipline has some deeper maladies like a near-total lack of diversity in senior positions.

So all in all, this first category of error points to a particular class of solution; essentially an exercise regime to get economics into better shape. This means becoming more intellectually meritocratic, so that bias doesn’t insulate sloppy thinking from challenge; more diverse to combat homogeneous thinking; and more independent from industry and politics so that money and dogma don’t distort research findings.

Second, there’s a class of economic error that I’ll call over-extensions. These are cases in which an economic theory or model is true or useful when it’s applied to the right problems in the right way, but where we’ve massively over-extended the application of the theory/model to the point where it misleads.

Bergin touches on this point briefly when he writes that the last few decades saw us assume that certain “economic principles apply to more and more domains of life.” I made a similar point in this earlier essay when I wrote about a phenomenon I call the ‘double-stretching’ of economics, which I summed up as follows:

“We trimmed back the cloth of economics to discard all but the most orthodox ideas and then we stretched that small cloth over an ever broader domain of our social and economic lives.”

The over-extension of economics is one of those phenomena that is hard to see at first because it’s so embedded in our public life. Once you spot it, though, you realise it’s a really peculiar thing for us to have done and a powerful explanation for lots of the recurring difficulties we encounter in public policy.[3]

Think of how, for example, we almost never draw on expertise from historians when making public policy choices, which might partly explain why we keep repeating mistakes. Or consider how we ignore psychology, which might explain why we’ve been continually surprised that people don’t respond to public policies like rational robots.[4] Or think of how we’ve underused the discipline of design, which means we optimise public policies in a spreadsheet and then forget to worry about how they land in people’s lives.[5]

The point I’m making is just that over-extensions are a very different type of mistake to chronic infections and they require a different response. The cure for over-extensions is to right-size economics, both by giving ourselves more cloth to work with — inviting heterodox economists to the table — and by ending the discipline’s trump status in public policy, so that we can enrich our discussions with insights from disciplines like history, psychology, and design.[6]

Third, there’s a category of economic error that I’ll call redundancies. These are cases in which an economic theory or model was useful in the twentieth century but is now unhelpful because our economy works differently in a digital age.

A troubling number of the core tenets of orthodox economics fall under this category. An example is diminishing marginal returns, as opposed to the increasing returns we now see with digital platforms. Or the idea that consumers act like isolated agents when they make decisions, as opposed to being so tightly networked that their social interactions are constitutive of who they are as units. Or even the idea that the choices we make as consumers in free markets reveal our underlying preferences, so that the interests of producers and consumers are aligned, which is something I wrote about here.

There’s also growing evidence that some of the most important analytical tools of economic policy — measures like inflation, productivity, and GDP, for example, or even basic concepts like ownership and property — are losing their utility with the shift to a digital economy in which so many goods and services are intangible and non-rivalrous.

The cure for this third type of error is different again: we need to update economics for a digital world. Although really the word ‘update’ is much too weak. Rather than modifying old economic theories, we need to find new ways to conceive of an economy that runs to a new logic, and this means we need new metaphors, mental models, and pictures to interpret the world.

When I put these critiques together I can’t help but think of the word comorbidity. It describes a situation in which a person has several serious health conditions at once. Comorbidity is a useful concept in healthcare because co-existing conditions interact, meaning their effects multiply, which raises sharply the risk of fatality. The same is true for economics since these different types of error interact, each exacerbating the other. Still, this gives us all the more reason to understand each type of error so that we can explore their interactions.

I’m conscious that this all sounds quite negative so let me end by saying I’m optimistic about our chances of rehabilitating, right-sizing, and refreshing economics. In all these areas great work is being done, so much so that I don’t think it’s fanciful to think economics is embarking on a long overdue paradigm shift.

Still, as we do this work, our conversations will be more productive if we’re precise about problems so that we can be equally precise about solutions. As Keynes wrote back in 1926, “there is no party in the world at present which appears to me to be pursuing right aims by right methods.” The clearer we can be about our diagnosis, the more likely we’ll find the right cure.

This post is part of a year-long series exploring how we govern the future. To read along, you can follow me on Medium here or support the project for £3 a month on Substack here. For the big story behind all this, from Victorian sewers to digital dragons, you can buy my book End State.

Footnotes

1. Keynes was originally making a more specific point about the alignment between intellectual/technical critiques of capitalism and emotional/moral critiques. In this post I’m focusing on a more general point about the importance of precise thinking.
2. I’m not saying, by the way, that Tom’s essay is confused. It was just the prompt that got me thinking about these topics.
3. Here’s a thought experiment that brings this home: imagine if we’d built the modern state just as singularly on the insights of another discipline, like sociology. Just think how odd the state would be. Well that’s basically what we’ve done with economics, and the resultant state is really odd, it’s just that we don’t see the oddities because we’ve priced them in.
4. It’s also interesting that we then solved this underweighting of psychology by inventing a subset of economics called behavioural economics — i.e. we expanded economics by drawing in various psychological insights and methods rather than drawing more directly on psychology as a discipline.
5. A good example of this is the way we calibrate benefit taper rates to optimise work incentives but we don’t stop to ask whether anyone who claims benefits has the faintest idea of how their benefit income will change in response to their behaviour, or how we could make these changes of income in response to behaviour simpler and clearer.
6. This could mean, for example, valuing experience from different disciplines more equally when people apply for senior jobs in government, and inviting experts in those disciplines into the roundtables and panel discussions that make-up the policy circuit. It could also mean reforming the machinery of government so that economics isn’t the only discipline with its own institutional architecture (OBR, IFS, CBO, CEA, Chief Economists, etc.).