Defending economists — from themselves

Economists need to stand up to economists who give their field a bad name

I am on occasion a fairly harsh critic of modern economics, for many reasons. I think economists use the concept of efficiency in a slapdash manner. I think they make a fetish of rigorous mathematics even when they gain no insight from it; it’s too often imported as a tool to impress others, rather than as a legitimate means to understanding (see the absurd Appendices of this paper, for example, proving various irrelevant theorems about Markov processes). I think economists (most of them) don’t make use of enough modern mathematics from dynamical systems theory.

I also think economists often infect their social analysis with their own subjective values, even while mistakenly and dangerously believing otherwise (as a result of their training). I think the modelling assumption of rational expectations, for agents dealing with anything but the simplest environments, is just a silly idea. I would go so far as to say that I think many economists don’t appreciate basic elements of scientific method, preferring the logical beauty (?) of deductive theories to empirically relevant ones. Etc. Read almost anything I’ve written on economics for similarly critical opinions.

But I do, just the same, also think there’s lots of good and useful economics, some of it even beautiful. And I think economists themselves should do a better job standing up for it. Some very prominent and well known economists are giving the field a bad name. Let me explain.

I’ve often heard from economists that I (and other critics) just don’t understand the field we are attacking; that economics has gone way beyond theories based on rationality, greed and equilibrium; that we’re totally mistaken in our claims that economists too often act as knee-jerk defenders of free markets. This sounds very strange to us, not only because we’re generally criticizing recent papers published in top journals, but also because we frequently see well-known economists from respected institutions proclaiming just the ideas we criticize. For example, University of Chicago economist Steven Levitt recently made the argument that simply putting a price on healthcare treatments could greatly improve healthcare and reduce costs. He thinks it’s essentially obvious that this should work, because people “overconsume” anything they get for free.

Now, this looks to me (as well as to some others, including Noah Smith and Cameron Murray) like a complete mis-characterization of what economists really know about the way markets in things like medical services actually work. But I haven’t seen the economics profession come down on Levitt like a ton of bricks, attacking him for seriously misrepresenting economic science. He’s cheer-leading for free markets, and so that seems to be OK.

Economists — Your work is being mis-represented! Defend yourselves! If you wonder why people think lots of economics is a joke, well, look at economists such as Levitt who go on making these claims very prominently in public.

The Academic Health Economists’ blog put up a nice reading list to help Levitt and others who think like him understand more about the good economic research which has been done on the topic. Look up Credence Goods on wikipedia and you can also find lots of useful links to good papers which Levitt seems unaware of, and which analyze the peculiar properties of markets in medical services. For example, this nice paper by Dulleck and Kirchbemer from 2005 uses simple game theory to study the conditions under which one might expect a market in medical services (or other credence goods, these being anything where we need to enlist the services of an expert to solve problems for us where our knowledge is lacking) to actually work at all, and finds they’re extremely restrictive. Let me quote first the abstract, and then follow with some conclusions:

Most of us need the services of an expert when our apartment’s heating or our washing machine breaks down, or when our car starts to make strange noises. And for most of us commissioning an expert to solve the problem causes concern. This concern does not disappear even after repair and payment of the bill. On the contrary, one worries about paying for a service that was not provided, or receiving some unnecessary treatment.
This article studies the economics underlying these worries. Under which conditions do experts have an incentive to exploit the informational problems associated with markets for diagnosis and treatment? What types of fraud exist? What are the methods and institutions for dealing with these informational problems? Under which conditions does the market provide incentives to deter fraudulent behavior? And what happens if all or some of those conditions are violated?

The paper, on my reading, uses just enough mathematics to carry through the intended investigation, and pays close attention to empirical reality to make sure its conclusions aren’t obviously in conflict with what we know. They conclude that a market for such goods can only work if 1) consumers have quite a lot (and equal) knowledge about the goods in question (which is not usually the case; can you accurately diagnose your medical needs?), 2) there is some mechanism in place so that people are committed to taking a treatment once the diagnosis has been made (also not generally the case), and 3) there is EITHER a way to verify the legitimate quality and appropriateness of a treatment afterward, or a way to make the provider of treatment liable for mistreatment (this third condition is also generally impossible or impractical to achieve). Or, as the authors say it in econ-speak:

Our analysis suggests that market institutions solve the fraudulent expert
problem at no cost if (i) expert sellers face homogeneous customers,
(ii) large economies of scope exist between diagnosis and treatment so that
expert and consumer are in effect committed to continue with a treatment
once a diagnosis has been made, and (iii) either the type of treatment is
verifiable, or a liability rule is in effect protecting consumers from obtaining
an inappropriate inexpensive treatment.

We have shown that inefficient rationing and inefficient treatment of some
consumer groups may arise if condition (i) fails to hold, that equilibria involving
overcharging of customers or specialization of experts — both leading
to a duplication of search and diagnosis costs — may result if condition (ii) is
violated, and that the credence goods market may break down altogether if
condition (iii) doesn’t hold.

Conclusion: what Levitt has proposed is totally bonkers and simply takes no note whatsoever of prevailing good work in economics on how such markets work. Absent lots of other regulatory mechanisms, one should expect a simple healthcare market where people just pay for treatments to be a disaster.

This is why economists need to defend themselves — from themselves. Indeed, I think they may need to defend themselves even from their critics less than from those overzealous academics who give the profession a bad name. If you’re an economist and you’re sick of being criticized by people like me, or by heterodox economists of many stripes, you need to think a little more about why we make the criticisms we do. There are plenty of economists out there peddling a whacky version of what economists really know and do not know about markets, and they ought to be stopped. Who better to stop them than economists themselves?