What good is economics? Economic Theory?

You know to expect a subjective answer, right? OK, then. Here I go.

I am revamping the introductory graduate microeconomics course for the fall and have added to my recommended summer readings that I emailed my students the book Economic Fables by Ariel Rubinstein. This went to their inboxes a few weeks after other recommended readings that are much more technical and was intended to reinforce what I feel is my most ignored injunction to graduate students, which is to be acutely aware of the limits of economic theories they learn and use. I elaborate here on how I hope this reinforcement can happen.

Rubinstein takes an apparently extreme stance in Economic Fables. He denies that economic theory is useful. He calls economic models “fables”. In the interview that you can find in the book’s link given above, he says that a fable is a fantasy story that, if it is a good one, gives us some insight about the real world. But you cannot use a fable to predict real-world outcomes.

For an economic theorist, like Rubinstein and myself, building fantastical worlds in economic models (or fables) is valuable for the insight it offers on the structure of economic activity, and that is value enough for Rubinstein. Creating and studying economic models needs no further argument to justify its presence in Universities, or the salaries of economic theorists. Further, there is a risk that unscrupulous people may point to economic models, written in a mathematical language that is inscrutable to most, to give the discipline of economics an unwarranted aura of being a true science.

After I sent my email to the incoming graduate students, I worried that they would come to our first class in the end of August a little puzzled by this book recommendation. Why did I ask them to read Economic Fables? Doesn’t it undermine the desire to learn microeconomic theory, the subject of our class? Does it not take time away from studying the other materials I asked them to study over the summer to get readier for the class?

Before I offer my answers to these questions, let me link to a recent piece I enjoyed about the good (useful!) recent developments in economics, by Noah Smith. He points out that criticisms of economics that say it has become a religion, with its dogmatic theories, abound. Doesn’t this fit well with Rubinstein’s use of “fables” for “models”?

It fits well, but it is not an accurate criticism, and it is not productive. Lest it seem that I am lumping Rubinstein in the previous sentence, I hasten to add that I read his book as a deliberate provocation to economists and as a potentially very useful one. It is true that economic models by themselves cannot help us predict anything. They are fantasies. How then did economists find so many applications of some of their models that have clearly worked in the real world? Here is a list of such successes, from Noah Smith’s piece:

First, economists have developed some theories that really work. A good scientific theory makes testable predictions that apply to situations other than those that motivated the creation of the theory. Slowly, econ is building up a repertoire of these gems. One of them is auction theory, which predicts how buyers will bid for things like online ads or spectrum rights — Google’s profits are powered by econ theory as much as by search algorithms. Another example is matching theory, which has made it a lot easier to get an organ transplant. A third is random-utility discrete choice theory, which is used in everything from marketing to transportation planning to disaster preparedness.

Nor are econ’s successful theories limited to microeconomics. Gravity models of trade, though fairly simple in nature, have proven very successful at predicting the flow of international trade.

This list includes, of course, the one success that lets economists claim an economic theory has saved lives directly (via organ transplant chains, made possible by the work of economics Nobel prize winner Alvin Roth and colleagues such as Tayfun Sönmez). Others will surely want to add their favorite successful economic theories.

How did these successes happen? And how did the economics profession turn successfully to empirical work informed by economic fables, as Noah Smith’s article discusses so well?

Answering these questions finally brings me to answer my previous ones. Fables are fantastical stories, yes. Yet, they can be sometimes matched to the infinitely messier world we observe around us, by setting up a correspondence between fable elements and aspects of reality, to allow us to make some good predictions and improve the fables by careful empirical testing. There is a classic paper by a physicist Eugene Wigner about the “unreasonable effectiveness of mathematics in the natural sciences“. Physicists were astonished by the effectiveness of mathematical fables in explaining the natural world around us. Social scientists have a much harder problem than physicists, studying large aggregations of human beings with all their agency and foibles, but they found fables useful too.

What makes the difference? How can a fable be useful in the social sciences, such as economics? It takes the talent of a good social scientist, coupled with hard-earned experience and knowledge of empirical methods, to find correspondences between the elements of a fable and observed social reality. The fables themselves do not provide instruction how to do this.

This is why I asked my students to read Rubinstein’s Economic Fables. I am convinced that you need economic fables, written in the powerful language of mathematics, to start being useful as an applied economist — the program in which I teach is designed to orient graduate students to applied economics in several fields. My colleagues can offer instruction on how to apply the fables better than I can, but I will teach some of the basic fables. I want the students to know just what these fables are for and what the limitations of fables are. This will be more useful for their careers in the long run than just the techniques (hard enough as mastering the techniques will prove in the next few months for my students).

So, dear students, I hope you manage to hold in your mind both the idea that economic models are fables (despite the implication some draw that they are useless because they are fables) and  the idea that these fables are essential tools for any economist, but not the only essential tools. As you study, pay close attention to the assumptions in every model you encounter. (One of the best defenses of using mathematics extensively in economics is that it forces researchers to state their assumptions.) Think about how you would connect these assumptions with economic data that you can conceivably obtain. Go back and forth between fables and data. In Econometrics class, think of fables you can use to design your term paper. In Microeconomics (our class) and Macroeconomics, think about how you would subject the fables you are learning to scrutiny when you are finally finished with exams and start doing some independent research. In Mathematics for Economics, motivate yourself to persevere by remembering that you are amassing fable-building tools in a universal language that facilitates clear thinking and pushes back against intellectual dishonesty. Do these things, and your education will be professionally and personally useful and rewarding.

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