Empirics and Psychology: Eight of the World’s Top Young Economists Discuss Where Their Field Is Going
Ali Wyne is a researcher at Harvard University’s Belfer Center for Science and International Affairs. He graduated from the Massachusetts Institute of Technology in 2008 with bachelor’s degrees in Management Science and Political Science, and, as a senior, received the Institute’s highest honor for students, the Karl Taylor Compton Prize. Prior to joining the Belfer Center, Ali was a Junior Fellow in the China Program (now the Asia Program) at the Carnegie Endowment for International Peace.
Ali is a member of Chatham House, the International Institute for Strategic Studies, the Council for Emerging National Security Affairs (CENSA), and Young Professionals in Foreign Policy. He also serves as a discussant at Bloggingheads.tv and a Next America Fellow at the Center for Strategic and International Studies.
Ali’s articles have been published in the Washington Post, the Boston Globe, the Christian Science Monitor, the International Herald Tribune, the Financial Times, Foreign Policy, and theNational Interest, among other outlets. He contributed an essay, “Public Opinion and Power,” to the Routledge Handbook of Public Diplomacy (London: Routledge, 2008), and will be contributing another to a book that is forthcoming from CENSA in early 2013, American Strategy and Purpose: Reflections on Foreign Policy and National Security in an Era of Change.
In 2011, Ali delivered the welcome address at the 41st St. Gallen Symposium and joined Big Think’s inaugural class of Delphi Fellows.
The past few years have been tough on economics and economists. In a searing indictment written one year after the collapse of Lehman Brothers, Paul Krugman concluded that
the central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess. Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality…to the problems of institutions that run amok; to the imperfections of markets…and to the dangers created when regulators don’t believe in regulation.
Last August, Graeme Maxton published a book arguing that “modern economics has failed us,” and this April, the New York Times hosted a roundtable “about how the teaching of economics should change in light of the financial crisis.”
This soul-searching has led to the establishment of organizations such as the Institute for New Economic Thinking and invigorated discussions about alternative metrics for gauging countries’ welfare (last July, in fact, the UN General Assembly adopted a resolution asserting that “the gross domestic product indicator by nature was not designed to and does not adequately reflect the happiness and well-being of people in a country”).
To get the pulse of a field in flux, I asked eight of the world’s top young economists to identify the biggest unanswered questions in economics and predict what breakthroughs will define it a decade or two hence.
Stanford University; 39
Why are developing countries poor? In terms of impact on mankind globally, this strikes me as probably the biggest and most important current economic question. I think the answer is complex and linked to a combination of factors around history, geography, luck, etc. I am personally working on management practices: people in developing countries are poor because wages are low, and wages are low because firms are very unproductive, and firms seem to be unproductive in large part because of bad management. An Indian worker makes in one week what an average U.S. worker makes in a half a day. One big factor seems to be that factories in India are frankly very badly managed: equipment is not looked after, materials are wasted, theft is common because inventory is not monitored, defects keep occurring, etc. In a recent project with the World Bank, we found in randomized experiments that giving simple management advice to Indian factories increased productivity by 20%, and I suspect that a number like 200% would be possible in the longer run.
Developed countries’ biggest question now is probably: how do we restart growth? There are a lot of issues here around innovation, curbing entitlement spending, etc. The area I know best is the short-run side of this, controlling policy uncertainty. A big factor that politicians and the media are pushing heavily right now is that growth is getting crushed by how policy has induced uncertainty. Basically, firms and consumers in the U.S. and Europe are holding back from spending until they know what is going to happen with taxes, spending, and (to a lesser extent) regulations over the next year or so. In the U.S., we have the November 2012 election generating a massive cloud of policy uncertainty, and in Europe, a rolling wave of elections and collapsing governments.
I do not think that any one single breakthrough will happen. The progress is likely to be heavily empirical—simply because more and more data is becoming available, and it is easy to analyze with fast computers (so empirics is now advancing faster than theory)—and spread across many hundreds of topics. So economics has gone from Victorian science, where one genius in his shed could invent the steam engine over the weekend, to industrial science, where innovation comes in thousands of tiny steps made by dozens of research teams.
Harvard University; 32
Many economists are concerned with two broad questions: how can we increase the rate of economic growth and overall well-being, and how can we reduce the rate of poverty? Countless policies—taxation, education, healthcare, etc.—have been implemented in an effort to achieve those objectives. One of our biggest challenges is to distill each policy’s unique impact so that we can understand which ones actually work and which ones do not.
The traditional state of economics is captured by the joke about ten economists, each of whom has a different theory of how the world works, none of which is directly tested or verified. Looking ahead, I am most excited about the prospect of having clear, evidence-based answers on which policies have the most beneficial economic impacts. I am especially optimistic that the expansion of access to large administrative datasets, such as earnings data from social-security records or student-achievement data from school districts, will yield sharp, quasi-experimental evidence that allows us to test theories and estimate key parameters of economic models. While theory will play an important role in guiding this research, its assumptions and conclusions will increasingly be empirically founded.
Within this broad area, I plan to pursue research on two sets of projects over the next few years. The first will try to identify the determinants of intergenerational mobility, with an eye towards finding policies that increase equality of opportunity. Should we be focusing on increasing access to higher education? Changing the structure of elementary schooling? Revamping the tax code? A second set of projects will explore the implications of behavioral economics for policymaking. Although we have accumulated considerable evidence showing that people do not always behave rationally, we do not have as good a sense of how they actually do behave and what this means for policy. I hope to make progress on this front, focusing on how we can design cost-effective policies that encourage people to save adequately for their retirement—to give just one example.
Federal Reserve Bank of New York; 37
I think the recent world economic crisis has firmly put back on the map basic macroeconomics: that is, the study of traditional questions, such as how to use monetary and fiscal policy to eliminate unemployment and control inflation. It was actually becoming quite unfashionable within economics to study these types of questions, even though they remain unanswered to a large extent. People even graduated with PhDs in economics with little idea about what role, if any, the government plays in stabilizing business cycles, the role of regulations, and so on. Instead, it was becoming increasingly fashionable to tackle smaller but more manageable questions for which data is rich and answers clear.
My guess, therefore, is that if one looks back 20 years from now, one will notice that a shift occurred towards studying the basic, big-picture, policy-relevant questions of macroeconomics—e.g., optimal currency areas, bank runs, fads and herding in financial markets, and automatic stabilizers—that have the power to change the course of history. I think there have been two comparable events that shaped the field in this way. As a discipline, macroeconomics was born in response to the Great Depression, giving rise to Keynesianism; the rational-expectations revolution in macroeconomics was born in response to the great inflation on the 1970s.
Perhaps somewhat under the radar, the past two decades have witnessed the integration of the macroeconomics that came out of the 1970s and 1980s with basic Keynesian models developed in the wake of the Great Depression. I suspect that the current crisis will accelerate that development, with models integrating financial frictions that were clearly central to its emergence.
New York University; 40
The most central open question in economic theory, as I see it, is how to model realistic economic agents. Traditionally, economists have relied on the rational-actor model, but it is clear that it is just a rough caricature. It has been greatly enriched by behavioral economics in the past 30 years. Still, we are far from a unified, versatile, believable alternative to the rational-actor model. I am hopeful, though, that this might be overcome—in part because of progress in the sister disciplines (psychology and neuroscience) and basic modeling, and also because empirical anomalies are forcing the economic profession to be more open-minded. Contributions by computer scientists and physicists will help inject new perspectives into economics.
The largest concrete questions in economics are, arguably, how to increase growth—particularly in developing countries—and how to avoid economic disasters and financial crises.
Progress in understanding limited rationality will lead to progress on answering the concrete questions. Low levels of growth are in part due to misapplied cognitive heuristics that lead people to be timid, inert, and gullible. Regarding disasters, during the unfolding of the crisis, traditional macro-financial factors (bank runs, deleveraging, etc.) have arguably been more important than behavioral factors. However, behavioral elements seem to have been paramount in the buildup of the current crisis (in particular, the neglect of tail events by financial actors and by the architects of the euro), as perhaps they are in most crises. The modeling of agents with bounded rationality will help us build economic models (in particular, macroeconomic and financial models) and institutions that better take into account the limitations of human reason.
Harvard University; 40
All countries wish to pursue sustainable growth without large boom-bust episodes. How exactly one accomplishes this remains a challenge that has been made starker by the current crisis. In an increasingly globalized world, the search for answers will necessarily require a much deeper understanding of three areas that interest me. One, we need a better understanding of the interlinkages across countries in trade, finance, and macroeconomic policy. The crisis in the Euro area brings this to the forefront. The complex ties across the member countries via trade, via banks, and through a shared monetary policy are central factors behind the ongoing sovereign debt, banking, and growth crises in the region. While trade interactions are better understood, financial flows remain a challenge.
Two, understanding the global economy requires a greater appreciation of the differences across economies. In the past, research mainly focused on analyzing interactions across economies that were similar in terms of their stages of development and their economic institutions. The most interesting questions today, however, concern interactions between developed economies and fast-growing developing economies, and between countries with diverse economic institutions. Questions on so-called global imbalances, currency wars, and capital controls have to do with interactions across diverse countries.
Three, understanding asymmetries in the international monetary system—with the prominence of the dollar in trade and financial transactions—will be crucial to understanding the propagation of shocks across economies. In my research, I find that international prices, regardless of what currency they are set in, respond very little to exchange rates. Since the dollar is the predominant trade currency, this implies that exchange-rate movements have a much smaller impact on U.S. import price inflation than they do on inflation in other countries.
Addressing these areas will require breakthroughs in theory and empirical work, with more micro-level datasets on prices, trade, and capital flows being brought to bear.
George Mason University; 32
My candidate for the biggest unanswered question in economics is the status of the rationality postulate: the decision to analyze actors as utility maximizers with consistent preferences. If we view economics as an “engine” for understanding the world, the rationality postulate was that engine in nearly all of economics until quite recently. The rise of behavioral economics has challenged the usefulness and, in a more subtle but radical way, the legitimacy of the rationality engine. While only a minority of economists would describe themselves as “behavioralists,” behavioralism has affected many more by influencing the kinds of questions economists consider important to ask and influencing the kinds of answers to those questions they consider illuminating. These influences have the potential to profoundly affect the way economics is done, and thus what economics is able offer our understanding of the world.
At the moment, most behavioralism avers merely to “fine tune” the rationality engine rather than replace it. But even such tuning can have and, as I intimated a moment ago, I think has already had, a noticeable impact on how a growing number of economists and those following them interpret society. To the extent that economists’ view of, say, markets as reflecting rational vs. irrational systems—or, more specifically, their interpretation of economic crises as the product of markets responding rationally to poor policy vs. the product of endemic irrational decision-making—either directly or indirectly influences public policy, the way in which the status of the rationality postulate is resolved will not merely shape what economists are doing. It will shape the kind of society we inhabit.
University of Chicago; 27
In his famous 1945 article, “The Use of Knowledge in Society,” F. A. Hayek argued that despite their inequity and inefficiency, free markets were necessary in order to allow the incorporation of information held by dispersed individuals into social decisions. No central planner could hope to collect and process all the information necessary for social decisions; only markets allowed and provided the incentives for disaggregated information processing. Yet, increasingly, information technology is leading individuals to delegate their most “private” decisions to automated processing systems. Choices of movies, one of the last realms of taste one would have guessed could be delegated to centralized expertise, are increasingly shaped by services like Netflix’s recommender system. While these information systems are mostly nongovernmental, they are sufficiently centralized that it is increasingly hard to see how dispersed information poses the challenge it once did to centralized planning.
Information technology thus fundamentally challenges the standard foundations of the market economy. For many years to come, economists will increasingly have to struggle with this challenge. Some will harness the power of the data and computational power provided by information technology to provide increasingly precise and accurate prescriptions for economic planning. Others, who value the libertarian tradition that has often been associated with economics, will be forced to articulate other arguments, perhaps based on privacy, that are not susceptible to erosion by the increasing power of centralized computation.
University of Pennsylvania; 39
Economics is in the midst of a massive and radical change. It used to be that we had little data, and no computing power, so the role of economic theory was to “fill in” for where facts were missing. Today, every interaction we have in our lives leaves behind a trail of data. Whatever question you are interested in answering, the data to analyze it exists on someone’s hard drive, somewhere. This background informs how I think about the future of economics.
Specifically, the tools of economics will continue to evolve and become more empirical. Economic theory will become a tool we use to structure our investigation of the data. Equally, economics is not the only social science engaged in this race: our friends in political science and sociology use similar tools; computer scientists are grappling with “big data” and machine learning; and statisticians are developing new tools. Whichever field adapts best will win. I think it will be economics. And so economists will continue to broaden the substantive areas we study. Since Gary Becker, we have been comfortable looking beyond the purely pecuniary domain, and I expect this trend towards cross-disciplinary work to continue.
Photo Credit: JFunk/Shutterstock.com
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