Economics, Science & What Works

By Joseph Calhoun

What works? That's the question my friend Bob Seawright asks in this post. Bob's post is a response to a recent NYT article, What Is Economics Good For?. Of course, that question is one that a lot of people have been asking after bascially the entire profession missed the Great Crisis of 2008. The bottom line, according to the NYT, is that economics "lacks the most important of science's characteristics - a record of improvement in predictive range and accuracy." The rest of Bob's post is an explanation of why that is so and it is well worth reading. But I want to comment on a statement at the end of the post:

Economics remains lost in an imaginary and mythical world where people are rational and the markets are efficient. That's their story and they're sticking to it with religious conviction if not fervor. The investment world isn't a lot better, even though it is supposed to be "marked to market" every single day. As William James famously noted, many people think they are thinking when they are merely rearranging their prejudices. That so many people will be forced to pay for that ideological failure - when market fragility inevitably rears its ugly again - is unfortunate in the extreme. If only they were more like Joe Friday - starting with just the facts and building from there. Doing so might provide us a more scientific economics and better investing too. Is it too much to ask to focus simply on what works? (Emphasis added)

"Is it too much to ask to focus simply on what works?"

In economics we can't even agree on what works. In fact, we can't even agree to a definition of "what works". Is the prosperity produced during the Clinton administration "what works"? Most would agree with that but there is an excellent argument that the "prosperity" of the Clinton years, or more broadly, the Great Moderation was a false prosperity produced by faulty monetary policy and that the mess we find ourselves in now is a product of 25 years of ever easier money. Another complaint might be that those years were marked by an uneven prosperity, one that only truly benefitted a small slice of the population - something that might also be a product of faulty monetary policy, or something else. What about another period? How about the 1950s for which a certain well known economist/polemicist seems to pine. The top tax rate was much higher then and there are economists galore who will tell you that fact alone largely explains the broad prosperity of the time. Is that what we should try now? Jumping forward to the Reagan era, the key to that period of prosperity, according to another tribe of economists, is that tax rates were cut drastically from those high rates that allegedly produced the equality and prosperity of the earlier period. So, what works? Post/Cum Hoc Ergo Propter Hoc may be too sloppy and simplistic for science but it is the very foundation of economics.

Even the facts are hard to ascertain with any degree of accuracy in real time. Policy - especially monetary policy - is made based on the present interpretation of incomplete data that is destined to be revised after completion, sometimes to such a degree that the chosen policy path turns out to be the exact opposite of the one truly needed at the time. Just the facts? We live in a world where the facts are only facts within the prism of the current policy paradigm. We live in a world where today's fact is tomorrow's footnote. We can't even accurately assess the health of the current economy much less predict the outcome of any combination of policies enacted today.

Economics is certainly not a hard science and I would venture to say that it isn't science at all. It isn't even a social science as it is practiced today. It should be the study of human behavior but most economics today either makes an unrealistic or biased assumption about the human behavior allegedly under study. In its purest form, economics is psychology. At its worst it is psychiatry. Neither, I must add, is known for providing concrete answers. I think if you explained to most people that economists are actually psychologists or psychiatrists in disguise, they would treat economists' pronouncements in more of the speculative realm for which those professions are known.

As for our profession, it is not now and never has been a science. Those who treat it as such are like the economists who want to take human behavior out of the equations that produce the model world they so fervently desire. Those tasked with providing investment advice face a nearly impossible task of navigating not only the human emotions that move the markets but also their own human emotions and motivations and, of course, those of their clients. At its best, the business of providing investment advice is art. At its worst, it is a criminal enterprise operated by someone unaware of its criminality.

I wish it were simpler my friend, but plumbing the depths of human nature is a messy and mysterious business. Neither economists nor investment advisers nor psychologists nor psychiatrists will ever master the complexities of the human mind.


Joseph Calhoun is CEO of Alhambra Investment Partners in Miami, Florida. He can be reached at

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