Professor David Colander Tells Congress Econ Models are Flawed

This may sound like common sense to investors and traders, but most people -- including policy makers -- do not readily accept the flawed nature of economic models.

Thank goodness we have professor David Colander testifying to Congress in order to enlighten an otherwise dim room. Colander's work at Middlebury College focuses on the incentives and work-product of economists. His work has become increasingly more important as economists have heavily influenced policy making in recent years.

In addition to exposing a few absurd underlying economic presuppositions such as "individuals behave with rational self-interest," Colander is helping shift incentives for professional economists away from publishing toward engaging in more useful studies. Based on these noble efforts to save us all from flawed economic models screwing up our daily lives, we are proud to award David Colander our third Medal of Honor for Excellent Service in addition to Josh Rosner and Chris Whalen ...

Damien Hoffman: David, what type of economics do you research and teach?

David: I'm called the "Court Jester of economics." I'm the person who says what everybody knows, but appropriate people know better than to say.

I'm an economist watcher. I look at the incentives economists face, then understand and interpret economics through those incentives. So, I look at the economics of economics of economists [laughs].

Most people assume economists are searching for truth. In reality, economists are searching to achieve certain institutional goals like getting tenure, publishing articles, or doing a whole variety of things which may be related to truth. Therefore, there's all kinds of incentive compatibility problems. What's happened in pure macro theory I have considered a travesty for a long time and have written about it for the last 20 years.

Damien: How did this travesty arise?

David: The models are useful and were useful at some point, but they quickly lost their usefulness. In order to make them manageable they had to use so many assumptions that they deviated so far from reality and ultimately stopped shedding light on reality.

Over time, we should have considered much more complicated non-linear dynamic models and a whole variety of new models -- but economists didn't do that. They kept dotting I's and crossing T's on a very restrictive equilibrium model which assumed away many of the most important elements that cause fluctuations and lead to the interesting effects that we see in the real macro economy.

Damien: How did this all lead to you testifying to Congress?

David: The Congressional Committee heard of that work and invited me for that reason.

Damien: When you testified and said the models are too rigid in the face of unpredictable human behavior constantly changing in real time, was that too scary for legislators whose role in society is to increase order and reduce chaos?

David: I hope not because that's reality. If reality is too scary, maybe some people think we have to hide it. I don't consider that especially scary at all. It's just a statement of common sense and the reality of what we know.

As opposed to moving on after discovering problems with the models, economists continued looking at the same model. Perhaps they did so to avoid the scary dimensions that would have all kinds of results happening.

Joseph Schumpeter once said when talking about these models that, "Most of the non-linear dynamic models that I favor have multiple equilibrium." And, he said, "You have to assume away all these multiple equilibria if economics is going to have any chance of being a science." I consider that absolutely wrong. You have to deal with the fact that there are multiple equilibria if economics is going to have any chance of being a science.

Damien: Over the past 20 years, economists have slowly altered their image as more of a hard science when in fact it's a social science. How do we return to understanding an economist's role in providing information instead of elevating them to a high priest of finance?

David: There are many different roles for economists. There's some roles for highly mathematical economists who analyze and study systems. There's some roles for people who understand the institutions. The problem is that economics has forgotten those advantages and gives people incentives to work only on fairly esoteric problems rather than practical problems. That has to do with the nature of incentives in academia.

Damien: How did you suggest Congress deal with these incentive issues?

David: The only way to change anything within the system is to change the incentive structure of the people who are operating there. That's a basic economic insight. The way to achieve progress isn't through regulation and telling people what to do. The way to do it is to change the incentives they face so their incentives match what you want them to do. Currently, the incentives in academia are for publishing articles written for other economists. And all economists compete in the same dimension.

My emphasis has been there should be multiple dimensions of competition -- multiple types of outlets for economic research. And, they should be equally rewarded. Economists need more cross-disciplinary input from outside. I suggest having a variety of people on the reviewing committee such as physicists, mathematicians, politicians, and business people.

My second suggestion was we need a lot more people with expertise in interpreting models -- people who can understand the reasons for the modeling, why it was done, and the mathematics behind it. Then, those interpreters will spend time in asking, "Is this particular model going to be useful for a particular problem?" Currently, there's no incentive for economists to ask these critical questions.

Damien: If economists are not focused on the efficacy of their models, what role should economists be playing as policy makers?

David: It depends on the particular economist. The training that economists get in graduate school does not prepare them to be policy makers. Instead, it prepares them to be article writers. Policy makers require a much broader sense and understanding. They need to know institutions. They need to know politics. They need to know a whole variety of issues. Some economists have that ability. Other economists don't.

A lot of economists don't have those skills because they're not trained in them. They have to learn them on their own. So, whether they should be policy makers or not depends upon the particular characteristics of the individual economist.

Damien: How has the Federal Reserve dealt with this problem?

David: I don't think the Fed can be condemned for causing the problem or praised for avoiding it. They're part of the whole overall system. However, they've told me in order to recruit the top economists, they've had to change their incentive structure. The only thing the young people want to do is continue publishing.

I get scared when the Fed gets more worried about publications rather than policy. In the past, the people at the Fed were promoted because they wrote good policy memos and provided good advice. Currently, Fed employees are being promoted in the research division by how much they publish.

Damien: David, thank you very much for all your hard work. We wish you the best in your efforts.

David: Thank you very much, Damien. I am honored you considered me for this award.

 

Follow Damien Hoffman on Twitter: www.twitter.com/wallstCS

Comments

[Caliwoman]

This is why I left academia. Publish or perish has been mental masterb*tion for some thirty years, with more and more research being esoteric and absurd. In the case of public universities, that's our tax dollars often supporting irrelevance. Applied researchers and field researchers in the social sciences and economics are often looked down upon. Applied research journals are seen as less prestigous, so lower pay and less job security is awarded to the people trying to be relevant to the challenges of our time. I know I did more good in the short term in my other career path, but I do miss the teaching, and the students loose out to end up with the most boring professors with the least interest in teaching surviving. I remember a Soviet Union expert who had never been there and couldn't speak Russian. She counted nukes. Never mind after the fall of the wall it was proven her counting wasa joke, she still got tenure.

[ILibertine]

1) Economists studying dynamic equilibriums and self-interest theories and publishing papers concerning outmoded models,
2) Corporations extracting dollars in any manner possible in the realization of their immediate gratification self-interests,
3) A system of government based upon the commonwealth that fails to adequately represent its people and falls prey to the very gratification of self-interest that it should, ideally, check.

It all leads to here: everyone but the priviledged and corrupt few (not most of those in the prison management system) are put in a deep hole from which the fruits of their labors are drained to replenish the empty baskets of those whose linear concept of self-interest ran roughshod and cavalier over the welfare of a nation. "Scary", he says.

[S1m0n]

I wish I was a newspaper copy editor, sometimes, so I could write a headline like, "Colander: Economic Theory Full of Holes".

[dart79]

I hear there is an economic model based on common sense. Apparently, it's so simplistic that few can comprehend its relevancy and ability to predict the future.

[Overtone]

A new economic model has been suggested by L.V. Watkins. It builds on earlier work by the late Economist Robert Edmonds.

It began with the their development of the so far ignored Human Investment Tax Credit (HITC) program aimed at generating up to 6 million jobs and launching perhaps 4 million entrepreneurs. The 1977 Jobs Tax Credit proved it can work. That stripped down version generated 900,000 jobs - 20% of the jobs created that year!

Download the early 2009 version free at: http://www.aesopinstitute.org

A new version is in the works and will be titled: A Human Development Based Economy via a Small Business Development Program.

The Administration and Congress should discuss, and then fine-tune, this updated program and turn it into law without delay!

Another path to millions of jobs is described in the article: 5 Steps to Revive the Auto Industry and the Economy - on the same website.

It outlines revolutionary new technology that opens paths to cars that need no fossil fuel or re-charge.

The technology is not in the textbooks and will be greeted with extreme skepticism and disbelief.

However, independent laboratory validation of one breakthrough took place at Rowan University. It produced far more heat than can readily be explained by existing science, suggesting a new source of energy is involved. The experiments should be repeated at other laboratories. They indicate new technology can allow a barrel of water to replace 200 barrels of oil!

Imagine the economic potential!

[solarguy1]

It sounds to me as if Professor Colender's comments echo the CP Snow position on the schism between Art & Science during the last century. Snow asserted that the schism between the artist and the engineer could be bridged and should be a goal of both groups.

Phaedrus spoke to this in the book "Zen and the Art of Motorcyle Mantainence". Phaedrus's travel companion was as creative type who really didn't understand the workings of mechanics, while Phaedrus had trouble drawing a straight line without a Tsquare.

The divide still affects us a century later and will always divide us.

Now Prof Colender says the engineer-economist types lack the artistic insight to expand the models into a three dimensional solution and the humanities trained rhetoritician lacks the scientific insight into the workings of the engine of game theory.

I think CP Snow would smile.

[peterg76]

The majority of people know when economists are wrong because, unlike the economists themselves, they are the ones who suffer. Some economists study, but most study theoretical models that they know full well have no connection to reality.