Monday, May 29, 2006

If you’re so smart, why do only politicians pay attention to you?

Politicians can’t live without economists. Every policy needs an economic rationale, and there are platoons of theoretical economists in think tanks and universities ready to opine at a moment’s notice. National well-being is measured in money, and economists are a convenient proxy for business.

Business people do fine without economists, thank you very much. Executives work hard to avoid the dismal science and its practitioners. Economists have directed some stellar business failures, like Long-Term Capital Management. LTCM’s board included two Nobel Prize winners in economics; it folded four years after its formation with losses of $4.6 billion.

Why is economic advice so essential in politics, but considered pointless in business?

First, politicians have learnt that wrapping themselves in science adds to their credibility. Conveniently, economists learned the same thing when they appropriated the mathematics of classical mechanics in the 19th Century. Economists and politicians happily conspire to stage a theater of scientific decision making about the economy.

Day-to-day business is, in fact, far more scientific than government policy making. The scientific method of trial and error works, since business moves rapidly enough to perform many parallel experiments. One can try ideas out in the market, and/or watch competitors doing it. When government makes law, the experiment takes longer to play out, and there are usually no controlled trials. Theoretical economists are needed to fake the experiments using their models.

Second, politics is about moral choices. Adam Smith, the founder of modern economics, was a professor of moral philosophy, and his heirs have stayed close to their roots. Economics is a curious science; when its predictions are contradicted by how people behave in practice, economists usually declare that the people are wrong, not their theory. It a theory doesn’t describe how people behave, they assert that it determines how people should behave, were they truly rational.

Since politicians love making moral judgments, they find economists to be convivial bed-fellows.

Third, politicians of every stripe can always find an economist to agree with them. Economics attempts to describe complex systems using simplified models where the assumptions make a huge difference. One can always find a plausible justification for any choice of model and assumptions, since the space of possibilities are so large. That model and those assumptions can then provide “economic proof” for the whackiest of policies.

There is really only one reason for businesses to take the advice of economists seriously: when they have to deal with artifacts constructed by economists, or deal with the government. The more esoteric instruments in financial markets are constructed on the basis of neoclassical economic models. Government spectrum auctions are the two-fer: one theoretical economist designs the auction for the government, and then all his/her buddies work as consultants to the bidders to exploit any weaknesses and loopholes that their friend had missed.

Update 5/31/06: Today's Forbes.com has a story from Chris Knauter about bidding in the FCC's upcoming spectrum auction. It's mostly an interview with game theorist Darin Lee. Excerpt:
"Anyone bidding in the FCC auction, which will sell off more than 1,100 licenses, will need deep pockets--and the help of game theorists, who specialize in a branch of math that studies how different players act and react to each other in complex situations: If X makes a certain move, how are Y and Z likely to react?"

1 comment:

Pippa said...

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I hope this is of some use to you