Wednesday, January 21, 2015

Macro Economics: Time for a Rethink

You would expect the Economist to support economists. Presumably, several of the writers studied the subject. One day, they might want other economists to give them a job. Yet in the last couple of weeks, the magazine has gone a long way towards decrying their own profession. And I think they are right.

To be fair, one way they have been having a side-swipe at macro economics has been to praise micro economics. For years, the micro cousins did not get much of a look in, as the macro sort held court with politicians, businesses and social sciences. Models were in vogue, and macro economists thrive on models. Meanwhile, the nerdy micro sort, who ponder individual relationships between variables and look at smaller units such as industries or firms, were considered interesting to technical sorts but not likely to change the world.

There is something of a parallel with maths, which was my subject. The micro economist is the pure mathematician. I spent most of a term at college learning to prove that a path between two infinite parallel lines would at some stage have to cross any third parallel line in between the two. Well, duh. Like, er obvious man. Beautiful it may be but so what?

Meanwhile applied mathematicians got to learn how objects behaved in the physical world, and applicable ones could calculate useful probabilities. They actually used the pure maths proofs to do these things, but usually they started from them as premises and moved on.

Now, the pure mathematician is like the micro economist, while the applied one works in macro. So why are micro economists top of the pile right now?

The first part is what micro economists are doing well. They are thriving in the era of big data. Before, behaviour of individual customer groups might have been interesting, but there was no money in it. A firm might employ a macro economist to try to predict how a market would develop, but a micro economist would be an expensive luxury.

But this has changed. Now, firms using the web can understand each of their customers to a valuable extent. When I log onto a travel website, how long do I stay on each page, and which pages do I visit together? That information can be a good guide to how likely I am to buy – am I shopping to buy or just browsing? If I am a buyer, I can be steered towards information and value added products. If I am a browser, I can be sent to advertising screens. All this can happen within fractions of a second. In this way the firm can maximize its chances of a sale from buying me, while using browsing me to make itself more popular with its other paymasters, firms using their site to advertise.

In this way, internet firms large and small are growing their revenues, one customer at a time, and to do this they need micro economists, to work out which connections are relevant, build models, and create algorithms. As a customer, I find it all as rather creepy, as though people are looking over my shoulder all the time. But as someone interested in economics and value creation, I find it fascinating.

So someone coming out of economics school can build a career from their micro economic expertise now. But there is another reason macro economists are floundering. It is because they are doing such a bad job.

The most glaring example of this came with the financial crisis. Barely a single economist predicted this, beyond a few private Frazer’s who cry doom every year. Their models simply and utterly failed. And since the crisis they have been scrambling to try to explain it and to build new models, with a singular lack of success. The whole field seems broken just now. I have some sympathy for people like Christine LaGarde and Janet Yellen, who seem to be doing a great job simply by following gut principles. We should also be careful before condemning politicians like Angela Merkel. Austerity may be wrong-headed, but most of the so-called experts were advocating it until very recently.

I have a couple of bits of advice for macro economists, ideas which might help understand how they got into the mess in the first place.

First, it seems to me that many macro economists have forgotten whom their customers are, or at least become to closely allied to the biases of too small a customer group.

Who are they trying to please? First, their own profession, which has ingrained bias towards established principles even when these have been proven inadequate by events. Next, and more insidious, economists are closely related to businesses and think tanks, often allied to political ideology. So instead of the flow going from analysis to model to policy, it seems to go the other way. Some vested interest wants a policy, comes up with a supportive model and produces selective analysis to back it up.

In this way, macro economics can become like politics itself, in thrall to big money and powerful interests. I am sure there are many economists out there trying to do a good job without such bias, but perhaps they are swimming against a strong tide.

Linked advice is to focus on metrics, including challenging existing metrics. A classic one is GDP, long quoted as almost the first predictor of health of an economy.

Yet GDP is plainly a flawed measure. The Economist pondered how the softer gains from modern technology, such as speed and range of choice, could be measured, since GDP fails. In the same issue, we learn that the British economy is hamstrung by something technical about a gap between performance of British firms overseas and foreign ones in Britain, again missed in GDP.

GDP itself strikes me as a measure more for businesses than people. If you are an investor or run a business, you want the total economy to grow, since that will create more demand. But as a measure of well-being, worthy of trumpeting by politicians, surely GDP per capita is better. If GDP grows 10% but population grows 10% too, then people are no better off. Look at GDP per capita, and China does not look so smart, Europe and Japan not so hopeless.

Then, it matters where GDP comes from. Does it all go to wealthy investors? At least someone had the smart of idea of measuring median income a few years ago, since that feels a good measure for Joe public. There must be more such innovations available, if only economists were to actively look for them.

Not all GDP supports competitiveness either. We read that the cost of corruption and poor investment choices in autocratic regimes hamper competitiveness. But market economies have “bad GDP” too – look at the massive legal and healthcare costs in the US. Why has no-one tried to understand how GDP could be segmented?

Other well-used metrics seem to be past their sell-by date as well. Unemployment rate is an example. Work has changed: some choose to work less, while others are forced to work multiple part-time jobs. Metrics should be developed to understand this better, and such models could help drive good policy.

To be fair, the Economist does as good a job as anyone in challenging shibboleths. I just wish the profession it represents to follow its lead. That way society could benefit.


Come on macro economists, rise to the challenge! It is a wonderful subject, loaded with uncertainty and potential. It is a regret of mine that I did not divert from maths to economics – I have never really used my college maths. I hope a new generation can lead the dismal science to somewhere less dismal. Escaping the pockets of vested interests and seeking smart new metrics would be good places to start.   

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