Probably the scariest revelation I’ve had in recent years is coming to undesrtand how little the experts at the top know what they’re doing, even as greater and greater trust is placed in them. As I’ve gotten older, friends have become CEOs, high level government officials, partners in law firms, and the like. While most are conscientious and careful, they are also generally, as a group, aware of their limitations. They are also aware that the public’s expectations and concomitant esteem for their respective roles is grossly out of proportion to their talents. But the academic economists, some of whom have moved laterally to advising hedge funds and the like, are as cocksure as the most precocious graduate students, replete with “six sigma” predictions and prognostications. And, as a consequence, a great many pension funds, homeowners, home builders, government authorities, foreign investors, FDIC insured banks, and other major institutions were long on housing well after the conditions for a major bubble had emerged. And they were cheered on by numerous economists and their explanations of “impounded information” and “efficient markets.”
The cause, in part, has to do with the empirical blindness of many economists, who eschew deep historical, data-driven inquiry for elaborate–indeed “perfect”–models, viz.:
The mainstream of academic research in macroeconomics puts theoretical coherence and elegance first, and investigating the data second,” says Mr. Rogoff. For that reason, he says, much of the profession’s celebrated work “was not terribly useful in either predicting the financial crisis, or in assessing how it would it play out once it happened.”
“People almost pride themselves on not paying attention to current events,” he says.
In the past, other economists often took the same empirical approach as the Reinhart-Rogoff team. But this approach fell into disfavor over the last few decades as economists glorified financial papers that were theory-rich and data-poor.
Much of that theory-driven work, critics say, is built on the same disassembled and reassembled sets of data points — generally from just the last 25 years or so and from the same handful of rich countries — that quants have whisked into ever more dazzling and complicated mathematical formations.
Consider the view of economists on something like free trade, for example. The free trade theory–a theory of comparative advantage–has been elaborated on by such diverse economists as Adam Smith and Ludwig von Mises. But respond that a particular country did well and prospered under protectionism–such as the US in the late 19th Century–and they will say that the country would have done even better with looser tariffs. Perhaps. But what fact would prove or disprove this theory? What kind of theory is it that can absorb any data set and not be adjusted thereby? This is not real scientific inquiry. It’s ideology . . . or religion.
It’s like Eliot Yeats said: The best lack all conviction, while the worst are full of passionate intensity.