Progress in economics
Economics is one of those endeavours where progress seems to be awfully slow at times. Unlike in the hard sciences like physics, chemistry, or biology where experiments and data can and do settle debates once and for all, theories in economics and finance can linger on for decades even though the empirical evidence against them is piling up year after year. This life beyond death of economic theories can be so frustrating that at least one economist has written an entire book about them.
The problem in economics and finance is obviously that we are dealing with humans who change their behaviour all the time, so there is always an excuse why a given theory failed in practice. “If the butter price in Poland would not have spiked, value would have outperformed growth”, so to say. Another important reason is that there are millions of people in business and finance who have learned about these subjects at university and then never bothered to keep their knowledge up to date with the changing consensus amongst researchers. This is why people can still get an audience with arguments how money printing leads to inflation and similar nonsense like that.
One of the goals with these daily missives is to help investors keep up to date with the latest rigorous research so they don’t make the same mistakes as other people do. That doesn’t mean I or my readers aren’t going to make mistakes. After all, knowledge changes all the time, and what we may consider true today may be considered naïve and wrong in the future. But even in economics and finance, knowledge doesn’t go in circles. We are not going to abandon one theory for another one, just to go back to the old abandoned one in the future. We abandon a theory or world view because there is enough evidence that this world view is incomplete or wrong and we move on to a better description and model of the world. But we are not going to move back to a description of the world where we know that it is wrong and why it is wrong.
This is why I was eager to see the results by a survey by Doris Geide-Stevenson and Alvaro La Parra Perez that is done once every ten years among the members of the American Economic Association (disclosure: I participated in that survey). Going back to 1990, this survey allows us to track how the consensus among economists on key topics changes over time and where it doesn’t. It also allows us to see where there is consensus in the first place.
In 2020, they asked professionals about 46 topics and found some areas where there is strong consensus, such as:
Tariffs and quotas usually reduce welfare
The distribution of income in the US should be more equal
Immigration generally has a positive economic impact on the US economy
The long run benefits of higher taxes on fossil fuels outweigh the short run economic costs
Universal health insurance coverage will increase economic welfare in the US
And then there are areas where there is little consensus, such as:
The economic benefits of an expanding world population outweigh the economic costs
The level of government spending relative to GDP in the US should be reduced
Macro models based on a “representative rational agent” yield generally useful and reasonably accurate predictions
Reducing the tax rate on income from capital gains would encourage investment and promote economic growth
Some of these debated issues are in effect the result of a change in consensus amongst researchers. Take for instance the question if a growing world population outweighs the economic costs. In 2000, 63.5% of economists disagreed with this statement and the rest agreed or largely agreed with it. By 2020 the balance has flipped with only 42.4% disagreeing and 57.6% agreeing.
Even more importantly because it is a trope that is still promoted amongst practitioners is the statement that “a large trade deficit has an adverse effect on the economy”. In 1990 two out of three economists agreed with this statement. Today, two out of three economists disagree and reject that statement. We know today that large trade deficits are nothing to be afraid of.
Similarly, the consensus about government deficits has changed (unbeknownst, apparently to many conservative politicians). In 1990 42.2% of economists said government deficits should be reduced and 38.6% said that’s not necessary. Today, with government deficits higher than in 1990, 57.3% of economists say that deficits need not be reduced and are nothing to worry about, while 23% say it should be reduced. The people who agree with the more general statement “a large budget deficit has an adverse impact on the economy” dropped from 39.5% in 1990 to 19.7% today, while the share of economists who disagree rose from 14.1% to 38.6%.
And finally, my favourite: “Management of the business cycle should be left to the Federal Reserve; activist fiscal policies should be avoided”. In 1990, at the end of the Reagan and Thatcher revolution, there was substantial consensus that this statement is correct with 71.6% of economists agreeing or largely agreeing. Today 66.6% of economists disagree with this statement and see a clear role for fiscal policy in managing the economy.