Technology

and Politics
Week 11: 
Can We Trust Economic Models?

College of Humanities, Hanyang University

Spring Semester, 2018
Why Discuss Economics in This Course?

 Economics as Technology
 Standard definition of ‘economics’
• a social science concerned chiefly with description
and analysis of the production, distribution, and
consumption of goods and services (Merriam-
Webster Dictionary)
 Economics as policy-relevant expertise
• From its very inception, economics has been
concerned with questions of public policy
• Has provided a series of technical tools for
managing, predicting, and analyzing economic
affairs
Why Discuss Economics in This Course?

 Economics as Technology (cont’d)

 Mathematization of economics
• From classical economics to marginalist revolution
• Neoclassical synthesis
 Emergence of macroeconomic modelling as a major
policy tool
• A system of equations and parameters designed
to represent the equilibrium conditions of the
complete economy
• Empirical Forecasting Models  Dynamic Stochastic
General Equilibrium Models
Video clips

 Ha‐Joon Chang on Economics

 Ha‐Joon Chang, a development

economist at the University of
Cambridge, U.K., and an author of
numerous international bestsellers
such as Kicking Away the Ladder:
Development Strategy in Historical
Perspective, Bad Samaritans:
The Myth of Free Trade and the
Secret History of Capitalism, 23
Things They Don’t Tell You about
Capitalism, and Economics: The
User’s Guide.
Macroeconomic Modelling

 Complexity of Macroeconomic Models

 Macroeconomic models used by the U.K. government
during the late 1970s typically had about 600 equations
and identities.
• E.g., an equation showing how consumption in
period ‘t’ is related to other
logCt = 0.628 log (Ct‐1) + 0.315 log (Ct‐2) + 0.165 log
(RPDIt‐1) − 0.0879log (RPDIt‐2) − 0.00365RLBt‐1 +
0.00161RLBt‐2 − 0.225 [log (PCt‐1/PCt‐2) + 0.0057] −
0.0111 [log (PCt‐2/PCt‐3) + 0.0057] − 0.196
 The numbers in the equations should be obtained by
looking at how things happened in the past
Macroeconomic Modelling

 Problems of Macroeconomic Models

 Problems of Data
• Existing data may be in short supply or inaccurate.
• Even when data are available, the equations may
come out differently if different sets of data are used.
• The ‘vintage’ of data may affect the outcomes.
 Choice of equations
• Economists have to make judgments which equations
to include in their model, what their form should be,
and how they are to be related to one another.
 The distinction between ‘theory’ and ‘guesswork’ is
not clear.
Macroeconomic Modelling

 Problems of Macroeconomic Models (cont’d)

 Macroeconomic models have to use information
about the environment (i.e., the state of the economy)
in which they are meant to work.
• E.g., population, population growth rate, the price
of oil, the state of world economy, etc.
• This kind of information is not generated by models
themselves  Exogenous variables
• When forecasts are to be made, the future values
of these exogenous variables have to be estimated
before the modelling can begin.
 Again, theory or guesswork?
Macroeconomic Modelling

 Problems of Macroeconomic Models (cont’d)

 Use of statistical techniques
 The outputs of equations do not have definite values,
but have probable values within a certain range.
The Case of ‘Seven Wise Men’

 Background
 In 1992, the British government appointed a panel of
seven renowned economists to predict the short and
medium term future of the British economy and to
advice the Chancellor of the Exchequer.
• Andrew Britton, Director, National Institute for Economic and
Social Research;
• David Currie, London Business School;
• Tim Congdon, Lombard Street Research;
• Gavyn Davies, Chief Economist, Goldman Sachs International;
• Wynne Godley, University of Cambridge;
• Patrick Minford, Liverpool University; and
• Andrew Sentance, Chief Economist, Confederation of British
Industry (CBI)
The Case of ‘Seven Wise Men’

 Failure?  None of their predictions provided the

type of information the government needed
The Case of Seven Wise Men

 How Could Macroeconomic Models Survive?

 Not only is there no agreement about which models are
the best, there is no agreement about what it would be to
be the best, and no agreement about what it would be for
an economic model to fail.
 Two approaches
• Economics as a heavily theoretical science 
The failure of prediction does not necessarily
indicate that of the underlying model.
• Economy is continually changing in significant ways,
and what we can expect from economic forecasts
are intuitive judgments.
The Case of Seven Wise Men

 How Could Macroeconomic Models Survive? (cont’d)

“I think there are really two different approaches.

One is to say that this is a branch of science and that
everything must be based on objective criteria which
people can understand.
The other is to say that is just too inflexible, and that
there’s something called judgement – intuition if you
like – which has its place in the sciences and that it’s
the people who are intuitive who are successful.”
(Andrew Britton)
The Case of Seven Wise Men

 How Could Macroeconomic Models Survive? (cont’d)

 License to be wrong?
• The ‘theory’ approach entitles one to be wrong
because the model is meant to represent only the
underlying structure of a varying reality;
• The ‘judgement’ approach allows one to be wrong
because there is never any expectation that one is
developing the kind of truth, accuracy, and
replicability which we expect under the standard
model of science.
The Case of Seven Wise Men

 How Could Macroeconomic Models Survive? (cont’d)

“I think tables of numbers are the enemies of good
forecasting. [Forecasts] should be judged by whether or not
they give a good idea of what the whole situation is going to
be like – what character it will have..” (Wynne Godley)
“[Forecasts] are all probability statements. All econometrics
is based on the idea of probability criteria, that you are
going to say that, you know, the likelihood of this result not
being consistent with theory is below 5% or something, and
you have to cut off at some point. You don’t get the one
definitive experiment which shows you that, you know, the
speed of light is the same in all directions.” (Andrew Britton)
The Case of Seven Wise Men

 How Could Macroeconomic Models Survive? (cont’d)

 Impossible to be wrong?
• If you choose to be concerned with stable structures
rather than detailed movements, you will not feel
accountable to quantitative errors.
• Small errors are always to be expected because of the
probabilistic nature of models.
 Input data may be wrong; certain terms can be
defined and measured in different ways; future
exogenous variables will have to be guessed at;
and a degree of judgement is inevitable.
The Case of Seven Wise Men

 How Could Macroeconomic Models Survive? (cont’d)

 Impossible to be wrong? (cont’d)
• Even if there are large errors, you may still argue
about the meaning of ‘large’ and you may still think
that the difference between accuracy and inaccuracy
was not clever economics but luck. You could always
say that the economy changed radically.
“The fact that virtually all the models, all the sort of formal
fully developed models failed to predict, suggests that it
was not that our model was particularly bad, but that the
underlying economy had changed.” (Andrew Britton)
 Basically saying that it was not the model but the
economy that was wrong
The Case of Seven Wise Men

 Experimenter’s Regress
 Experiments are working when they give the right
answers, but one knows the right answers only after
becoming confident in those experiments.
 Tests are needed to identify the problem ⬌
Difficult to judge the validity of those tests before
we get the results from them ⬌ Difficult to
evaluate the results without valid tests
 More uncertainties in economic models than in
natural science models
Politics of Economic Modelling

 Problem of Technocracy?
 If there is a scientific method available for doing the
job, decision making can become free from undesirable
social and political interventions. It would also relieve
politicians of some of their decision making
responsibility.
 Substitution of calculation for moral responsibility:
this depoliticization is, in fact, a very political
process.
 In some cases, esoteric economic arguments and
analyses are deliberately used as a way of avoiding
social and political responsibility or as a way of
mollifying criticisms.
Politics of Economic Modelling

 Problem of Performativity?
 Economic forecasts themselves often play an important
role in changing the economy.
 If one is a powerful forecaster, and we believe that
he or she is going to predict changes that will have
the effect of pushing industrial confidence up, it
makes sense for us to act on this prediction
immediately because the forecast is an element in
the change that is being predicted.
 The more people believe him or her, the more likely
is it that his or her forecast will come true.