What economists do: theory versus empirics

Down to dirty work today, as I make the bold claim to start talking about the guts of the economics profession. What are we up to? The first distinction in economics research methodology is ‘theory’ versus ’empirics’. Specialization has gotten to us in a big way here, in that theorists and empiricists don’t really associate at all.

So what’s what? Both methods are trying to attack similar questions – what happens if this changes, how do I achieve this, what is the relationship between these things – but use very different standards of proof. A theoretical ‘proof’ is to create a simplified model of reality to speculate on how the things might be related, while empiricists dig into big datasets to try to find the real-world relationship, the common problem being that things are pretty complicated. When economists talk about “applied economics”, they are using a label for the practice of statistical analysis of data in empirical economics research, so in some sense “applied” is not really an informative word here.

When we actually want to answer questions, say for policy analysis or just because we care, it is obviously smart to draw on diversity and explore the theoretical reasoning behind the relationship you’re interested in as well as whatever suggestive real-world evidence exists. Being that this isn’t what economic research papers do, this isn’t what economists do, though: we all do either one or the other whenever we write a research paper. Every economist is, first and foremost, a theorist or an empiricist (or both, but you see what I mean – they are distinct concepts at all moments).

The problem for empiricists is, in a way, harder than for theorists, because finding meaningful relationships in real data is surprisingly difficult, and assuming something away is a much more technical proposition when you have to kill it in your actual data rather than just in your abstraction. For example, if I see that the airport built a new terminal and that house prices went down, I can certainly argue that one caused the other, but actually proving it is a very different proposition. Econometrics is the branch of economics that tries to develop methods to analyze data where it’s difficult to infer causality. Of course, this problem is common to all statistical analysis, not just economics, and it is surely true that really strong evidence is revealed without fancy techniques.

A lot of economists do “applied economics”. Now this is going to be mostly just an anecdotal claim, but it’s certainly plausible to argue that the things that made economists decide to become economists seldom include a burning desire to trawl through huge datasets and run a bunch of regressions; the questions that can be answered in this way are interesting, sure, but the work itself is not a lot of fun. On top of that, despite the positivist teaching of economics, the proportion of time spent on the empirical methods is very, very small compared to the proportion of economics research that is empirical. Not that this is a bad thing: there isn’t a huge amount you can say about empirical methods before you’re actually in a position to use them (and again: not that much fun), but it might be presenting a drastically skewed picture of what it means to be an economist.

There’s actually a bit of a rift within empirical economics about the role of theory, which is a different matter entirely – I’ll try to paraphrase to the best of my ability. That rift concerns the seed of the empirical test being done – should it be explicitly associated with a theoretical model of the relationship you’re looking for in the data (that’s ‘structuralist’), or should the data be allowed to speak for itself and leave models out of it (‘reduced form’)? Now, the funny thing is that, as we know, it’s possible to write down a self-contained and consistent theoretical model that proves any relationship you want; the value of the model depends entirely on how you judge the value of its own little world. Thus, employing theory as some kind of dual proof while doing empirical work is actually redundant; it can offer some clarification of what you think might be driving the relationship you’ve found in the data, but it’s not especially helpful to say “hey, I found this empirical evidence – and look, the model says the same thing!”.

Which, again, is different from the idea of puzzling out a theoretical idea then trying to find evidence to see if it’s true or not. This kind of thing is actually not incredibly popular, perhaps because of the vastly different worlds theorists and empiricists orbit in – different methods, different seminars, different journals. The paradox is thus that very little empirical economics research actually tests theoretical economic hypotheses. Does each approach lend itself to different questions, never the two to meet, or is it in fact just that we don’t like following on each others’ coattails?

Back to the big point. Let’s say I’m a research economist and I’m thinking of a question like this: “would a national health service be good for the United States?” What I will not end up doing is writing an answer to that question, drawing on the arguments and evidence from a variety of sources. The economist’s role in answering such questions depends on which flavor of economist he is. The theorist might end up asking “how would it change the problem for an individual if they were faced with a national health service rather than the current system?” She might create a little model of a person facing choices between spending their money on health care or on other things, who goes on to interact with an insurance company in one instance or the new health service in the other, and figure out how that person’s choices might plausibly change.

The empiricist might end up asking something like “how does the size of a deductible affect people’s health care spending?”, since this might tell us something about the zero-deductible world of national health care, or “how do wait times affect health outcomes?”. Note that to answer the original question – should the US switch systems – using any kind of data, or indeed any kind of theoretical model, is staggeringly complicated and difficult.

Neither type of economist actually writes about the answer to the big question in their academic research. Instead, they go to the questions that their method might be able to answer, making just one brushstroke on the painting of the argument, and for theorists and empiricists, those questions are very seldom the same.

One thought on “What economists do: theory versus empirics

  1. Jim, I encountered your post as the result of a Google Blogs Alert. You’re obviously a student of economics.I’m not. At least, I don’t have formal training in economics. (I’m an engineer who spent his life in engineering and manufacturing.) However, fifteen years ago, while visiting the St. Louis Science Center, I saw a graph on the wall that changed my life. The graph depicted the growth in the human population from the time of Christ to the present. It set me to contemplating what this meant for the future.The end result is a book I’ve recently published that I think you may find very interesting. The title is “Five Short Blasts: A New Economic Theory Exposes The Fatal Flaw in Globalization and Its Consequences for America.” To make a long story short, the heart of this theory is that, as population density rises beyond some optimum level, per capita consumption of products begins to decline. This occurs because, as people are forced to crowd together and conserve space, it becomes ever more impractical for them to own many products. Falling per capita consumption, in the face of rising productivity (which always rises), inevitably yields rising unemployment and poverty.Some may quickly dismiss me as a Malthusian. But, unlike Malthus, whose theory dealt with a shortage of food, my theory deals with space, and what happens when people are forced to conserve space and use it more efficiently. It may indeed be possible for man’s genius to overcome any shortages of resources through efficiency, recycling, substituion, and so on. But when it comes to space, the very act of attempting to use it more efficiently exacerbates the problem of falling per capita consumption and rising unemployment. This theory has huge implications for U.S. policy toward population management (especially immigration policy) and trade. The population implication is obvious, buy why trade? It’s because when we engage in free trade in manufactured goods with nations that are much more densely populated than our own, we actually import these effects of an excessive population density – unemployment and poverty. We become one nation economically. The work of manufacturing is spread evenly across the combined work force. But while the more densely populated nation gets free access to our healthy market, all we get in return is access to a market emaciated by crowding and low per capita consumption. The result is an automatic trade deficit. No amount of productivity improvement, dollar devaluation, etc. can have any impact because none of these alter the fundamental problem – the disparity in population density and the disparity in our markets. The relationship between population density and per capita consumption is borne out by consumption data from around the world. And one need look no further than our trade data to find proof of the effect of attempting to trade freely in manufactured goods with grossly over-populated nations. Using our 2006 trade data, an in-depth analysis reveals that, of our top twenty per capita trade deficits in manufactured goods (the deficit divided by the population of the nation in question), eighteen are with nations much more densely populated than our own. Even more revealing, if the nations of the world are divided evenly around the median population density, we had a $17 billion trade surplus with the half of nations below the median population density. With the half above the median, we had a $480 billion deficit! Through most of human history, the interests of the common good and business (corporations) were both well-served by continuing population growth. For the common good, we needed more workers to man our factories, producing the goods needed for a high standard of living. This population growth translated into sales volume growth for corporations. Both were happy. Economists looked upon this situation and concluded that population growth is always beneficial economically.But, once an optimum population density is breached, their interests diverge. It is in the interest of the common good to stabilize the population, avoiding an erosion of our quality of life through high unemployment and poverty. However, it is still in the interest of corporations to fuel population growth because, even though per capita consumption goes into decline, total consumption still increases. We now find ourselves in the position of corporations influencing public policy in a direction that is not in the best interest of the common good. In 1947, the United States signed the Global Agreement on Tariffs and Trade, turning its back on 170 years of tariffs that protected our domestic industries and built the U.S. into the wealthiest nation on earth – the preeminent industrial power. Why? Because disciples of Ricardo’s principle of comparative advantage, the economic theory upon which the concept of free trade is based, believed we could do even better by opening more markets. But now, six decades later, we find that our nation has been transformed into a skid row bum, literally begging the rest of the world for money to keep us going. This has happened because we’ve placed our faith in a theory – Ricardo’s principle of comparative advantage – that is overly simplistic and flawed. It is flawed because it does not take into consideration the effects of population density I’ve described above. I believe this theory has the potential to revolutionize modern thinking about the human population and its relationship to economics. To learn more about this new theory, please visit my web site at OpenWindowPublishingCo.com where you can read the preface for free, join in my blog discussion and, of course, purchase the book if you like. (It’s also available at Amazon.com.)Please forgive the somewhat “spammish” nature of this reply. I just don’t know how to inject this new perspective into a discussion without drawing attention to the book.Pete MurphyAuthor, Five Short Blasts


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