Tuesday, October 15, 2013

Nontrivial Economics

In his biography Surely, You're Joking, Mr. Feynman, Richard Feynman recalled a story about mathematicians at Princeton challenging him with counterintuitive possibilities. One example they gave him was an orange:
It often went like this: They would explain to me, "You've got an orange, OK? Now you cut the orange into a finite number of pieces, put it back together, and it's as big as the sun. True or false?"
And that was true for the special orange that we can keep cutting indefinitely. A mathematical orange. After some time spent listening such examples, Feynman just responded to each such case with "It's trivial!"—parodying his interlocutors.

It happens in economics, too. Mathematician Stanislaw Ulam famously asked Paul Samuelson to name an economic idea that is true and nontrivial. Samuelson took a long pause and suggested Ricardian comparative advantage as an example: a country with absolute technical advantage in producing any goods still benefits from trading with less efficient nations. Like the US buying vegetables from Liberia, in which agriculture still contributes more than a half to the GDP.

The definition of "nontrivial" is itself a trivial question: you can define it as you like and get the desired property. But generally, "nontrivial" is something that goes against popular opinion. Mathematicians hold an advantage here because in math you define your own rules, and other people remain too far from this world to make educated guesses. Economists pursue a different task: finding nontrivial results in the everyday world. If the results don't go against popular opinion, then what's the point?

And these nontrivial results happen to be more numerous than Ricardo's logic exercise in the 19th century. Each field offers its own examples:

Growth theory. Geography is a long-standing favorite in explaining the income gap between countries. The impact of bad weather on work is so natural, and who needs more? Still, the geographical hypothesis is far more advanced than, say, the assertion that countries are poor because of natural intellectual limitations of their populations.

In contrast to both these stories, the institutional hypothesis suggests endogenous causes of growth. It warns against the China hysteria: the opinion that this model is viable for economically advanced societies, and we soon may see the demise of democracy. Third, it suggests that direct financial aid to developing countries not necessarily improves these countries' growth prospects.

Macroeconomics. Anything that we find out about relations between inflation and employment, or the absence of thereof, is non-trivial. What about the efficiency of fiscal policy in economic downturns? Important arguments here cannot be discovered with just common sense.

Labor economics. In the well-known 2000 study of New Jersey and Pennsylvania fast food restaurants, David Card and Alan Krueger discovered that the minimum wage increases employment. The result was so counterintuitive for economists themselves that David Card had to clarify their position to explain political attacks that followed.

The wage example shows that most interesting findings basically inform us about our gaps in understanding. We had a too-simple model of labor markets: here is one reason to look deeper. Unlike mathematics, economics has little a priori knowledge. Whether the first derivative of a labor demand function is greater or less than zero depends on our ability to discover this function's parameters. When we discover these parameters, they necessarily surprise us compared to our previous experience. Non-triviality in science is just new facts uncovering old mistakes.

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