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Saturday, June 23, 2007

Is Economics a Science?

I thought I'd return to a topic that comes up here occasionally. Alvin Roth says of course economics is a science:

Is Economics a Science? (Of course it is...), by Alvin E. Roth: What follows is an unpublished letter to the Economist, responding to their negative conclusion to the above question..:-)

...Sir: In "News from the lab" ... it is flattering to read that Kagel and Roth (Handbook of Experimental Economics) is "the indispensable reference" on experimental economics. But it is distressing to read that because "...unlike physics, economics yields no natural laws or universal constants" it follows that "...with or without experiments, economics is not and never can be a proper science." By this definition, astronomy, geology, biology, perhaps parts of physics itself, and certainly psychology must not be proper sciences either.

Rather than quibbling about definitions, it may help to consider how laboratory experiments complement other kinds of investigation in economics, as they do in those other sciences. Let me give an example.

One strategy for looking at field data (as opposed to laboratory data) is to search out "natural experiments," namely comparable sets of observations that differ in only one critical factor. The benefit of using field data is that we are directly studying markets and behavior we are interested in, but the disadvantage is that in natural markets we can seldom find comparisons that permit sharp tests of economic theory.

In a 1990 paper (in the informatively named journal, Science) I studied such a natural experiment, involving the markets for new physicians in different regions of the U.K. in the 1970's. The markets in Edinburgh and Cardiff succeeded while those in Newcastle and Birmingham failed, in ways that can be explained by how these markets were organized. But as will be apparent to readers of the Economist, there are other differences than market organization between Edinburgh and Cardiff on the one hand and Newcastle and Birmingham on the other. So, how are we to know that the difference in market organization, and not those other differences, accounts for the success and failure of the markets?

One way to approach this question is with a laboratory experiment. In a paper in the Quarterly Journal of Economics, John Kagel and I report such an experiment, in which we study small, artificial markets that differ only in whether they are organized as in Edinburgh and Cardiff or as in Newcastle and Birmingham. Unlike in those naturally occurring markets, the market organization is the only difference between our laboratory markets. And our laboratory results reproduce, on a smaller scale and despite far smaller incentives, the results we see in the natural markets. So the experiments show that the differences in market organization by themselves can have the predicted consequences.

Does this "prove" to a mathematical certainty that the different market organizations are the cause of the differences observed in the natural markets? Of course not. Does it provide powerful additional evidence in favor of that hypothesis? Of course it does.

Alvin E. Roth

References cited:

Charlie Plott, at Cal Tech, also wrote an (also unpublished) letter in response to the same piece: at his suggestion it is posted here.


Charlie Plott's letter to The Economist:

The Economist
Letters:

The issues about laboratory experimental economics methods, addressed in your May 8 issue editorial, are not new. They have been examined extensively. The rapid growth in use of these methods is precisely because the implicit questions raised in your editorial have been answered in many ways. The issues are (1) whether or not there are principles of economics that can be observed operating under laboratory conditions and (2) what might be the value of using laboratory methods to study them, if such principles do exist. There is a third issue, which seems to grate against the editor's sense of what constitutes proper science, and that is how the profession as a whole deals with theories that are rejected by laboratory experiments.

Have experimentalists uncovered basic principles of economics? The law of supply and demand might be the best example. This principle, which predicts the price and volume of ultimate market equilibration, works with amazing accuracy under appropriate conditions. The price that is discovered in competitive markets is exactly the one predicted by an application of the competitive model. The nature of price stability and the information content of prices are both actively studied. The findings are robust, not depending on income, culture, education and perhaps not even age (since it seems to work with children). Furthermore, not only do multiple market systems follow the same principles, markets respond to institutional changes in predictable (but not always understood) ways. I think that no other branch of science can claim success in identifying principles that govern something as complex as a multiple market system with human participants. And, there is no need to stop with markets. Game theory and Nash equilibria are demonstrating similar powers of prediction. Circumstances have been identified where the models are stunningly inaccurate, yet even when the inaccuracies occur, experiments have been able to supply explanations from closely related disciplines, such as psychology.

Have the principles been put to valuable use? Experiments have played a central role in several major instances. These include the allocation of the rights to land at major U.S. airports, regulations governing pricing in natural gas pipelines, the Ethyl case in antitrust, the design of the auction mechanism used by the Federal Communications Commission, the architecture of the Regional Clean Air Markets in Southern California, the electric power markets in operation in Southern California, decisions regarding access to public railroad tracks, methods of allocating resources on Space Station Freedom, etc. Many other applications are underway. The editorial carried the implication that laboratory experimental work has no applications and that impression is seriously wrong.

Has the profession acted responsibly when the basic theories are rejected? The preference reversal phenomenon, used as an example in the editorial, was introduced to the economics literature by David Grether and me. The editorial reported accurately. We concluded that the phenomenon is inconsistent with all theories of economic decision making. Has the profession abandon the theories as a result? Of course not and it would be silly to do so. While the theories do have problems, paradoxes do exist, they nevertheless continue to help us understand phenomena of staggering complexity. They continue to help us design and implement very successful policies. Critics of the theories, scholars who relish in pointing out that the theories have been falsified, have produced absolutely nothing that will do a similar job. Much like the editorial, these scholars suppose that the sole purpose of economics is to study individual choice. They ignore the fact that much of economics is about markets.

The editorial did not provide many references for those who would want to pursue the issues. In addition to the excellent reference contained in the editorial, readers should be directed to sources such as Davis and Holt. There are also several other good books and collections of papers. (Douglas D. Davis and Charles A. Holt, Experimental Economics, Princeton University of Press, Princeton New Jersey (1993). Vernon L. Smith (editor), Experimental Economics, Edward Elgar, 1990. John D. Hey and Graham Loomes (editors), Recent Developments in Experimental Economics, Volumes 1 and 2, Edward Elgar, 1993. Daniel Friedman and Shyam Sunder, Experimental Methods: A Primer for Economists, Cambridge University Press, 1994. Elinor Ostrom, Roy Gardner and James Walker, Rules, Games and Common-Pool Resources,The University of Michigan Press, 1994. A new Journal Experimental Economics, Special Issues of Economic Theory.)

It is nice to know that the use of experimental methods in economics caught the eye of The Economist. However, whether or not economics or any other science, is a "proper science" according to the criteria used in the editorial, is probably not an answerable question. Of more interest to the readers are the existence of a laboratory experimental methodology in economics, its limitations, and the areas of potentially successful applications.

Professor Charles R. Plott
Edward S. Harkness Professor of Economics and Political Science
California Institute of Technology
Pasadena, California 91125

The letter was in response to a May, 1999 Economist editorial. For more on this, these pages from Alvin Roth's web page will keep you busy with more recent material on a variety of related topics:

Game Theory, Experimental Economics, and Market Design Page

For example, this is a link from the section called Short Expository Papers:

Various Critiques of Experimental and Behavioral Economics

    Posted by on Saturday, June 23, 2007 at 02:52 AM in Economics, Methodology, Science | Permalink  TrackBack (1)  Comments (46)

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