August 17, 2011

I'm Back: Economic Musing Number One

First and foremost, I'm back from Hungary. Before now, I've been to Hungary just once, in 1987, back in the Communist Era. Needless to say, there were quite a few changes, mostly economic changes, between then and now. More about this in later musings.
Second of all, despite the title of this post, I don't intend to number all of the Economics Musings, and like I said in the previous post, I don't intend to write only Economics Musings. Nuff said.
Let's get down to business.
The main reason that I think that modern Economics is broken is that it's not a predictive science. Let's make this clearer: since at least the time of Isaac Newton, Physics has been a predictive science. We know with fantastic accuracy where hundreds of objects in our Solar System are going to be in the next few centuries (never mind the wonderful experiment of dropping your pen and checking whether and when it hits the ground!).
We can say the same thing about the predictive ability of Genetics since the times of Gregor Mendel. However, this is definitely not the case with economics!
Arguably the most important economic variable is GDP. Now, if one were to predict say the GDP in Israel in the next couple of years, one would probably not be very wrong, if one were to use the current GDP. So the GDP changes from year to year, but not by much, only a few percent. Needless to say that this adds up over the years, and if one were to predict the GDP of Israel 50 years from now, one would be in serious trouble!
But that's not all. The change in GDP is called Economic Growth, and it is also very important (the question of whether the Economy is in a recession or in a boom is a question of Economic Growth). Now Israel's growth was supposed to be something like 5% this year. Yesterday we found out that in the second quarter it was only 3.3% (on a yearly basis). Anyone care to guess what the 2011 GDP growth in Israel is going to be? (when more than half the year is over! this is predicting the present, not the future!)
Like I said yesterday we found out the the earlier prediction might be 50% off, and will almost certainly be at least 20% off. This is normal in Economics, hence my saying that current economics is not a predictive science.
Economists faced with this truth are saying to me things like: 'Look, Economics is hard, so many things effect GDP Growth, it's hard to predict!" They are right of course.
All I'm claiming is that given how many things effect GDP, the tools (equations, models) used by economists are too simple, and too simplistic.
More about this next week.