How Economics Lost Itself in Data

Today’s researchers have tossed out price theory and don’t realize they’ve been politically compromised

By Alexander William Salter. He is an associate professor of economics at Texas Tech University. Excerpt: 

"Data doesn’t interpret itself. Contrary to the rallying cry of this new breed of economists, we cannot “just let the data speak for itself.” What and how you measure rely on theoretical judgments about how markets work. The way you understand concepts like competition, barriers to entry, and market power can completely change how you interpret identical data. Is an industry with a small number of high-earning firms oligopolistic due to its concentration? Or is it competitive due to continued customer satisfaction? Price theory helps us make sense of these questions. Going to the data without a strong theoretical grounding is an invitation to confusion.

The heights of the economics profession are increasingly inhabited by people who disdain price theory. Reliance on the economic way of thinking in solving problems is viewed as obsolete and unscientific. The data jockeys think they’re cutting-edge, but they’re merely repeating old mistakes. In the late 19th and early 20th centuries, economists of the German Historical and Old Institutionalist schools thought they could make do with history and statistics alone, unconstrained by theory. In the end, they got so bogged down in details that they came up with very little that lasted.

A common anti-price-theory trope is that its practitioners are political ideologues masquerading as scientists. The opposite is closer to the truth. Old-school economics recognized that trade-offs and constraints are everywhere. There are no free lunches. Armed with price theory, economists resisted the politically appealing but economically unsound proposals of both the right and left. Today’s economists, innocent of price theory, have no such armor.

The atheoretical approach of contemporary economists makes them particularly susceptible to the technocratic pretensions of the center-left. If, contrary to the claims of price theory, there are no enduring laws of economics, then there is no reason to stop the technocrats from tinkering. Many of these economists don’t realize they have been politically compromised. They see it as “just the facts, ma’am” pragmatism. In reality, it is ideology sneaking in through the back door.

As an example, consider the corporate tax cut debate of 2017. At issue was whether labor or capital would benefit from the cut. Price-theoretic economists such as Greg Mankiw, Casey Mulligan and Steve Landsburg predicted big benefits for workers. Empirical pragmatists such as Gabriel Zucman, Emmanuel Saez and Larry Summers thought this prediction was not only unscientific but borderline dishonest.

As it turns out, Team Price Theory was right: Workers saw large wage increases after the corporate tax cut. Because capital adjusts over time in response to tax hikes, labor is left bearing the brunt of the reduction in productivity. But the reverse is true, too: Cut taxes on capital, and labor will gain big. The long-run adjustability of capital is a classic price-theoretic result. Score one for the old school.

While the divergence between price theory and pragmatism is obvious in policy debates, policy isn’t the biggest issue here. What the government should or shouldn’t do is a value judgment. An economist could agree with Messrs. Mankiw, Mulligan and Landsburg about the growth effects of corporate tax cuts but oppose them on deficit grounds, for example. Nevertheless, that the supposedly ideological and unrigorous economists came out on top in this kerfuffle shows that by scientific standards—intelligibility and predictability—price theory still matters."