Can economics embrace unpredictability?

In yesterday’s Financial Times, Gideon Rachman argued that the “soft” discipline of history should replace economics, which has failed as a hard science because it is unable to predict the future. While I agree with the view that mainstream economics has an excessive dominance over policy-making, the article relied a little too much on some widespread and surprisingly persistent misunderstandings about the nature of the future.

A central misconception is the belief that the “hard” sciences are predictive, while the “soft” sciences are not. Joseph Stiglitz was quoted on this point: “If science is defined by its ability to forecast the future, the failure of much of the economics profession to see the crisis coming should be a cause of great concern.” But a hard science such as physics can predict the future only in a very narrow sense. Given certain types of tightly constrained experimental set-up, it can predict specific types of phenomena. But when things get very small, as in quantum physics, even these tightly constrained predictions become probabilistic rather than precise. And when things are very complex, as in complex adaptive systems, fundamental uncertainties enter the picture that make it mathematically impossible to make reliable predictions. Given that the messy realm of human affairs is a complex and therefore uncertain system, the message physics holds for economics is that prediction will not be possible.

So if mainstream economics, rather than suffering from “physics envy,” paid a little more attention to physics itself, it might conclude that the quest for predictive power was a basic error. However, this does not mean that economic thought is not useful. After all, Keynes argued forcefully for the acceptance of fundamental uncertainty about the future, after his experiences running a proto-hedge fund. Nevertheless he forged useful economic theories, not despite unpredictability but because of acknowledging it. This goes some way to explaining his increasing popularity since the economic crisis.

The article compares the predictive ability of physics and economics with a simple example: “buildings constructed according to the laws of physics seem to stand, whereas policies and trading systems constructed according to the ‘laws’ of economics have a nasty habit of collapsing.” But buildings constructed this way only stand under a relatively narrow set of conditions – assumptions about the future – as earthquakes and hurricanes demonstrate. Physics cannot predict that a particular building will stand for a particular length of time. So while economics will never achieve the kind of absolute predictive power that even physics does not have, it might, with a little more humility, achieve policy prescriptions less prone to failure. But to do this, it would have to accept, as Keynes did, that it was working with the grain of unpredictability in the world, not against it.