Why can’t economics be more like physics?

In recent months, physicists have been lamenting that economics needs to be completely revamped to be more like physics (for example see here).  Meanwhile, some nonphysicists are blaming physicists for our current mess (for example see here).  I will argue in this post that economics is not more like physics mostly because it is not like physics.  I also think that everyone on Wall Street from the CEO to the quants must share in the blame for the credit crisis.  However, I don’t blame the models they have used.  All models are based on a set of assumptions and it is up to the modeler to decide when they hold.

The first reason why economics and especially macroeconomics is not like physics is that it is almost impossible to verify theories.  The problem is even worse than in biology because in biology you can at least try to average over cells or organisms.  But in economics you only have one sample.  The analogy to physics would be to ask when a specific spin in a magnet would flip. The theories can only predict what the distribution will be.  For example, we can never really know if the stimulus package recently passed in the US will actually work because we can’t do the controlled experiment where we see what happens if we didn’t have the stimulus.  Even economists agree on this point (for example see what Harvard economist Greg Mankiw says).   So you can have prominent economists vehemently disagreeing on basic points like whether or not more government spending will help and they can always point to reasons for why they are correct.  That is one of the reasons why economics is so mathematical.  Without any strong empirical evidence, the best you can do is to prove theorems.

The second reason why economics is not like physics is that you can’t separate the normative from the descriptive.   For example, the celebrated Arrow-Debreu theorem shows that if you have rational players with full information in a market then there will exist an equilibrium state that is Pareto efficient, meaning that no one can improve on their  allocation of goods and income without making another person worse off.  See here and here for nice reviews.  Now, even if the assumptions were true (and they probably are not), who’s to say that a Pareto efficient market is fair.  Just because you can’t improve without making someone worse doesn’t mean that your situation is good.  Such a society could still have great income inequality.  A belief in free and efficient markets is not just an economic idea but also a normative one.  It is belief that we should let the market decide how resources are to be divided.  If you so happen to be blessed with skills and talent  then you should reap the benefits.  If you are not then so be it.  Some people may feel that that is not a society that they wish to live in.  They may feel that government intervention is necessary to make things more fair.  This debate will never be solved by a better understanding of the economy.

Now, this is not to say that ideas from physics wouldn’t be useful for economics.  Certainly, concepts like phase transitions or even gauge invariance could be applied to economics.  We can certainly get better at predicting what may happen or establish rules and regulations to make things work better.  But we can never be sure that they will work.  I’ve heard the argument that economics (and biology) needs a Newton or Einstein to start a new revolution.  However, actually I think what economics really needs is a Heisenberg or a Godel or a Turing.  What we really need is an economic  Uncertainty Principle (e.g. you can have local efficiency or global efficiency but not both),  or an economics Incompleteness Theorem (e.g. any regulatory regime that is consistent is incomplete and if it is complete then it is inconsistent), or an economics Halting Problem (e.g. there will never be an algorithm that can predict the next crisis or bubble).  Then, we will know that we must always be vigilant, that we can never know what may come next, and we must always be prepared to adapt.

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9 thoughts on “Why can’t economics be more like physics?

  1. Great insights, though it seems to me that you’re missing a really big reason why economics cannot be like physics, arguably more fundamental than the reasons cited above.

    When a physicist sits down, takes measurements, and creates a model for the way that planets go around the sun or electrons probabilistically occupy the space around a nucleus, the mere fact that he/she writes down those models (and espouses them widely) doesn’t cause the physical behavior of the planets or electrons to change (and luckily so!).
    On the other hand, if I hypothetically write down a model that accurately predicts tomorrow’s stock prices, that model only has value until everyone knows it, then quants would work to build a model that predicts stock prices two days in the future. In other words, the financial system itself has a feedback for the very models that try to describe it, rendering those models obsolete as a function of how much money is moved with those models as a guide.

    This is not to say that models of the financial system are impossible to write down, but it says that maybe it simply falls into a harder class of problems. Likewise, I’m sure we’re evolutionarily hard-wired to behave certain ways when given certain risks and rewards, such that some financial models will have broad relevance – our animal side/herd instinct has some power over us.

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  2. Hi Tristan,

    Thanks for your comment. I would say that your argument is more of why finance is not like physics and your example is a financial uncertainty principle – The act of modeling affects the system. However, the efficient market supporters would also argue that if the model worked then it was exploiting an inefficiency in the market and using it was making the market more efficient.

    Carson

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  3. Hi Carson,

    Been following your blog on and off – great post; enjoyed reading it. I think ‘quants’ (in finance or biology) are obligated to share the limitations of their models with their consumers and remind ourselves constantly of GIGO :)

    Biologists (& seems economists/finance folks too) are often so impressed by how much better math models do than mental models that they risk using them indiscriminately.

    -R

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  4. Hi Rukmini,

    Nice to hear from you. I think if you don’t fully understand the model, you may not also understand it’s limitations even when it is explained to you. I see this all the time including in myself.

    best,
    Carson

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  5. OHH Every now and again I find a web site that is a real source of useful information and content. This is one of those. A rare beast indeed. Keep up the good work. Kind regards

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  6. Look… We are comparing Apples and Oranges here. Yes they are both ‘Sciences’, but one is a ‘Physical Science’ and one is a ‘Social Science’. With that said, and wit my limited understanding of Physics (I’m an Economist), I do understand why the two sciences are compared:

    #1) In order for people to understand the gibberish coming out of our mouths, both Economists and Physicists get to draw cool graphs.

    #2) On a more serious note: Physics, like Economics is all about equilibrium, velocity, and force. We use like terms to express both the Physical Universe (Physics) and Human Behavior as it relates to Mans use of Resources (Economics). Unlike most there social science, economics, like physics use exact quantitative measurements, unlike most other social sciences. It is difficult to measure feelings, happiness, sadness, satisfaction or dis-satisfaction as would be measured in Psychology, Sociology, or Anthropology, but Economists can measure and/or calculate Price, Quantity, Velocity or other Production/Consumption Functions as a Physicist would measure Mass, Volume, Velocity, Etc.

    An example of like terms is how we use the word ‘Velocity’.

    Velocity of circulation (Economics): The speed with which MONEY whizzes around the economy, or, put another way, the number of times it changes hands.

    Velocity (Physics): Distance traveled by a body in a particular direction per unit time or the displacement of the body per unit time. It is a vector quantity.

    There is even a Economic Discipline called ‘Econophysics’! Econophysics is an interdisciplinary research field, applying theories and methods originally developed by physicists in order to solve problems in economics, usually those including uncertainty or stochastic processes and nonlinear dynamics. Its application to the study of financial markets has also been termed statistical finance referring to its roots in statistical physics. (Source: Wikipedia http://en.wikipedia.org/wiki/Econophysics#Basic_tools)

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