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.