Economics will continue to grow more empirical, more experimental, and more focused on understanding individual beliefs, expectations, and behaviors, according to panelists at "Honoring Gary Becker: A Conference."
These trends can help adjust, refine, and extend classical economic theory that doesn’t readily explain economic events of the last decade.
“Rationality—the notion that people acted rationally given their beliefs—has been enormously fruitful. Gary applied it to understand the economics of fertility, crime, and more,” said Andrei Shleifer, professor of economics at Harvard University. “It remains a very useful assumption, but for many questions that I consider important in economics today, it has outlived its usefulness. If we were to make forecasts, and that’s what we’re asked to do here today, I would put my money on relaxing these assumptions.”
“I think [economists] have to focus our energies on understanding how people think,” Shleifer added. “We have much more data than was available 20 or 30 years ago, with much more ability to get into peoples’ heads.”
His Harvard colleague Edward Glaeser took a similar view. After decades of “economic imperialism” that spread common views around the world and into other disciplines, “we have a battle on the home front,” said Glaeser, Fred and Eleanor Glimp Professor of Economics. “The events of the last 10 or 12 years challenge classic economic models. It’s also clear that great economists disagree on major aspects of economic policy; that was less true five years ago.
“Today, conventional rational models don’t get you very far. For instance, it’s very hard to understand why Las Vegas housing prices tripled in two years, then plummeted, with no obvious constraints on supply,” he said. “Fundamentally, we don’t understand what happened. We don’t have good models.”
Shleifer gave examples on the macro, intermediate, and micro level for seeking to better understand individual incentives and motivations. On the macro level, he cited Glaeser’s voting studies as evidence that social norms, morality, and religious beliefs shaped voter behavior more than their economic status or expectations. On the intermediate level, he turned to the 2007-08 financial crisis: “In order to understand what’s going on, we have to focus on incentives and moral hazard. But the bigger issue is that people really did have the wrong picture of the world. The essential reason people took on so much risk is that they did not understand how much risk they were taking on.”
Finally, he mentioned the Allais paradox as a specific example of a growing body of research showing that people’s choices often don’t follow economic theory, often because of loss aversion or other information biases.
Glaeser noted that economic imperialism had injected powerful ideas and methods from economics into many other fields. Few have done so more than Becker, who influenced sociology, law, and political science. Lately, Glaeser noted, “instead of imperialists, we’re Viking raiders on the shores, stealing ideas from psychology. The field of public health has also intruded on economics, not just in the analysis of insurance markets but in the notion of how healthy people are behaving.”
While generally acknowledging the benefits of free trade in ideas across disciplinary borders, Glaeser added, “I deplore the importing from psychology into economics the goal of being happy. Why are we privileging that emotion over all others? I can be firmly in favor of utility maximization and equally insistent that it has nothing to do with happiness. It has more to do with freedom.”
Still, he concluded, “the economic imperialism agenda is alive and well and will be stronger.”
Steven Levitt, the William B. Ogden Distinguished Service Professor in Economics and the College, predicted three directions economics research will take in the future. “The first is easy: Economics will continue to be an increasingly empirical endeavor,” he said. Greater availability of data sets and cheaper computing power will continue pushing this trend. “In the 15 years I’ve been at Chicago, Gary’s applications workshop has changed dramatically” in this direction, Levitt said. “It’s been very impressive to watch Gary to become a connoisseur of empirical research.”
Levitt, who has built a career at spotting natural experiments and never dreamed of creating his own, forecasted a second trend toward more experimentation, where economists set up randomized situations and create data. “It won’t look like what has come before. A lot of what has been going on is lab experiments, which have not been all that useful,” he said. “The challenge going forward will be how to come up with brilliant ideas and then really try to engage more intimately with true economic theory, testing in ways that truly randomization when accidental variation hasn’t been sufficient.”
Levitt’s final suggestion was more of a recommendation than a prediction. “We could do better as a profession at integrating theory and data,” he said. “We’ve gotten good at taking a pile of data and describing what’s in it. And we’ve gotten really good at writing internally consistent models. What we’re bad at is doing both.” While the current trend is to write down a model and apply analytical tools to test it on a data set, he saw a loss of transparency in that approach.
“I think we should be doing something very different: we should begin the exercise without the model. First, understand the data. Then decide, in the universe of models, which fit the data and which don’t. This means we must truly understand the mapping, the deep characterization. I think it’s a very different approach, but it fits more with the actual methods by which economists work.
Panel moderator Kevin Murphy spotted a common theme in the forecasts: “One thing that carries across all that’s been said here today is that I think we need to try harder,” he said. “The standard economic framework—the thing that carries across Gary’s work— still answers a lot, but we have to plug holes. As Steve mentioned, more analytical power has lowered the cost of plugging the holes, but the models still hold up.”
Murphy, the George J. Stigler Distinguished Service Professor of Economics, called for preserving the focus on markets. “One trend that worries me is a movement away from market analysis behavior in favor of individual behavior,” he said. “One of the things we know is that the market effect is not equal to the aggregate effect of individuals. There may be equilibrium effects.
“We need to put more and more market analysis back into economics; that’s what separates us from other scientists.”
Becker had the final word: “I want to put my oar in on rationality. What I see in the examples put forth here [such as voting behavior] are interesting questions, certainly things we should be exploring in economics, but I don’t see the challenge to rationality. I think where rationality literature has gone in the last 60 years is that it started from very narrow view, then expanded to take into account misperceptions. The challenge to the researcher is where the promise leads and how we expand or extend the theory.”