It was on this day 20 years ago that I formally started my career as a student of economics. I’d like to think that I’ve remained a student of economics ever since, and that as the field develops it continues to present new challenges and new opportunities to learn.

Here are some more philosophical reflections on what I’ve learned about economics in that time.

The science of rational behaviour

This is the definition I choose whenever I am asked to describe what the subject of economics is about. It goes beyond the often given definition (usually something about allocation of scarce resources) – because economics as a science concerns itself with understanding how economic agents interact in all circumstances. In that sense, it is fundamental to our understanding of the human world.

It has become popular to criticise economics because “people don’t behave rationally” and so economic models based on rational behaviour must be fundamentally wrong. But it’s a criticism that’s skin deep: behaviour that departs from an economic model doesn’t prove that the behaviour isn’t rational – all it proves is that model isn’t good enough.

Rationality – our ability to rationalise action – is much more fundamental than that. The philosopher of mind Daniel Dennett described how models of rational behaviour are central to our understanding of our fellow humans and ourselves. He gave this explanation of how we form an understanding of human behaviour:

“Here is how it works: first you decide to treat the object whose behavior is to be predicted as a rational agent; then you figure out what beliefs that agent ought to have, given its place in the world and its purpose. Then you figure out what desires it ought to have, on the same considerations, and finally you predict that this rational agent will act to further its goals in the light of its beliefs. A little practical reasoning from the chosen set of beliefs and desires will in most instances yield a decision about what the agent ought to do; that is what you predict the agent will do.”

Daniel Dennett, The Intentional Stance.

Behavioural economics is a (relatively) new and powerful tool for expanding the reach of economics. But it’s simplistic to say that the behavioural approach means leaving rationality behind: it means taking a much more sophisticated view of how to rationalise human behaviour, that’s not always about a narrow view of optimising behaviour. Humans are amazingly sophisticated creatures; calling them irrational the minute they depart from a model based on five lines of algebra is as patronising as it is wrong.

When you take on a challenge as complex as explaining human behaviour, no model is going to explain it all. In that sense economics is a bit like meteorology: how can you reduce an infinitely complex system to something workable, something that can generate insight?

It’s also the reason economic models are about as accurate as weather forecasts.

A methodology, not a set of models

The idea that economics is reducible to a set of models is at the heart of the problem. Some economists are like peacocks, wearing the ever increasing complexity of their mathematical and statistical models like vainglorious plumage. The idea of a “better” economist as one with a bigger more complex model is one that I have always resisted. Complexity for complexity’s sake does economics a major disservice. Economics is at its most powerful when the analysis is both as simple as possible, and as complex as necessary.

Earlier this year, the Nobel Laureate George Akerlof set out what he calls the “sins of omission” in an academic economics community that has fetishised mathematical “hardness” of problems, causing academics “to ignore important topics and problems that are difficult to approach in a “Hard” way”. The beauty of being an economic consultant is that you don’t choose the problems you work on. Real problems present themselves, and one must choose solutions that can both be understood easily and which stand up to intense scrutiny. Analysis that doesn’t take the real world seriously enough is quickly kicked to the curb.

Economics is not a set a mathematical and statistical models – above all, it is a methodology – a way of approaching problems. Decision makers of all stripes are constantly faced with competing claims. “We must do A, or otherwise B”; “C is the most important priority, it is a critical driver of D”. The job of economics is to construct a framework within which all these claims can be assessed. Good economics works out what the testable predictions of a theory are, and assembles all the relevant evidence to test it.

In that sense, economics is truly a science. Karl Popper, another great philosopher of the 20th Century, separated science from non-science according to whether its predictions were falsifiable:

“In so far as a scientific statement speaks about reality, it must be falsifiable; and in so far as it is not falsifiable, it does not speak about reality.”

Karl Popper

For Popper, a scientific theory needs to have predictions which it is possible to prove wrong with evidence. Economics has no shortage of those.

Policing the boundaries of capitalism

For something that catapulted a large majority of the world’s population out of sickness, death, hard labour and feudal servitude, capitalism gets a pretty rough ride. But even Karl Marx had to give it some dues:

“feudal relations of property became no longer compatible with the already developed productive forces; they became so many fetters. They had to be burst asunder; they were burst asunder. Into their place stepped free competition”

“its rule of scarce one hundred years, has created more massive and more colossal productive forces than have all preceding generations together. Subjection of Nature’s forces to man, machinery, application of chemistry to industry and agriculture, steam-navigation, railways, electric telegraphs, clearing of whole continents for cultivation, canalisation of rivers, whole populations conjured out of the ground – what earlier century had even a presentiment that such productive forces slumbered in the lap of social labour?

The Communist Manifesto

Marx predicted that capitalism would destroy itself – by concentrating ever more power in the hands of an ever more distant bourgeois class, it would sow the seeds of revolution. And in the early decades of the 20th century you could have been forgiven for saying he had pretty much called it.

But (spoiler alert) the last hundred years featured a major plot twist. Capitalism learned to save itself. It’s pretty obvious that capitalism, left to its own devices, leads to a disastrous concentration of economic power. Think about mergers: a monopoly is always more profitable than a competitive market.

In that sense, the economy is like a nuclear reactor: markets are incredibly powerful forces that can generate a lot of useful clean energy. But if they get out of hand, they can literally destroy the planet.

As the science of economics developed, it was able to articulate where the boundaries of capitalism should be set, pointing out the circumstances (and rules) that were needed to ensure that markets operated in service of society and not vice-versa. The concept of “market power” was born, and an army of lawyers and economists were assembled to police it with economic regulation.

So there you have it folks, economists are just like nuclear physicists and we are literally saving the world from destroying itself. Right, back to that RFI…