Economics is the field of knowledge that is concerned with the way the economy works. It consists of a collection of theories as well as a set of methods by which the theories are confronted with the real world. Does this make it a science? Although many would say yes, some would claim that for a field of knowledge to claim the status of a science, it must be possible to test its theories under laboratory conditions. On this criterion, although experimental economics is in fact an interesting new development, economics fails to be a science. We economists must mainly rely on the real economy to provide us with the data we need to confront theories with facts. Subject to this limitation, economics is a science in that it attempts to analyze the workings of the economics system by the use of scientific methods. Theories that have been confirmed by the use of scientific methods can be use to make predictions about the future and so make us better able to make rational decisions, both at the level of the individual firm and consumer and at the level of the nation or the international community of nations.
The history of economics as described in my book Economics Evolving (Princeton University Press, 2011) has a number of examples of predictions derived from theories and observations. Some of them are generally judged to have been failures while others have been more successful. At the end of the eighteenth century, the Englishman Thomas Robert Malthus published a theory of population growth which became for a long time a dominant influence on social and economic thought. On the basis of this theory, he predicted that wages in the long run would be stuck at the subsistence level, i.e. the level that is just sufficient to ensure the survival of the working class. His argument was that if wages were to rise above this level, workers would have more children, and the resulting increase in the work force would have the effect of pushing wages down again. The dramatic increase in living standards over the last two centuries, at least in a large part of the world, shows that this theory must be wrong. But was it a failure? The prediction as such cannot be judged a success. On the other hand, the way that Malthus formulated the growth problem as a race between population and resources has been of great importance for the development of more successful approaches to the study of economic growth, making him one of the most influential economists of all time. Unsuccessful predictions may lead to scientific progress, so that the distinction between successful and unsuccessful predictions is less clear than one might at first believe.
The Malthusian theory of population is theory on a grand scale. On a more modest level, the French economist Antoine Augustin Cournot, writing in 1838, put forth the hypothesis that he called the law of demand. This law is the proposition that as the price of a consumer good falls, the quantity demanded will increase. Some would say that this is so obvious that we do not need an economic theorist to convince us of its truth. However, it was the first time that the proposition was stated in a precise form that allowed it to be formulated mathematically and illustrated in a diagram that is now familiar to every first year – or indeed even first day – student of economics. Cournot was careful to point out that the relationship between price and demand must be built on the assumption that all other factors that have an influence on demand, such as the consumers’ tastes and average income, are kept constant during this thought experiment. But how can the thought experiment be converted into a statistical test of the hypothesis? Cournot suggests that we can make observations of price-quantity combinations at different times or in different locations, plot them in a diagram and connect them by a curve. But Cournot’s suggestion suffers from the weakness that in the real world all other things are not constant during our collection of the data. So how do we know that the observed variation in the price is the cause of the variation in the quantities? A hundred years later, problems of this kind became the focus of attention in the field known as econometrics which attempted to combine economic theory and statistics for the purpose of deriving more securely founded conclusions about the functioning of the economy. Once again, a faulty suggestion led to improvement in research methods and better insights into the workings of the economy.
In the nineteen-thirties, the English economist John Maynard Keynes advanced the theory that there was a stable relationship between income and consumption, known as the consumption function. He suggested that with an increase in income, consumption would increase also, but proportionally less than the increase in income. Statistical data for consumption and income for different income groups tended to support this view: The rich consumed a smaller proportion of their income than the poor. On this basis, Keynes (and particularly some of his followers) went on to predict that as society grew richer, demand would fail to keep up with the level required to ensure full employment. But the actual experience of most countries in the following decades failed to support Keynes’ hypothesis. In fact, the fraction of society’s income devoted to consumption turned out to stay roughly constant. Although Keynes’ theory seemed to be supported by data for a cross section of the population, it was not confirmed when one looked at the development of income and consumption over time. Clearly, there was a need for a new theory that could make the two sets of observation consistent with each other. Among the economists who rose to this challenge was Milton Friedman of the University of Chicago. He developed the theory of what is known as the permanent income hypothesis, by which individual consumption is related not to current but to permanent or normal income. He showed how this theory could reconcile the two apparently conflicting sets of observations and explain why Keynes was wrong regarding the long-run relationship between income and consumption. This was a major improvement in economic insight which came about precisely because an earlier theory had been proved wrong by the facts.
The interaction between theory and observation is obviously one of the hallmarks of a science, and by this standard, as demonstrated by my three examples, economics is clearly a science. While prediction forms part of the purpose of scientific economics, the fact that some predictions turn out to be wrong does not make economics any less scientific. Indeed, if the predictions of economics could neither be shown to be right or wrong, they would be without real content. Identifying errors and using them to develop new and better theories is at the heart of scientific progress – of economics evolving.
Agnar Sandmo is professor emeritus of economics at the Norwegian School of Economics and Business Administration. He has been described by economist Avinash Dixit as “one of our clearest thinkers and most lucid expositors.” He is also the author of Economics Evolving: A History of Economic Thought, a new book that describes the history of economic thought, focusing on the development of economic theory from Adam Smith’s Wealth of Nations to the late twentieth century.
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