Does economics need less maths or more?

Mathematics is an indispensable tool for economists – but has it become too dominant in economics? Michael Kitson, Senior Lecturer in International Macroeconomics at Cambridge Judge Business School, suggests that an over-reliance on mathematics may have been an important contributory factor in the failure of most economists – in business, in government and in academia – to predict the international financial crisis.

In the wake of that crisis, many economists have questioned the principles of economics as practised today, particularly ideas around rational behaviour, or the idea that the economy will naturally return to equilibrium. “But often their solution seems to be that the mathematics used wasn’t good enough, that you just need to change the assumptions upon which the models were based,” says Kitson. “Better maths will help, but what will help more would be to allow economics to become an eclectic subject again. You need talented mathematicians, but they need to be talking to people in the real world.”

Kitson quotes a letter sent by Professor Tim Besley and Professor Peter Hennessy to HM the Queen in July 2009, responding to a question the Queen posed during a visit to the London School of Economics in November 2008: why had economists failed to spot the impending crisis? In the letter, Besley and Hennessy conclude that the failure of the “best mathematical minds in our country and abroad” to foresee “the timing, extent and severity of the crisis and to head it off … was principally a failure of the collective imagination … to understand the risks to the system as a whole.”

This lack of imagination will remain, says Kitson, “as long as economics remains tethered within the confines of mathematics”. He firmly believes that if economists placed less emphasis on maths and more on intelligence and insights gleaned from a wider range of evidence, including studies of history, anthropology, sociology and other social sciences, they might stand a better chance of avoiding the next crisis.

But distinguished scholar Dr William H. Janeway, also a managing director at private equity investment firm Warburg Pincus and a senior research associate at Cambridge Judge’s Centre for Financial Analysis & Policy (CFAP), thinks economists failed to predict the crash because the mathematics they were using was too simplistic. Dr Janeway accepts that mathematics used by economists, policy makers and others failed to predict the crisis, but he does not believe this was the result of over-dependence upon mathematics. He says economists need to use more sophisticated mathematics, not less mathematics.

"The assumptions used were reduced to a ludicrously simplistic level,” he says. “The more realistic the assumptions about human behaviour, social context – about the dynamics between people interacting with each other – the more challenging the maths has to become."

Dr Janeway is more positive about use of computer simulations to examine more complex systems. “One sign that confirms the opening of the economic mind is the growing acceptance of simulations as legitimate instruments for exploring the behaviour of complex systems.”

His view is that there has been a growing trend towards the use of more realistic assumptions in microeconomics and finance since the bursting of the dotcom bubble and that this work is now having an influence in macroeconomics.

He agrees with Kitson that simulations or analytical models should be informed by reading of history and of other social sciences, but says that sophisticated mathematics should then be used to determine the practical worth of those models and simulations. Without that mathematical rigour an economist is doing no more than “telling stories … which is what ideologues do when they want to justify policy”.

Dr Janeway notes with approval the work of economists such as Professor Hyun Song Shin at Princeton, where the “rational representative agent” concept has been supplanted by an approach considering the behaviour of “heterogeneous agents who are challenged to make decisions with uncertain outcomes … who … lack complete information and know that everyone else does as well.”

He points, in particular, to Hyun Song Shin’s book Risk and Liquidity, which examines the sometimes destructive interaction of investors and intermediaries in the capital markets. “There you see the outline of the mathematical models needed to understand the complicated interaction between the financial system and flows of cash through the production economy and the consumption economy.”

Yet Kitson, while recognising the insights that such models can provide, is still concerned by the extent to which maths continues to dominate economics:

"I am not convinced that the failure of mathematical economics can be repaired by doing more maths,” he says. “Economics needs to stop clinging to the notion that the complexities of human behaviour can be explained by algorithms or mathematical proofs."