Why Can't We Run the Economy Better?
Economics and the limits of what it has uncovered
Why aren’t we better at running the economy?
It seems like we have so much information with many very smart people working on the problem, yet it still has its ups and downs. We can have good or bad economies, low or high inflation, unemployment, wages, or stocks. All of this is constantly in flux for forever, and it seems like it doesn’t ever get to a place where we can catch our footing.
It also doesn’t help that we hear economists make predictions that often seem closer to chance than deeply informed predictions. In an infamous example from the last few years Larry Summers, one of the most influential economists of the last few decades, made this prediction in 2021 about the economy in the coming couple years:
Larry Summers on U.S. economic outlook:
33% odds of stagflation
33% odds of recession
33% rapid growth, no surge in inflation
https://bloomberg.com/news/articles/2021-03-20/summers-says-u-s-facing-worst-macroeconomic-policy-in-40-years?srnd=premium&sref=cv51C53O via
@economics
If you’re familiar with the economic data you know that none of those three options happened. We ended up having high growth and high inflation for the last couple years with no recession.
This is one of the top economists in the world with all the data at their disposal who made a prediction and what actually happened was the unspecified remaining 1% “other”. How does someone that is this acclaimed and knowledgeable in their field fail so hard in predicting the future?
Why is Economics so wrong all the time, why can’t they get it right? Why can’t they be more like Physics where they seem to have a good amount figured out?
Economics is tough for many reasons, mainly due to the infinite variables that need to be taken into consideration. But the main point that I hope to impart in this essay is this: economies, and therefore the field of economics as we know it, are brand new relative to human history. The modern world with sustained economic growth is only about 200 years old. This is way too recent a phenomenon for us to know everything about it.
A Brief History of Economic Growth
In the last few years there have been a slew of books that have come out that attempt to tackle the history of economic growth. As part of a much larger project I have brewing I’ve been reading through these. So far I’ve read How the World Became Rich by Koyama and Rubin, Slouching Towards Utopia by Brad DeLong, and am currently reading Power and Progress by Acemoglu and Johnson.
Based on my reading of these books here is an approximate history of economic growth:
Before the year 1000 economic growth for the whole world was maybe .01 percent per year. In some areas there was more growth but it was never sustained (Jones pg 8)
From the year 1000 to 1820 economic growth across the whole world was around .05 percent per year. Again with some areas experiencing small bits of growth but never sustained over the long term (Acemoglu & Johnson pg 143)
Starting in Britain around 1820, economic growth climbs to about 1 percent per year and is sustained, it doesn’t die out after a few years like it had in other parts of the world. This continued until about 1870. (Acemoglu & Johnson pg 144)
From 1870 onward we got worldwide economic growth of about 2 percent annually that is sustained. Some places like the United States have economic growth of 3 percent or higher. This has continued roughly until the current day or at worse ended in 2010. (DeLong pg 3)
In simpler terms, the first time the world started to experience significant sustained economic growth was in 1820 and only in Britain. From 1870 onward that growth has spread to almost the entire world at an accelerated pace.
Before 1820 the average person’s life wasn’t all that different if they were born in 1000 or 1800. Sure there were technological advances, but for average folks outside the top 10% of people, very little had changed in terms of material conditions in those 800 years.
After 1820, the pace of change was quite rapid. The difference in living standards between the average person in 1824 is a whole different world than the living standards of someone in 2024.
It’s not so much that our lives and economic systems are truly first emergences of these phenomena, but that it’s still relatively new compared to the total history of human experience. To go back to the example of physics, Isaac Newton discovered gravity around 1665. This has been one of the foundations of physics since it was first formalized as an idea.
But the thing about gravity, and not to diminish Newton’s discovery, is that it’s forever and always been a pretty obvious factor in human life. Not only that, but the experiments that it takes to prove gravity or see the principles in action are pretty straight forward, hold something out and drop it and you’ll see it fall down. It’s been that way for all of humanity, it’s a condition we know well.
Sure there was economic activity before 1820, but nowhere near the level we have today. Before 1820 close to all economic transactions were between two people acting as individuals, with those individuals often being the producers and consumers of what was being exchanged. Something as basic in our lives as a corporation is less than two hundred years old. Even the idea of a larger “economy” beyond that of a city is just about as new. We haven’t been able to observe it for long enough and can hardly keep up with all the variables. It’s way too vast.
To put it into perspective how different this era of economic growth is, here's a little demonstration. Let’s say you had $1000 to invest in the world economy. First you try investing it in the world economy of the year 1000 and the investment lasts until 1820. Over those 820 years of that money growing at an annual rate of .05 percent of compounding interest you’d end up with a total value of $1506.66. Compounding interest means the added interest gets added to the original investment, and then the new percentage is taken from the new larger bit. When economies grow it’s compounding growth.
So for that $1000 you’d earn slightly more than a 50% return over 820 years. If you took that same $1000 and invested it in the US economy starting in 1900 to now, 124 years compounding at an annual rate of 3.2 percent you’d have $49,691.54. That’s a growth of over 4,800%. 50% vs 4,800% in an eighth of the time is insane. We are dealing with a world of truly different circumstances.
So knowing how the economy of a whole nation or the world is going to act is actually quite hard to do. In physics the apple you drop isn’t affected by someone across the world also dropping an apple, but in economics there can be stark effects from actions across those distances.
Economics’ tools in the micro sense are pretty good, like dealing with one transaction or company. The problem comes when you try to add all those small transactions into predictions for an aggregate economy, there are just too many variables.
Predicting how economies are going to run is much more like Atmospheric Sciences than physics. The study of weather has also made leaps and bounds over the last century. But the problem with predicting the weather is that to be able to perfectly predict the weather you’d have to measure literally every single molecule and atom on earth. Every single one can affect the weather and start something.
To be able to fully predict what an economy is going to do would require modeling every single transaction that does and does not take place. How is a model supposed to anticipate how often you’re going to go by the gas station for a candy bar on your way home from work? How is it supposed to predict when you’re going to start buying pasture raised eggs instead of the normal eggs? How does it predict a random storm happening and what actions governments take or not take to recover from the damage? Sure there are trends and averages that can be figured out, but sometimes the unexpected happens. Larry Summers was wrong in part because he wasn’t able to predict the war in Ukraine and the resulting energy and food inflation across the world. Events taking place anywhere in the world can affect the prices of the things you buy and what businesses are going to exist.
We as humanity are getting better at economics but it takes time. There are so many variables involved, and oftentimes we can only do educated guesses. Maybe someday we’ll have it all figured out, but we may still be at the beginning of the story. What if rapid economic growth continues for 1000 years? Or ends in 10 years? We don’t know! The full story is yet to be told, but there’s a good chance we’re still at the beginning. All of this is to say is that we aren’t exactly sure how to make the economy good for all people at all times yet. Maybe we’ll get there someday, but we still have a lot to learn.