What Is an ‘Uneconomist’? He Might Help You Predict the Markets
first published in The Street | Nov 11, 2015

Pundits have taken a beating over the last few months. Equity market volatility, the Chinese economic slowdown, the Greek and Euro crises, U.S. growth, unpredictability in Fed policy, and geo-political chaos have made it difficult to generate sensible financial short-, medium- or long-term financial views.

This was a particularly volatile period, although most financiers and economists also entirely missed the credit crisis coming. The recent history of financial prediction has shown generally that we’re not much better at it than previous generations.

This dismal performance draws parallels to the cravat that Humpty Dumpty received in “Through the Looking Glass” by Lewis Carroll. The cravat was an “unbirthday” present given to Humpty by the White King and Queen to celebrate a day that was not Humpty’s birthday.

This same scenario may hold true for economists and financiers: it is perhaps time to coin another neologism, the “uneconomist.”

For the key to financial prediction is both to understand mainstream economic theory and yet often to put it aside, tinker with it, even turn it upside down or see its flaws when it comes to making practical investment decisions. The good financier needs, in other words, to be an “uneconomist.”

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Academic economics was largely hijacked over the last 20-plus years by a type of scientism — the idea that economics could be reduced to hard empirical science. Any credible economic theory had to be grounded in a series of quantifiable formulae. The result was a great deal of mathematics, but not a great deal of progress in economics. In general, if hard, immutable and mathematically definable laws are identified in a discipline, this should allow for rigorous, continually testable prediction of observable phenomena. This is what we find in various areas of physics, for example.

Unfortunately, the academic economists found that their mathematical models did not usually allow for successful prediction — whether of GDP growth, unemployment rates, movements in securities markets or interest rates.

This led some economists to retreat to the idea that their discipline was not about prediction. It was about a method of thinking, a cognitive approach. It trains the mind to think about certain problems (in this case politico-economic problems) in a particular way. But like philosophy it did not provide answers. The answers seemed to be hidden behind some impenetrable epistemological wall. Of course, economists only retreated to this position precisely because of their failure. Had they had the success of physicists, economics would all be about prediction.

But of course, the whole economic scientism model (something that actually was alien to economist John Maynard Keynes) was probably doomed from day one. The prediction of human affairs is different from the prediction of protons and electrons. It is not even clear what our society would look like if we could predict human affairs on a regular basis. It would profoundly impact numerous concepts, such as free will, moral choice and political freedom.

Instead, the problems of quantification and hard prediction in economics have become increasingly clear. They include: an inability to assess the group behavior of millions of moving parts (people); the self-referring nature of human prediction; the intrinsically normative nature of economics; and so on.

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It was the behavioral economists who first started to recognize also that human irrationality undermined many of the economists’ mathematical modeling, which was usually predicated on the arithmetically convenient assumption of rational agents. There are now a wealth of books that show the pseudo-scientism of modern economics for what it is, while simultaneously identifying the “craft” element in the discipline — see: Lecturing Birds on Flying; Can Mathematical Theories Destroy the Financial Markets? (Pablo Triana); Superforecasting, The Art and Science of Prediction (Philip Tetlock and Dan Gardner); Economics Rules: Why Economics Works, When it Fails, and How to Tell the Difference (Dan Rodrick).

The common feature of all these books is not that we should just ignore all the economists’ insights. There are plenty of useful, even profound, ideas embedded within economic theory that can help us in financial prediction and decision making. It is just that these ideas tend not to be immutable laws. They tend to be sign posts, markers or suggestions. This type of thinking about finance seems to come much closer to the patterns of thought of great investors, such as Warren Buffett. These investors have guiding principles but also flexibility.

In other words, the effective application of economic theory to financial practice is to use ideas when appropriate. In finance, it’s important to understand economic theory, but also to know when to let it go, to adjust it, and when to flip to another idea. The successful investor knows his work has something to do with economic tools. He may use some of them, but he knows also sometimes to invert academic, economic practice, and often to avoid immutable economic theory and modeling.

It is then that the good financier morphs into this strange type of analyst — the “uneconomist.”