When can economists claim to "understand" an event or phenomenon?

Question

It's a common refrain that economists still don't have a solid grasp of the causes of business cycles (in particular, the Great Depression), despite decades of serious study. What would it take to say that this (or another event/phenomenon -- economic growth, the collapse of the Soviet Union, the causes of inequality) is "understood"? Are any key questions in economics "solved"?

Some additional questions for discussion- Can economists say that they "understand" something when they can craft policy to manipulate it as desired? Does the ability to predict phenomena constitute "understanding"? Is something "understood" when there is a broad consensus in the profession?

Answer 1

I'm not sure there is a correct answer to this question (or if there is, we don't understand it yet!), but here's a first shot at an answer:

Even if you look at the natural sciences, there is a process whereby ideas are refined over time. In the 17th century people 'understood' mechanics thanks primarily to Newton. But that didn't mean Einstein couldn't improve on the theory with relativity. One approach would then be to say that we never really understood mechanics in the first place, we were just confused until Einstein came along. But that binary view of understanding sets a very high threshold that economics may never meet; indeed, by that standard it might very well be that humanity never truly understands anything. I think most good scientists would be very cagey about ever describing a problem as solved—theories cannot be proven correct, only 'not disproven' and subsequently improved.

An alternative view would therefore be that understanding is measured on a continuous scale so that partial understanding is recognised and new discoveries refine that existing understanding. One might then define something as (at least partially) understood when

1. Economists share a broad professional consensus on the matter.
2. The consensus view is consistent with available empirical data.
3. The consensus view represents a meaningful contribution over and above the knowledge that might be expected of a lay-person.

An issue for which economics performs better on all three dimensions might be said to be better understood.

• Something like the effect of a rent ceiling, the role of adverse selection in a market, the potential benefits of free trade, or the static welfare effects of monopoly appear to be fairly well understood (at least by social science standards) because economists are in broad agreement, these things are not well-understood in society at large, and economists' views on these issues are generally bourne out empirically.

• Things like the effects of a fiscal stimulus, the dis-employment effects of a minimum wage, or the dynamic relationship between competition and innovation seem to be less well-understood because economists frequently disagree on these issues—both with each other and with the data.

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The rationale for the three components of the definition is as follows:

1. Consensus is not a direct measure of understanding. But I include it as a proxy to get at the fact that there are some areas of economics in which seemingly convincing theories that match some aspects of the data quite well are in direct conflict with alternative theories that also do well in some respect. It seems like having two conflicting views on an issue that you are not able to reconcile ought to be penalised in any measure of understanding.

2. Obviously, economics is an empirical undertaking—it aims to describe and explain empirical phenomena. A description of or explanation for a phenomenon that is not consistent with data is clearly not part of a good understanding of that phenomenon.

3. This criterion is aimed at getting at the idea that economists have been especially successful in improving upon a common sense understanding of the world in some areas. In these areas, economists might be viewed as having a particularly good understanding relative to society at large. Consider two examples: (i) a monopolist will charge more when demand is less elastic; (ii) two countries can benefit from trade even when one of them has an absolute advantage in every good. Both are issues that economists agree on, but (i) is common sense whereas (ii) is utterly counter-intuitive. The definition is designed to capture the idea that understanding (ii) is more meaningful because society depends upon economists to figure such things out. Society could probably figure out (i) without economists' help.

Answer 2

Ubiquitous has provided a very good explanation for what constitutes understanding an economic problem. I'd like to address the second part of your question about what sort of "key questions" are solved in economics (if any).

First, the obvious. We have to talk about what meaningful economic problems are, that economists are best suited to address. This is my attempt at structuring the major issues (and there will probably be disagreements with the importance I place on some aspects).

Fundamental Problem: Scarce resources and unlimited human desire requires us to determine:

• What to produce and to do it efficiently, that producing more of a good does not reduce the production of another.
• How to allocate the goods efficiently, so that no one can be made better off without making someone else worse off.

Public Problem: Externalities absolutely reduce welfare. Public goods and services will not be allocated efficiently under normal market conditions, which absolutely reduces welfare, and require us to determine:

• How to find the least costly/burdensome way of internalizing externalities (including deadweight loss).
• How to end up at efficient allocations after subsidies and taxes, so that no one can be made better off without making someone else worse off.
• How to balance the social planner's public budget among infinite periods. (The state is not corrupt and increasing its welfare at the expense of others.)

Welfare Problem: Macroeconomic volatility absolutely reduces welfare. Poverty and persistent, large income inequality have negative externalities that reduce total social welfare. (You could also argue that poverty should be treated as a public good and so falls under the previous category.) These require us to determine:

• How to set macroeconomic stability policy efficiently, where the tradeoff between inflation and growth cannot be improved upon. We may be willing to improve one aspect at the expense of the other though.

• How to provide insurance against risk efficiently and broadly, where everyone is able to consumption smooth by accessing insurance that guarantees a basic level of welfare for themselves.

• How to guarantee a basic level of welfare for every user through a balanced budget tax or subsidy with the lowest deadweight loss.

The last section is probably the hardest for me to be precise about. Is poverty about absolute standards, relative standards, or being most at risk to suffer greatly from unemployment? What is everyone's marginal cost for eliminating poverty (especially problematic since it is probably a function of actual income)? Nevertheless, I think it's some of the most compelling material we have to deal with in economics; the reason we care about all this is because of human interest, and this is where we'll find the most competing interests.

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So what are some key questions in economics?

Here are some common, relevant ones, that are for the most part solved:

1. Are price controls welfare reducing? (Yes)
2. Are tariffs on trade welfare reducing? (Yes)
3. Do large federal deficits hurt a nation's economy? (Yes)
4. In an ideal economy, should we have floating or fixed exchange rates? (Floating)
5. Are metal backed currency standards garbage? (Yeeeeessssss)

Those are a few that I first think of when writing this. But there are plenty more that are unsolved:

1. How do we resolve the equity-premium puzzle?
2. When should a government subsidize trade to resolve the Myerson-Satterthwaite bilateral trade problem?
3. Is there really a feasible Walrasian auctioneer for [insert market here]?

Maybe these questions seem very small scale compared to other questions you posed above, but they serve as important foundations for understanding further ideas, or for the unsolved ones, they serve as long standing problems that probably require a whole new innovation to grapple with.