GURU's new thematic bookshelf has volumes talking about how economists perceive and study the world. NES Professors and alumni give their recommendations and review books from their personal "shelves".
– Hi, Jack. Are you going to see the new Wim Wenders movie? Today is the last day.
– I would like to, but I can't. Tomorrow, we have a test in Russian. I still need to memorize some words. Otherwise, I will get an “F”.
– Come on. Tomorrow, between classes, you will take my cards with words. An hour of learning before the test and you are guaranteed a “B”.
– Okay, but the Redskins and Miami are playing tonight. If I don't study anyway, then I would rather watch the match.
– We can go to the 6 p.m. show and will be back by the beginning of the match.
– Okay. Just let me check how much money I have left before the next allowance payment: five, six, seven, eight dollars until Thursday. And I've run out of food stamps!
– Eat peanut butter sandwiches! Ah, I thought you really wanted to see this movie.
– I really do. Okay, my stomach can take it until Thursday. Shall we leave at a quarter to six?
This dialogue of two students from Paul Heyne's The Economic Way of Thinking nicely describes how economists make choices. “You think about the opportunity costs of a particular solution more often. You understand that life is one continuous trade off,” NES Professor Olga Kuzmina comments.
“Maybe the first thing that future economists learn (in Gregory Mankiw's Principles of Economics, it is, in fact, the second principle) is that the costs of anything should be considered as the costs of a missed opportunity. The real economic benefits and costs only manifest themselves in comparison with the nearest alternative,” Anna Schetkina, NES graduate and PhD student at the Wharton School of the University of Pennsylvania, explains. A classic example from textbooks is the cost of higher education: its economic costs include not only tuition fees, but also income lost due to the fact that a person was studying and did not work.
Anna gives an example from her own life: she asked friends to help her move to a new apartment and in return invited them to a restaurant. The dinner for six persons cost her $220. “It would not even occur to me to consider this money as costs: after all, moving company services would cost more than $1,000, which means that while spending $220 I was actually saving around $800. In addition, we got the opportunity to spend an evening in a new venue, have a delicious meal and discuss the latest gossip. A true economist always takes into account such benefits,” she says.
Cost saving is a kind of professional deformation of economists, NES Professor Konstantin Egorov says, adding that they constantly save (or optimize, as they say) time, money, and anything else. “It often gets totally absurd: for example, finding the fastest route can take much more time than it saves,” he notes ironically. “And the most distinguished and experienced of us have already got rid of this bad habit, thereby saving on efforts to save anything.”
Another feature of economists is that they take into account not only their own actions, but also actions of those around them, Dmitriy Muravyev, a Professor at the University of Michigan and NES graduate, says. “My friend who is a statistics expert wanted to predict stock prices based only on their historical values. He was very much surprised when I, without even looking at the figures, said that it would not work. Why? Because before him, millions of other smart people used the same data to trade. I advised my friend to apply his talents to less studied data,” Dmitriy recalls.
John Maynard Keynes once toasted economists as “trustees, not of civilisation, but of the possibilities of civilisation.” This is a very good point and the economic way of thinking, especially in a democracy, is an important condition for successful development, Paul Heyne once said. “After carefully reading his book The Economic Way of Thinking, you will begin to think like an economist, and will hardly be able to think in any other way,” Anna Schetkina notes. This is the easiest textbook you can imagine, based on examples and cases that are as clear and close to everyday life as possible, and besides, very witty and ingenious.
You can go through this book starting with questions at the end of each chapter. Heyne does not give answers (many readers boil over this in their reviews): he introduces a way of thinking that will help you find the answer yourself. Some questions are taken from everyday life: for example, why does a firm advertise that its products are expensive; what would happen if a large city decides to reserve a lane for emergency vehicles on each motorway; how to save paper napkins; etc. Others may seem abstract and philosophical: for example, how ignorance affects the elasticity of demand.
In some of his cases, the author refers to the “furious four” economists: Adam Smith, David Ricardo, Karl Marx and John Maynard Keynes. Imagine, for example, that they are ready to teach an introductory economics course. Each of them wants to have an 8-hour workday, and each has his own salary expectations. Marx wants to earn $4/hour, more than the preparation of the revolution brings him. Smith would prefer to teach moral philosophy and wants to earn $7.9/hour. Ricardo is the most expensive of all, but he will work less than others, since he also has a shoe business. Keynes is also expensive and collects donations for the benefit of the local symphony orchestra. After describing their requests (and at the same time wittily presenting the economists themselves), Heyne suggests drawing different supply curves considering, for example, how it could change if the public suddenly becomes very interested in moral philosophy.
Economic science has long gone beyond its classical definition. Today, it offers tools for studying society in very many respects, including seemingly the most philosophical topics: for example, what makes us happy. “We believe that economics should be engaged in the study of human relations, which in some cases can be expressed using numbers; it should be a science that studies both commodities and things that cannot be a commodity (friendship, freedom, efficiency, growth),” Czech economist Tomas Sedlacek wrote in his book Economics of Good and Evil (in this work he is looking for an answer to the question whether it actually pays to be good).
The book by Harvard Professor Dani Rodrik Economics Rules: The Rights and Wrongs of the Dismal Science is about the economic understanding of the world. “It is a typical book that teaches modesty, humility," Sergei Guriev, Professor and Provost of Sciences Po, says. It is devoted to economists and their models. In these concepts expressed in mathematical language, Rodrik sees both the strength of economics and its Achilles heel; he criticizes and honors economists for them. And he admits that most economists like to play with mathematical models more than spend time trying to grasp the essence of real-world phenomena.
“In our research, we allowed math to come out on top and suppressed the humane principle. And so we got distorted artificial models, which are useless in the real world.” Tomas Sedlacek, Economics of Good and Evil
Economists are often accused of only complicating the obvious by putting common sense into mathematical formulas, Rodrik writes. One of the many economists' jokes about their profession sounds like this: “An economist is someone who says, when an idea works in practice, 'let's see if it works in theory.'” Economists are often criticized for simplifying the picture of the world and excessive formalization. But it is the formalization and failure to take into account many circumstances that make economists' models useful, Rodrik explains. He (and many others) compares them with fables, which also sacrifice realism for the sake of a clear storyline.
According to Rodrik, math ensures that elements of a model – the parameters, behavior mechanisms and the main conclusions – are formulated clearly and transparently. Karl Marx, John Maynard Keynes, Joseph Schumpeter made a huge contribution to economics, but they formulated their models mainly in verbal form, and we still have endless debates about what these economists really meant. Rodrik recalls Alfred Marshall, who used mathematics to present a model, and then translated it into common language. Rodrik also tells students that economists use math not because they are very smart, but because they are not smart enough.
“A theory or its ‘assumptions’ cannot possibly be thoroughly ‘realistic’ in the immediate descriptive sense so often assigned, to this term <…> Any attempt to move very far in achieving this kind of ‘realism’ is certain to render a theory utterly useless.” Milton Friedman, Methodology of Positive Economics.
Rodrik's book teaches that there is no single model of everything in the world, Sergei Guriev notes. An economist, he believes, should not only be able to produce models, but also to respond to the question “what should be done here and now?” with the right model instead of the most beautiful or the most pleasant one.
The best way to test a model is to see how it works, to set up an experiment. Economists often do not have such a luxury as they are left with just the possibility to study natural experiments set by life itself.
We recommend listening to the episode of the “Economics Out Loud” podcast about the work of economists with the participation of the NES Rector Ruben Enikolopov and Professor of the University of Chicago Konstantin Sonin.
The research of David Card, who received the Nobel Prize in Economics in 2021, and his co-author Alan Krueger, who did not live to see that moment, is an example of how a natural experiment can dismantle the standard ideas of theoretical thinkers about the impact of minimum wage on unemployment. This case is described in their book Myth and Measurement: The New Minimum Wage Economy, recommended by NES Professor Evgeny Yakovlev. In theory, raising the minimum wage leads to firms hiring fewer workers. Meanwhile, data collected by Card and Krueger do not support such a relationship..
Natural experiments of the past are described in the articles collected by Jared Diamond and James Robinson (authors of nonfiction bestsellers) in a book called Natural Experiments of History (recommended by NES Professor Gerhard Toews).
A systematic study of natural experiments would allow us to significantly deepen our understanding of the powerful hidden forces that guide the long-term processes of historical, social, political and economic changes, MIT Professor Daron Acemoglu and his co-authors write in one of the articles in this book. Their own research was devoted to understanding whether Napoleon’s impact on the economic development of Europe in the 19th century was positive or negative.
In another article, Stanford University Professor Stephen Haber studies the development of banking in three countries of the New World – the United States, Brazil and Mexico (this is also the subject of the book Fragile by Design. The Political Causes of Banking Crises and Scarce Credit, written by Haber in collaboration with Charles Calomiris). These natural experiments, staged in the three countries, help to understand the role that political institutions play in the development of banking systems and how the lack of effective political competition limits competition in the banking sector.
One of the questions that arises when studying the results of natural experiments is whether statistical correlation itself can indicate a causal relationship, Diamond and Robinson write. GURU bookshelves have books that help to search for the cause of an event without confusing it with a simple correlation and separating ‘due to’ from ‘after’.
One of these books is The Book of Why: The New Science of Cause and Effect. Its authors, mathematician Judea Pearl and science writer Dana Mackenzie, introduce the reader to the fundamental concepts of statistics giving examples of real-life cases, NES Professor Olga Kuzmina says.
“What do we mean when we say, ‘That’s just a coincidence; it doesn't prove anything’? How does theory distinguish relevant facts from mere coincidences?” Paul Heyne, The Economic Way of Thinking
The last chapter of the book is devoted to data science and artificial intelligence. It gives you a clue to how, instead of looking for data correlation (that is, acting like an owl watching a mouse), the artificial intelligence learns to look for cause-and-effect relationships (that is, tries to understand why this mouse runs exactly in the particular direction that it runs).
Does health insurance make you healthier? Should the state save banks during crises? Was there a chance to save the life of the wife of the famous football player O. J. Simpson? These are some of the questions that MIT Professor Joshua Angrist, who received the 2021 Nobel Prize for his work on natural experiments, and Professor of the London School of Economics Jorn-Steffan Pischke use as examples to explain how econometrics works. In the book Mastering Metrics: The Path from Cause to Effect Angrist and Pischke introduce the reader to the ‘furious five’ methods of modern empirical research, Olga Kuzmina says, listing these methods:
- randomized experiment;
- instrumental variables;
- discontinuity design;
Perhaps, after this book you will start to look for a cause-and-effect relationship between different events in history employing one of the described methods, Gerhard Toews expects. In any case, it will increase the quality of discussions you will have in a pub and over dinner at a family gathering, he adds.