Theory Effect: Why Economics is Tougher than Physics
Many criticize economics as not being scientific, and it seems they're partly right. Working scientifically involves proposing and reasoning within established models. Models are abstract representations of the world with assumptions and rules that help us understand, explain, and predict phenomena. Most interestingly, one can use real-world observations and a model to predict what happens next. If a model fails to predict phenomena correctly, scientists are supposed to revise the model.
The scientific method has worked in natural sciences like physics. Physicists discovered rules like , which allow me to calculate the force given mass and acceleration. Such theories are valid everywhere and every time (until we observe contradicting evidence and someone proposes a better theory). In contrast, the rules of the economy change permanently based on what's happening. An economy is a self-regulating and self-referential system that we cannot model by closed-form math formulas we all love. So, economic models that don't incorporate self-referentiality are fundamentally flawed.
This text looks at one specific self-referentiality: How theories about the system can affect the system itself. In physics, the interactions of subatomic particles don't depend on the type of theories that physicists put forward. Unlike the observer effect, economic theories permeate into the public and can alter people's behavior. It's crucial to distinguish that behavior shifts occur not due to observation but because of the dissemination of theories.
People's underlying world model (the beliefs, expectations, and assumptions about how the economy functions) can influence their decisions. The world model can influence how they perceive value, risk, and opportunity, affecting behavior. In this way, the field of economics disseminated through media not only seeks to understand human behavior but may also change the behavior.
For example, if I went to a bar and started talking about economics, I could effortlessly stir up a discussion about interest rates, government debt, taxes, etc. Everyone has an opinion, irrespective of the amount of professional economics training. In contrast, when I start talking about physics, I probably get one of the following: People are curious to learn more about a theory. Or they tell me that they never understood physics anyway.
(Sidenote: My explanation for this phenomenon is news. News has trained people in pseudo-economics for decades, so they falsely believe in an understanding, whereas reporting about physics is limited. I don't remember having seen opinion journalism about physics. For economics, one can see this frequently.)
In sum, this self-referentiality in economics, where individuals' beliefs about the economy influence the system they are part of, makes the field more complex than physics.