The Economics Revolution Will Be Televised

There’s a revolution underway in economics. It’s not due to the financial crisis, but rather something more mundane: Data, and computing power. At least that’s the claim that Betsey Stevenson and I make in our latest Bloomberg View column:

“Consider the stream of data you will create today. Your metro card will record what time you caught the train. Your Web browser will note how you go about your job, and how much you procrastinate. A mid-afternoon purchase at Starbucks will reveal your penchant for lattes and the occasional cookie. Your flow of e-mail traffic will trace out your professional and personal networks.

At the same time, computing power has made it extremely easy and cheap to analyze all the data you produce. An economist with a laptop can, in a matter of seconds, do the kind of number crunching it used to take a roomful of Ph.D.’s weeks to achieve. Just a few decades ago, economists used punch cards to program data analysis for their empirical studies.”

Two weeks ago, Harvard’s Raj Chetty gave a spectacular talk at the National Bureau of Economic Research, about what he called “The Transformative Potential of Administrative Data.” He documented that today’s cutting-edge research is based on crunching newly-available data from the vast databases which underlay our schools, welfare state and tax systems.  I’m just as optimistic that new data coming online from the private sector will prove to be just as useful.

This empirical revolution is reshaping economics in at least four important ways:

1. The role of economic theory is changing:“The shift toward an even more empirically grounded economics doesn’t mean theory is less important. When facts were expensive and scarce, the role of theory was to “fill in” for missing data. Now, its purpose is to make sense of the vast, sprawling and unstructured terabytes on our hard drives.
2. Empirical economics is a natural bedfellow for behavioral economics:“The data revolution is, however, changing our theories — specifically the way we choose to model how people behave. For decades, economists assumed that people made calculated, rational decisions. Without better data to help structure our understanding of people’s preferences, it was a safe and convenient choice, even if it was often wrong.  With new data on everything from how we choose our retirement savings plans to how NBA referees call fouls, we have learned to look beyond “homo economicus.” We have a much better grasp of the systematic flaws in reasoning that often get people into trouble. We know they have a hard time committing to do difficult things in the future — to go to the gym, to lose weight, to save. So we know people can benefit from policies, such as making 401(k) contributions automatic unless they opt out, that help them commit to good behavior.”
3. Individual-level data meant that we can say more about individual differences:“In the mathematical models they build to help them understand the world, economists have also long made another peculiar assumption: that the behavior of an entire group of individuals — say, U.S. consumers — can be modeled as if it were a single “representative agent.” Today, we have much better data describing the decisions of individuals, and the power of our computers allows us to populate our models with millions of such people, rather than just one.”
4. And a theme that will be familiar to readers of this blog: Economics has become a much broader social science.“Perhaps the broadest insight that has come with the explosion in data is the understanding of how economic reasoning suffuses almost every aspect of our lives. The economic lens can be very helpful in parsing strategic interactions, the causes of discrimination, patterns of marriage and divorce, and how our political machinery operates.”

The bottom line:

“Technological change has brought opportunities to do economics in a way that our predecessors could only have dreamed about. Those opportunities have, in turn, yielded a field that is more connected to reality. Our hope is that these insights will improve our understanding of the economy and give us a better shot at avoiding the next crisis.”

You can read the full column here.  And let me know in the comments if you think my optimism is misplaced.