A Scientific Revolution for Economics

Does economics qualify as a hard science, along the lines of physics, chemistry, or biology?

With its embrace of data and technology, use of complex mathematics, and adoption of experimental methods, economics is undoubtedly the hardest of the soft sciences, but as Jean-Philippe Bouchaud, a Paris-based university physicist and head of research at Capital Fund Management, points out in the Oct. 30 issue of Nature (early draft version, HT: MoneyScience), the dismal science is still immature:

If empirical observation is incompatible with a model, the model must be trashed or amended, even if it is conceptually beautiful or mathematically convenient. So many accepted ideas have been proven wrong in the history of physics that physicists have grown to be critical and queasy about their own models.

Unfortunately, such healthy scientific revolutions have not yet taken hold in economics, where ideas have solidified into dogmas...The supposed omniscience and perfect efficacy of a free market stems from economic work done in the 1950s and 1960s, which with hindsight looks more like propaganda against communism than plausible science. In reality, markets are not efficient, humans tend to be over-focused in the short-term and blind in the long-term, and errors get amplified, ultimately leading to collective irrationality, panic and crashes. Free markets are wild markets...

Surprisingly, classical economics has no framework through which to understand 'wild' markets, even though their existence is so obvious to the layman. Physics, on the other hand, has developed several models that explain how small perturbations can lead to wild effects. The theory of complexity shows that although a system may have an optimum state, it is sometimes so hard to identify that the system never settles there. This optimum state is not only elusive, it is also hyper-fragile to small changes in the environment, and therefore often irrelevant to understanding what is going on. There are good reasons to believe that this paradigm should apply to economic systems in general and financial markets in particular. We need to break away from classical economics and develop completely different tools. Some behavioural economists and econo-physicists are attempting to do this now, in a patchy way, but their fringe endeavour is not taken seriously by mainstream economics.

Having read quite a bit of economic research over the past two years, I don't agree with Bouchaud that economists don't attack old assumptions. (A couple of examples.) Unfortunately, I think the problem lies with the older generation of prominent economists, who by the nature of their profession's career ladder, get themselves entangled in politics.  In fact, it's hard to think of a field more politicized than economics. Once your salary starts to depend on your Democratic or Republican Party leanings, you have much less use for the scientific method.