Noah Smith has an interesting note on the “death of theory” in economics. Obviously that’s an exaggeration, but there has been a measurable decline in the number of papers that offer theoretical innovations as opposed to empirical analysis, and also a harder to measure but unmistakable shift in the profession’s value structure, with empiricists reaping greater rewards and theorists valued less.
What’s it about? Smith lays credit or blame at the feet of Daniel Kahneman, who produced clear evidence that people don’t behave the way maximizing models say they should. It’s a nice story, but I don’t think Kahneman shook things up all that much; anyone sensible had long known that the axioms of rational choice didn’t hold in the real world, and those who didn’t care weren’t going to be persuaded by one man’s work.
So what did cause the change? Hey, I don’t have a theory! Well, not at this point anyway. What I can do is describe how I perceived the change as it was happening in two fields I follow closely: trade and business cycle macro. The funny thing is that the story in those two fields seemed, at least at the time, to be quite different.
In trade, we had an explosion of theory in the 1980s — an explosion set off by new models of industrial organization, especially but not only Dixit-Stiglitz, that made it possible to talk coherently about increasing returns and imperfect competition. This was hugely liberating; the New Trade Theory suddenly made sense of observations about the world, like trade between similar countries, that had been terra incognita before. It was a great time to be in the field.
So what happened? After a while, the new approaches came to seem too liberating; by the early 90s the joke was that a smart graduate student could devise a model to justify any policy. And while some important new theoretical work continued to be done, for example the Melitz work on heterogeneous firms or the Eaton-Kortum work on bilateral trade flows, I think you have to say that the field got tired of clever theorizing and wanted data instead. (Both of the bodies of work I just mentioned were in fact inspired by the desire to make sense of the incoming data).
In business cycle macro, the story was on the surface very different: what happened there was that theorists were able to prove some strong results — notably, that anticipated monetary policy should have no real effects — that were manifestly untrue. And while New Keynesian theory tried to patch this up with some ad hoc assumptions about price setting, etc., the sad truth about macro is that, as tools of practical analysis, the models in 1978-vintage undergraduate textbooks seem to work as well as — or, in general, better than — all the theory the field has turned out since then. Not totally true, of course; some useful theory has been turned out by the likes of Mike Woodford, or (on the international side) Ken Rogoff and Maury Obstfeld. But still, theory arguably failed.
So in my experience, anyway, theory lost its luster in trade because it could prove anything; it lost its luster in macro because it proved things that weren’t so.
There may be an overarching story here, but we need more data before we can start telling it.