Economists, with their love of elegant theory and making simplifying assumptions, would seem to be unlikely detectives. Did Sherlock Holmes assume the hound of the Baskervilles was a perfectly spherical dog moving in a frictionless environment? Surely not. True, my first book sported a hard-boiled private investigator on the cover. But I did not realise I was anticipating a new trend: the emergence
of 'forensic economics'.
A celebrated example of the genre in the mid-1990s is the discovery by academics William Christie and Paul Schultz that prices on the Nasdaq stock market were always rounded to the nearest quarter-dollar instead of the nearest eighth of a dollar. The likely explanation: collusion between investment banks trying to keep their margins up. The Securities and Exchange Commission waded in — not a typical response to an academic study.
A more famous case of forensic economics is the research of Brian Jacob and Steven 'Freakonomics' Levitt. Like Christie and Schultz, Jacob and Levitt did not rely on any special economic theory. They simply unleashed the statistical tools of economics on the
test scores of Chicago public schools, discovering some very improbable patterns — every student in some classes gave the same answers to a series of multiple choice questions. Their explanation: the teachers were cheating to boost test scores.
Other economists, such as Eric Zitzewitz, deploy more economic theory in their research. For example, theory says that what a share price does before, say, 4pm tells you nothing about what the price will do after 4pm. Zitzewitz discovered a cluster of trades that seemed to say otherwise, and he also suspected the reason why: the trades were carried out late in the day and then illegally 'backdated'. An investigation was announced and the suspicious patterns vanished.
Why, you might ask, do economists think they are qualified to do this kind of academic crime-fighting? There is more at work here than the traditional self-confidence of economists. Economics, like some natural sciences, requires statistical sophistication. But like anthropology and psychology it also requires the ability to think about man-made institutions and human motivations. That's a powerful combination when seeking statistical evidence of crime. Economists are also naturally suspicious. Our textbooks are populated by potential criminal masterminds — homo economicus is both intelligent and amoral.
Perhaps we should ask not what economics can do for forensic analysis, but what forensic analysis can do for economics. To excel, we must spend more time thinking about the messy way in which human institutions actually work and favour the noise of data over the elegance of theory. These are useful habits to acquire.
Tim Harford is a Financial Times columnist
and author of Adapt: Why Success Always
Starts With Failure (Abacus, £8.99)
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