Economics has long modelled itself after hard sciences such as physics and engineering. For example, we speak of ‘financial engineers’, who use sophisticated models to mathematically eliminate risk (in theory). However, in the immediate aftermath of what has become known as the Great Financial Crisis of 2007/8, it became rather obvious that economics is a little different. For example, machines can be built to obey well-understood laws, the economy less so. And, as a number of people pointed out, engineering and economics have also evolved in very different ways, particularly in how they relate to the question of ethics.
Engineers have always realised that their work has an ethical dimension – especially because machines, if designed incorrectly, have a tendency to blow up and hurt people. In 1964 the US National Society of Professional Engineers decided to draw up an ethical code, which began with the key principle that “engineers, in the fulfilment of their professional duties, shall hold paramount the safety, health, and welfare of the public”. Other engineering bodies around the world have since adopted similar codes. But a strange exception is those financial engineers.
The ethics of ethics
As Australian economist Jason West observed in a research note entitled Ethics and Quantitative Finance: “The International Association of Financial Engineers does not consider ethics worthy of inclusion in [its] suggested core body of knowledge.” Furthermore, “No postgraduate mathematical finance programmes integrate the teaching of ethics and professional standards in their curricula and in fact, very few programmes even offer the teaching of ethics as an elective”.
The same holds true for the field of economics in general. According to Denver University Economist George F DeMartino: “We have no professional economic ethicists, or any texts, journals, newsletters, curriculum, regular conferences, or other forums that explore systematically what it means to be an ethical economist, or what it means for economics to be an ethical profession.”
Of course, one factor is that economists don’t directly experience the effects of their mistakes the way an engineer might. Their policy recommendations might indirectly make a factory go broke or a business collapse, but it doesn’t blow up right in their face. Financial disasters have health impacts, increase the suicide rate, and lead to social disruption, but few take their protests to the corridors of economics departments.
A more troubling reason is that ethical codes are omitted from finance because they just wouldn’t fit. After all, the dominant lesson of mainstream economics has long been that the markets are (nearly) always right, and that considerations of right and wrong have no role to play – and can even be harmful. According to Adam Smith’s ‘invisible hand’, the selfish pursuit of profit will lead to an optimal balance in the economy between supply and demand.
The efficient market hypothesis tells us that markets perfectly set prices of financial assets, again with no recourse to ethics. The result of this theorising, according to Czech economist Tomas Sedlacek, is that mainstream economics has neglected ethics to the point where “it is almost heretical to even talk about it”. However, there is also another issue, which has to do with the nature of mathematical models, and applies to any field where these models play a role.
The modeller’s oath
One property of mathematical models is that they can only be understood by a relatively small number of experts. And mathematical equations can seem imposing to those outside the field. So the details of models, and the assumptions on which they are based, are usually only debated by people working in the specific area, who usually share similar biases and incentives. This grants a degree of immunity from external scrutiny – with a resulting atrophy of ethical questioning.
This issue was recently raised by transport forecaster Yaron Hollander from the UK consultancy firm CT Think!, which published a report highlighting ways in which transport models are misused in order to give a false impression of accuracy. The list includes things like “reporting estimated outcomes and benefits with a high level of precision, without sufficient commentary on the level of accuracy”, or “avoiding clear statements about how unsure we really are about the future pace of social and economic trends”.
According to Hollander: “If you’re doing highly specialised work that affects people but they can’t challenge it then you’re like a doctor, and people need to know that you’ve taken some kind of ‘Hippocratic Oath’. My point is that we don’t have our own hippocratic oath for modelling, and we use tools that can do much less than what many people think, so we need to be clear that these forecasts aren’t the primary justification for any decision.”
A version of what such an oath might look like for the world of finance was proposed back in 2008 by two leading quants, Emanuel Derman and Paul Wilmott, with their Financial Modelers’ Manifesto. Drawing inspiration from Karl Marx and Hippocrates, the authors included what they called the Modellers’ Hippocratic Oath, which is worth quoting in full:
- I will remember that I didn’t make the world, and it doesn’t satisfy my equations.
- Though I will use models boldly to estimate value, I will not be overly impressed by mathematics.
- I will never sacrifice reality for elegance without explaining why I have done so.
- Nor will I give the people who use my model false comfort about its accuracy. Instead, I will make explicit its assumptions and oversights.
- I understand that my work may have enormous effects on society and the economy, many of them beyond my comprehension.
Of course, getting quants and bankers to sign an oath is unlikely to fix the world financial system (malpractice suits, of the sort that doctors experience, might do more). But it would be a first step towards reminding financial engineers that their work has significant impacts – and not just on their bonuses.