When speaking or reading about economics, you've probably heard someone drop the phrase the dismal science. If you did not know what this phrase meant, you may have dismissed it as a clever joke, or, harboring a secret passion for experimental observation and beakers, you may have been too shy to question how on earth any science could be dismal. Looking at what the dismal science is and why it carries such a depressing name, however, may help you better understand why you may face uncertainty and contradictions in your investing endeavors.

The phrase "dismal science" was coined by Thomas Carlyle in response to Thomas Malthus' beliefs that the exponential population growth would outpace the linear growth of the world's food supply, resulting in a global famine. Malthus didn't foresee the leaps in science, such as the development of fertilizer, that have allowed the earth to support many more people than was previously imagined. Still, one of the fundamental concepts of economics is the principle of scarcity - the idea that there will never be enough for everyone. That dreadful outlook is one of the reasons economics is considered a dismal science.

Why Economics Isn't Really a Science
In addition to the blunder of Malthus the phrase dismal science refers to the unreliability of economics in comparison to conventional sciences such as mathematics, physics or biology. Most sciences work through an initial explanation of a proposed phenomenon (also known as a hypothesis). The scientist then forms a model to test and scrutinize this hypothesis until only the important variables remain. These variables are repeatedly tested to determine whether they are the causes of the end result. If in fact a variable can be isolated and determined as the sole cause, then the theory underlying the hypothesis is referred to as a law. (Please keep in mind that this is a gross simplification of the scientific method.)

Economics, like science, aims to explain certain phenomenon, but for many reasons economics cannot fulfill the criteria of the experimental model. To better understand the constraints on the study of economics, let's take at look at what the methods of science demand:

Scientific Method Example - Car Door Experiments
So let's say we're studying the phenomenon of why my hand hurts when I slam it in my car door. For me to use a scientific approach I would form a hypothesis. Suppose my theory is that it's because I'm wearing an Investopedia T-shirt. To test this theory, I create a model to test different scenarios and variables. This model involves slamming my hand in the door while wearing different shirts, including my Investopedia T-shirt. I eliminate factors (variables) that don't affect the result (my pain) and I continue testing other variables until I am left with one that is the cause of my pain: the fact that I'm smashing my hand in a car door.

After several hairline fractures, I've figured out that the real reason my hand hurts is not because of the T-shirt I'm wearing, but because a slamming car door on my hand translates into pain through my nerves. So, a law has been formed: the Andrew Law, which states that if I slam my hand in a car door with "X" amount of force, my hand will absorb "Y" amount of energy causing my nerves to relay "Z" amount of pain to my brain (a gross simplification).

The Uncertainty of Economics
Economics cannot ascertain any clearly defined laws because in the market some unidentifiable factor always may be influencing a particular event or phenomena. It's nearly impossible to isolate any given variable in economics, so the dismal science is mainly based on theories.

These theories may contradict each other, like efficient market hypothesis (EMH) and behavioral finance, but they may be proven true in certain cases or even at the same time. Furthermore, when studying economics, evidence often turns out to be coincidence more than a fact.

Typically, these unreliable characteristics are a result of three specific things that economists cannot control:

Un-testable Economy
Unlike other scientists, economist don't have special laboratories where they can create isolated models to test their hypotheses. A vacuum of the economy just doesn't exist and cannot be created. Because of this, economists can't verify or prove their hypotheses as easily as other scientists. For instance, when Sir Isaac Newton had to repeat his tests for the existence of gravity, all he needed to do was find more apples to drop from different trees. For my law, all I needed to do was wear different T-shirts (and eventually stop slamming my hand in the door). For an economist to test a theory, he or she has to appeal to different governments to implement a specific change in the economy or, even worse, wait for them to do so under their own accord and then take the necessary measurements.

Homo Economicus
Aside from the many different assumptions that economists make when debating their theories, probably the most hotly debated one is the idea of homo economicus, or the rational human. Nearly all economic theories assume that people are rational at all times, that they always prudently allocate their resources in a predictable manner that is beneficial. Unfortunately, this doesn't always hold water in the real world. People will gamble even though the odds are against them; they will forget to go to the supermarket with a calculator to see if the 32 oz. can of soup is cheaper than the 16 oz. can, and they don't routinely analyze the opportunity cost of different goods.

Blind Man's Bluff
Imagine you were blind with a deck of cards laid in front of you and someone expected you to be able to sort out the three of hearts. We know that there is a one-in-52 chance of being right and that, if the cards are randomly sorted, there is no scientific methodology that can help you improve those odds. However, if you pull the right card, you might attribute it to anything: the way you reached out, how many breaths you took, the twitch in your right eye - anything.

Once again you are stuck slicing and applying variables, but you can't repeat the test with any kind of consistent controls. This is similar to economics: the number of testable variables is enormous due to the sheer size of the economy. As a result, there has been little success not only in predicting phenomena but also in proposing reasons for why observable things happen. The economy can't be controlled like a math equation or a science experiment, and there are simply too many variables to test with any sort of reliability and verifiability.

The Bottom Line
So there you have it. Next time you see someone dropping the phrase "dismal science" you can check if he or she uses it correctly; furthermore, you know that the person using the term could not possibly predict or explain market events with any smug confidence.

Related Articles
  1. Fundamental Analysis

    The 3 Best Investments When Bull Markets Slow Down

    Find out why no bull market lasts forever, and why investors should shift their assets away from growth and toward dividends when stocks slow down.
  2. Economics

    Industries That Thrive On Recession

    Recessions are not equally hard on everyone. In fact, there are some industries that even flourish amid the adversity.
  3. Economics

    Economist Guide: 3 Lessons Adam Smith Teaches Us

    Learn three critical lessons about economics from 18th century philosopher Adam Smith, considered by many to be the father of economics.
  4. Fundamental Analysis

    How Globalization Affects Developed Countries

    The increase in communications technology has companies competing in a global market.
  5. Term

    What's the Economy?

    The economy is the production and consumption activities that determine how scarce resources are allocated in an area.
  6. Markets

    What Saudi-Iranian Tensions Mean for Oil Prices

    The recent break in diplomatic relations between Saudi Arabia and Iran adds complications to the already chaotic environment of Middle East geopolitics. 
  7. Economics

    New Mexico's Economy: The 6 Industries Driving GDP Growth

    Discover the four primary industries that are considered to be the most important drivers in the well-being of the economy of New Mexico.
  8. Entrepreneurship

    Economics of Owning a Bar

    Understand what costs go into starting and running a bar, as well as what earnings can be expected. Learn whether or not it is smart to own a bar.
  9. Stock Analysis

    3 Reasons Southwest Is Growing Faster than Its Competitors (LUV)

    Understand how Southwest Airlines operates and what makes it different from competitors. Learn three reasons why it's growing so much.
  10. Economics

    Explaining Income Per Capita

    Income per capita measures the amount of money that’s earned per person in a defined area.
  1. What are the arguments against using ceteris paribus assumptions in economics?

    Ceteris paribus assumptions are at the heart of nearly all mainstream microeconomic and macroeconomic models. Even so, some ... Read Full Answer >>
  2. Is economics a science?

    Economics is generally regarded as a social science, although some critics of the field argue that economics falls short ... Read Full Answer >>
  3. What's the difference between microeconomics and macroeconomics?

    Microeconomics is generally the study of individuals and business decisions, macroeconomics looks at higher up country and ... Read Full Answer >>
  4. How do you make working capital adjustments in transfer pricing?

    Transfer pricing refers to prices that a multinational company or group charges a second party operating in a different tax ... Read Full Answer >>
  5. What is the utility function and how is it calculated?

    In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >>
  6. What does marginal utility tell us about consumer choice?

    In microeconomics, utility represents a way to relate the amount of goods consumed to the amount of happiness or satisfaction ... Read Full Answer >>
Hot Definitions
  1. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  2. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  3. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  4. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  5. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  6. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
Trading Center