Economics has long had the ambition to become an “exact science”. Indeed, Walras, usually recognised as the father of modern economic theory, said in his Lettre no. 1454 to Hermann Laurent in Jaffe (1965):
“All these results are marvels of the simple application of the language of mathematics to the quantitative notion of need or utility. Refine this application as much as you will but you can be sure that the economic laws that result from it are just as rational, just as precise and just as incontrovertible as were the laws of astronomy at the end of the 17th century.”Furthermore his successors openly declared themselves as having the same goal...
This model of “perfect competition” is considered a useful idealization, and features such as the aggregate effects of the direct interaction between individuals are thought of as inconvenient “imperfections”. However, deviations between economic theory and reality may be of crucial importance in practice, and the consideration of the links between individuals and institutions cannot be written off as being of little relevance to the behaviour of the system as a whole. This is a lesson that is clear to all those, who are familiar with the analysis of complex systems.
In a comment on a previous post, Unlearning Economics observed that creating idealized models that are perfect and considering deviations from perfection to be "imperfections," misrepresents the reality of markets, which are not perfect and for a variety of reasons cannot be perfect. So it is incorrect to call these supposed phenomena "imperfections."
This is an important point not only with respect to models as representational but also rhetorical. When a phenomenon is labeled an "imperfection" rather than simply a phenomenon that is a regular feature of such conditions, the implication is that the situation can be improved by removing or reducing the "imperfection." However, this may not be the case, or the whole enterprise may be futile due to its construction.
As Paul Meli has observed, arguing about "imperfections" on the basis of an idealized perfect market is similar to considering friction an "imperfection" in physics and attempting to eliminate it, which is the goal of those who have sought to create a perpetual motion machine. This, of course, is ruled out by the laws of thermodynamics.
So modeling economics on physics must also take the laws of thermodynamics into account, so to speak, which implies that perfect models are necessarily non-representational.
It may be argued that an objective in engineering is to reduce friction in order to improve efficiency and this holds in economics, too, where friction is often called "drag." However, to suggest that this phenomenon can be eliminated in the actual world is wishful thinking, since idealized models can only be rough approximations of the behavior of a limited number of variables rather than the basis for laws that apply generally.
Moreover, attempting to model what is complex, adaptive, and emergent, that is, determined by system relationships that are flexible rather than fixed, makes social science quite different from physical science, where simple models (however complicated) can be employed in that physical motion is regular across time. While ergodic modeling is appropriate in the natural sciences, it is not in the life and social sciences, where organisms are not simple stimulus-response mechanisms following general laws, as behaviorists had assumed. Reductionism did not work in psychology; it has not worked in social science, and it will not work in economics, and we know precisely why.
Why then do economists persist in their folly? The reason appears to be ideological, especially when buttressed by special interests promoting a status quo that favors these interests. For example, according to neoclassical economics and its offspring, the primary source of market "imperfection" is government "intrusion." Granting that government policy can create drag, it does not follow that reducing government also reduces drag automatically, as often assumed.
The answer might be, and often is according to heterodox economists, that changing policy to reduce drag or improve performance might involve more government in some cases and less in others, depending on context such as the business cycle and the financial cycle. It is becoming clear from evidence that "expansionary fiscal austerity is not working as projected, just as heterodox economists warned would be the case when applied at the trough of a cycle, where more government is needed rather than less to offset the drag of flagging demand during a period of deleveraging at the culmination of a financial cycle.
Of course, conventional economists also realize the importance of government policy even though they may not admit it. For instance, they call for government to increase activity when and where it benefits ideological interests, such as military and security in protection of private property, to access resources, and to extend market reach through intimidation of weaker parties. The type of policy recommended or pursued is based on ideological bias, based either on purely ideological considerations or special interests that are promoted by the ideology.
For example, for the right government support of labor by legislating collective bargaining is an "intrusion," while supporting military Keynesianism is a requirement of national security, even when the military does't want the weaponry being appropriated. The left would take up the opposite position.
These are normative, ideological issues that should be argued as such rather than using the rhetorical sophistry of complicated mathematical (econometric) models to bias the debate on the basis of pseudo-scientific claims that do not pass the smell test.
