REVIEW ESSAY–The Reformation in Economics: A Deconstruction and Reconstruction of Economic Theory by Philip Pilkington Marc Morgan

Book review.

American Affairs

REVIEW ESSAY–The Reformation in Economics: A Deconstruction and Reconstruction of Economic Theory by Philip Pilkington

Marc Morgan | research economist at the World Inequality Lab of the Paris School of Economics.

Lars P. Syll — Economics — too important to be left to economists

The problem with economics as a discipline, and this generally includes all forms of economics including heterodox economics to some extent, is "economics." That is is to say, economists assume that economics is chiefly or exclusively about economic behavior when economic behavior is embedded in social and political behavior and includes the entire "human condition."

The only "economist" that really grasped this in depth was Karl Marx, and he was a philosopher coming from a Hegelian background rather than being an "economist" in today's terminology. He understood and emphasized social embeddedness, as do the economic anthropologists, economic sociologists and institutionalists that followed. Even Keynes approached economics in terms of the existing neoclassical paradigm that prevailed, and he did it as a mathematician would since his background was it mathematics and his principle work was the Treatise on Probability.

Conversely, almost as a reaction to Marx, the economic profession got sidetracked by Alfred Marshall's emphasis on formalizing economics in an attempt to make it "scientific." This led to the presumption (hidden assumption) that economics is chiefly or even solely about economic behavior. The result was the assumption of homo economicus as a homogenous agent behaving "rationally" to maximize self-interest in economic dealings, principally in markets, which act as calculating machines to maintain economic equilibrium through adjustments in price based on supply and demand.

The problem is that this model is based on a generalizing from economic behavior at a micro level, irrespective of social embedding. Therefore the scope of application is limited by the extremely narrow scale. Unfortunately, most economists ignore this limitation of scope and the significance of scale.

Macroeconomics cannot be scaled up microeconomics because behavior at the individual level is not the foundation of behavior at the macro level as is conventionally assumed by those promoting microfoundations; for the simple reason that most people's behavior is not exclusively economic but includes social and political factors as will as ideological presumptions that differ temporally, geographically, by class and according to affiliation and personal disposition.

Economics is embedded in society just as are individuals and their behavior. Social networks (systems) are comprised of individuals as elements but networks (systems) also influence individuals that are related to them, either as members or those affected peripherally. A social system is not an aggregation of individuals acting independently but rather a system in which relationships are highly influential. Therefore, economic aggregates cannot tell the whole tale.

Individuals often have conflicting interests as well. People do not always prioritize their economic interest over their social and political interests as the assumption of homo economicus posits. Their choices are influenced by personal disposition, knowledge base, and cognitive-affective biases. At a most evident level, people that belong to different political parties and their factions think, feel, and act differently, including with respect to economic affairs and interests. For example, traditionalists regularly set tradition and traditional values above economic interests such that they act "irrationally" from the economic point of view while not being actually irrational. They view themselves as acting on the basis of higher reasons.

While homo economicus may have a place in the study of microeconomics, at the scale of macroeconomics and political economy, the agent is not homo economicus but homo socialis, and homo socialis is non-homogenous and not necessarily economically "rational." So game theory does not apply in this case.

The fact that societies are complex adaptive systems, especially at the national and international levels, means that model-building is challenged by tractability. Many conventional approaches are based on introducing conventions for inducing tractability at the expense of realism, which effects the usefulness of such models in pragmatic application.

This can result in social and political disarray that is serious enough to lead to conflict. But even if it does not, it can produce in anti-social consequences instead of the pro-social result that free markets, free trade and free capital flows promise based on the erroneous assumptions.

Many economist do not stay abreast of developments in economic anthropology, economic sociology, social science in general, evolutionary theory, and other fields that impact economics. Many do not even consider institutionalism as important, and even deprecate accounting, money & banking, and finance as relevant. Even in economic matters per se, many economists dismiss or deprecate externality, market imperfection, distributional factors, etc. as relevant to their field. Moreover, the insist that the methodological debate is over and they won it — end of discussion.

Economics needs to expand its horizon to remain relevant. 

Lars P. Syll’s Blog
Economics — too important to be left to economists
Lars P. Syll | Professor, Malmo University

There is No Economics without Politics: Every economic model is built on political assumptions — Anat Admati

I would add philosophical, social, and scientific to economic assumption. For example, academic economics focuses on homo economicus, ignoring that there is no clearcut, hard and fast distinction among the aspects of life that the various disciplines study. In previous times, when knowledge as a whole was more tractable, one was expected to know the fundamentals of the spectrum of life and knowledge. With the proliferation of information and knowledge, this is no longer possible.

But even in the days when a broader scope was the rule, the field of knowledge was largely limited to that of one's down culture and language. The intellectual tradition meant "the Western intellectual tradition" and that was further narrowed to one's linguistic group.

This presents a challenge in the age of globalization, in which different groups view the world through their own lenses. The result is the silo thinking that Anat Admati warns to avoid. Each of these silos has its own lens embedded in its assumptions, stated, unstated, and often simply presumed as assumptions hidden even from the ones assuming them.

Just about everyone confuses reality with their own worldview, which is a presumed framework that structures one's approach to life.

Evonomics

There is No Economics without Politics: Every economic model is built on political assumptions
Anat Admati is the George G.C. Parker Professor of Finance and Economics at the Graduate School of Business, Stanford University.

Econometrics and the problem of unjustified assumptions — Lars P. Syll

This is important but may be too wonkish for those who are not intimately familiar with econometrics. So let me try to simplify it and universalize it.

The basic idea in logical reasoning is that an argument is sound if and only if the premises are true and the logical form is valid.  Then the conclusion follows as necessarily true.

This is the basis of scientific reasoning.

In modeling, a set of assumptions, both substantive and procedural, is stipulated, that is, assumed to be true. In a well-founded model all the assumptions that make substantive claims are known to be true empirically on the basis of evidence. This is called semantic truth. The logical truth of logical form is formal proof. This is called syntactical truth. Only the former contains substance. The latter is purely procedural.

A key methodological assumption of the scientific method is naturalism. Being "scientific" signifies being based on observation, rather than say, intuition or "common sense," that is, self-evidence. No self-evident first principles — that's doing philosophy, not science. Not that such speculation is not useful. It's just not science and should not be conflated with science. There is often a tendency to do so.

This presents two major difficulties with scientific modeling versus philosophical speculation. The first is the empirical warrant of the starting points, the stipulations that are assumed to be true and serve as the premises of the argument. The second is knowing that all relevant information is included in the assumptions. This is called identification.

Paraphrasing Richard Feynman, we do science in order to avoid fooling ourselves and we are the easiest ones to fool (owing to confirmation bias, for example). This requires following scientific method scrupulously when substantial claims are made.

Keynes pointed out to Roy Harrod that econometrics did not conform to this strict procedure and that owing to the nature of the subject matter, economics was "moral science," which at the time signified what we would now call "philosophy." The social sciences and much of psychology fall into this category. They are basically speculative exercises that employ some formal methods that may be scientific, or not. 

Accounting is a formal method that is proto-scientific in the sense that double entry it is made up of tautologies. But the entries can be checked for substance against journals and inventories. It is a method to prevent fooling ourselves on one hand, and to prevent cheating on the other.

When accounting tautologies (identities) are interpreted causally, then causal explanation demands empirical corroboration through data, e.g., measurable changes in stocks and flows.

Lars P. Syll’s Blog
Econometrics and the problem of unjustified assumptions
Lars P. Syll | Professor, Malmo University

See also

Bond Economics
Comments On "Business Cycle Anatomy"
Brian Romanchuk

Is There Really A Trade-Off Between Inflation And Unemployment? — Brian Romanchuk

Rather than attempt to explain what the mainly neoclassical economists are going on about, I want to step back and try to translate their debate into terms that would be understood by people who do not share the same assumptions. I am pretty sure that post-Keynesian economists have a lot to say about the topic as well, but once again, they tend to be discussing wonkish points that would elude an outsider.…

I have an engineering background, and engineering is largely the science of trade-offs. I have no strong objections to qualitative discussions, but I would argue that we need to at least know the sign of the exchange ratio between two variables in order to say that there is a trade-off between them.

Very simply, if we can have a policy that lowers both the unemployment rate and the inflation rate (or at least leaves inflation unchanged), we cannot pretend there is a meaningful "trade-off" between them.

And this is hardly theoretical: in the United States, we saw a near monotonic decrease in the unemployment rate after the Financial Crisis, yet the inflation rate has done absolutely nothing interesting....

Bond Economics
Is There Really A Trade-Off Between Inflation And Unemployment?
Brian Romanchuk

Lars P. Syll — Arrow-Debreu and the Bourbaki illusion of rigour

It's about mathematical economics and its limitations. Don't let the title scare you off. Not at all wonkish (no math), although it helps if have some background in the controversy.

Basically, it's Plato (formalism) versus Aristotle (empiricism). Most mathematicians today are Platonists, while most scientists are Aristotelians. But that is another story.

Lars P. Syll’s Blog
Arrow-Debreu and the Bourbaki illusion of rigour
Lars P. Syll | Professor, Malmo University

The Fall of the Economists' Empire — Robert Skidelsky

The problem is not so much with the modeling, actually. People are free to construct any models that please for whatever reason. The problem is with the conclusions that are drawn from the model when they exceed the limitations of the of the assumptions.

This is not a problem with modeling but with logic. Drawing conclusions that exceed the scope and scale of the premises in a context other than the model is flat out illogical, and any inferences drawn on this basis are unsound, that is, do not follow from the premises of the argument and the reasoning about them.

Models don't automatically transfer to the world that they purport to model. This is a fundamental of scientific method. Semantic interpretation is required, along with methodological rigor, and hypothesis testing is necessary.

Project Syndicate
The Fall of the Economists' Empire
Robert Skidelsky | Professor Emeritus of Political Economy at Warwick University, fellow of the British Academy in history and economics, member of the British House of Lords, and author of a three-volume biography of John Maynard Keynes
ht Lars Syll

Brian Romanchuk — Why Doesn't The Government Impose Taxes In Chickens?

Silly question? Brian is responding to someone who asserted that in effect government does. 

Actually, it used to be that government confiscated property to move it to government use, but that is no longer considered "proper," unless the police do it on other pretexts. In a monetary production economy, taxes are payable in "money," that is, the government's currency.

What David Andolfatto apparently means is that one's purchasing power declines as a result of taxation, which is true. But that is not all there is to it, as Brian points out. In addition, neoclassical assumptions come embedded in the assertion.

Physicist Richard Feynman famously pointed out that a major purpose of science is to keep us from fooling ourselves and we are the easiest one's to fool (because of cognitive-emotional bias). 

While David Andolfatto states the obvious at the household level with respect to barter, this is not actually what happens and that makes a big difference in the approach to economics.

Thomas Aquinas is famous for his paraphrasing of Aristotle in De ente and essentia, "A small mistake in the beginning becomes a big one by the end."

Framing counts. Get the framing wrong and miss the point.

Bond Economics
Why Doesn't The Government Impose Taxes In Chickens?
Brian Romanchuk

Andrew Gelman — Our hypotheses are not just falsifiable; they’re actually false.

On the practical side of philosophy of science. Adding nuance to Karl Popper on falsification.

Further argument for the view that theories are useful but not "true." This may seem to contradict the realist view that theories are general descriptions of causal relationships. But I don't think that this is what is is implied. Rather, useful theories can be viewed as fitting the data because they reveal underlying structures that are not observed directly but only indirectly. 

There is a often a tendency to transfer simple analogies too complicated and complex situations and events. Some causal relationship are observable, as it a hammer driving a nail, with the physical theory explaining it in terms of simple variables related in a function. 

But most interesting issues are much more complicated and nuanced and may be complex, e.g., subject to emergence owing to synergy. There may a constellation of factors involved, and this may be difficult to order in a hierarchy. Some factors may be catalysts that are necessary for an operation but do not themselves enter into it. These may be presumptions that are hidden assumptions.

In addition, statistics is by definition "inexact" in that it deals with probabilities, unlike deterministic functions in which the variables are all known and measurable, and are expressible in terms of a simple function.

While physics is mostly tractable other than at the edges, life sciences are less so, and social sciences and psychology even less. Economics combines social science and psychology, especially macroeconomics and political economy. Economic sociology and economic anthropology take this into account, global economic history also demonstrates it.

This is coming to the fore now as some critics of MMT, the Green New Deal, and "socialism" demand to see data-based model that "prove" proposed solutions have worked in the past. Of course, the record is important, but the demand for "proof" requires a degree of stringency that is not applied in social science and psychology because it is unattainable. Nor is this standard applied to conventional economics either, its econometric approaching being based on formalism rather than being empirically based.

Another important point that Andrew Gelman makes is the futility of pitting theories against each other. That is a recipe for disagreement in that the party that determines the framing wins. Whose assumptions are going to set the criteria? Why?

And, no, I don’t think it’s in general a good idea to pit theories against each other in competing hypothesis tests. Instead I’d prefer to embed the two theories into a larger model that includes both of them.

This is a good suggestion but it is general. Often, the disagreement is over fundamental criteria that determine a frame of reference. This should be obvious in the different approaches to economic theory and economic practice., e.g., econometric and institutional, static and dynamic, simple and complex, natural and historical.

Obviously, a short post like this can only suggest matters that need deeper reflection, open inquiry and sincere debate aimed at solutions to pressing design problems. This is no long just "theoretical." Humanity has to get this right to survive, let alone prosper. We have seemingly dug ourselves into a hole based on policy that is has turned out to impractical in the extreme, such as socializing negative externalities that have led to environmental degradation and threaten ecological collapse if not addressed successfully in a timely fashion. So, let's get with it.

Statistical Modeling, Causal Inference, and Social Science
Our hypotheses are not just falsifiable; they’re actually false.
Andrew Gelman | Professor of Statistics and Political Science and Director of the Applied Statistics Center, Columbia University

Sandwichman — "I’m not sure I follow the arithmetic here."

All of the above, of course, is simply the fleshing out of assumptions. We assumeddiminishing productivity in the last hours, we assumed heightened productivity from a shorter working week and we assumed declining marginal utility of goods and services produced. Finally, we assumed a preference for free time over a vanishingly small increment of total income. The point is that each of these assumptions were relatively modest but when combined "add up" to a rather substantial cumulative result.

Econospeak
"I’m not sure I follow the arithmetic here."

Sandwichman

Peter Cooper — One of the Fundamental Differences Between Modern Monetary Theory and New Keynesian Economics

Independent economist Peter Cooper addresses the "we-knew-it-all-along" claim and shows, not really.

heteconomist
One of the Fundamental Differences Between Modern Monetary Theory and New Keynesian Economics
Peter Cooper

Lars P. Syll — Mainstream economics – peddling fake knowledge

Say's Law ("money is a hot potato").

Lars P. Syll’s Blog
Mainstream economics — peddling fake knowledge
Lars P. Syll | Professor, Malmo University

Chris Dillow — Facts vs hand-waving in economics

On Twitter this morning Jason Smith asked a good question. Is this, he asked, an “anonymous blog comment from a simpleton? ... Or analysis from a prominent financial economics professor?”...

Stumbling and Mumbling
Facts vs hand-waving in economics
Chris Dillow | Investors Chronicle

Jacob A. Robbins — How the rise of market power in the United States may explain some macroeconomic puzzles

These new facts are particularly puzzling from the point of view of the standard neoclassical economic model, in which markets are perfectly competitive. In this view, profits should not persist over the long run, let alone enable the owners of corporations to increase their share of income over time. The standard model, however, cannot address many of the fundamental changes that have occurred in the U.S. economy over the past 40 years.

In order to explain these new trends, I and my co-authors make several modifications to the standard model, among them positing imperfect market competition, financial assets based on monopoly profits, and the possibility that the natural rate of interest can change. With these parsimonious modifications, our model can explain the data in ways the old model cannot.

Here’s how it works: 

WCEG
How the rise of market power in the United States may explain some macroeconomic puzzles
Jacob A. Robbins, Ph.D. candidate in economics at Brown University and a doctoral fellow at the Washington Center for Equitable Growth

See also

Kaldor and Piketty’s facts: The rise of monopoly power in the United States
Gauti Eggertsson, Jacob A. Robbins, Ella Getz Wold

David F. Ruccio — Utopia—without classes

Good analysis of utopian versus utopianism. Short and important.

The difference is that between ideal and real. 

If the core assumptions are unrealistic and infeasible, then the consequent conceptual model will be "utopian" in the pejorative sense, and the project unachievable — "pie in the sky." If there is a disconnect between the ideal and the real, then it's utopianism.

If the assumptions are realistic and feasible, then the conceptual model will be "utopian" in the positive sense, and the project is achievable if implemented correctly.

If there is a disconnect between the ideal and the real, then it's utopianism.

Professor Ruccio explores how neoclassical economics and Marxian economics stack up in this regard.

Occasional Links & Commentary
Utopia—without classes
David F. Ruccio | Professor of Economics, University of Notre Dame

Lars P. Syll — Where modern macroeconomics went wrong

Experience has shown that assuming a framework based on methodological individualism, microfoundations, and rationality based on utility leading to general equilibrium through the so-called "invisible hand" of market competition generating spontaneous natural order is not fruitful for explaining the macro scale of economic behavior and its results in terms of a general theory.

Assuming that scaled up micro analysis explains macro effects risks the fallacy of composition, at the very least. The whole is more than the sum of its parts owing to the relationships being a key component of the system. Methodological individualism abstracts from relationships.

The fundamental problem arises from liberalism assuming methodological individualism based on ontological individualism. Since this contradicts the conception of human beings as social animals, it leads to paradoxes of liberalism and models that do not correspond to reality either in their construction or output.

This is likely owing to the origin of liberalism in the 18th century, a time when the mechanistic view of science was in vogue owing to the successes of physics in explaining natural phenomena.

Biology began to dominate in the 19th century but economics never caught up by replacing mechanistic model with organic ones.

Lars P. Syll's Blog
Where modern macroeconomics went wrong
Lars P. Syll | Professor, Malmo University

Lars P. Syll — Dani Rodrik’s Ten Commandments

Longish and detained, but worth a read if you are following this debate.

Lars P. Syll’s Blog
Dani Rodrik’s Ten Commandments
Lars P. Syll | Professor, Malmo University

Peter Radford — 1937

Hayek, Coase and uncertainty.

In any case I find it fascinating that the two, Hayek and Coase, both in their own way, brought the impact of uncertainty to the fore in the same year.

It’s a shame that economics has never fully embraced, nor realized, the full richness of their ideas. Neither author was willing to step into the world that they clearly understood existed. Hayek was right about universal central planning: it is an impossibility. He was wrong to assert that this implied anything about the market place or prices. By his own argument we simply cannot know whether something is optimal. Uncertainty makes such a thing inscrutable too us. And Coase was equally correct when he saw the need for local central planning: it is the only way we can organize production adequately in the face of uncertainty. But his focus on transactions was a legacy of the classical emphasis on exchange. It ignored the need for active coordination. He missed the requirement for management. He should have talked about “management cost” not “transaction cost”. They’re different animals.

So: an interesting question is this: what happens to Coase’s “institutional structure of production” when information, and by association knowledge, is less clumpy in the economic landscape? Does something like the Internet, which is a vector for information and knowledge, obviate the need for such structure? Does it smooth that landscape out sufficiently for firms not to exist?

We need to think about that.

We need a new version of the discussion that ought to have taken place in 1937.

The Radford Free Press
1937
Peter Radford

Dilbert on modeling, math, and assumptions

If you didn't catch these Scott Adams Dilbert cartoons over the last couple of days.

Comic for November 28, 2017

Comic for November 29, 2017

Comic for November 30, 2017

Comic for December 01, 2017

Comic for December 02, 2017

The Arthurian — Grab a Barf Bag!

Here's a quote that would make Lars Syll retch:

Because DSGE models start from microeconomic principles of constrained decision-making, rather than relying on historical correlations, they are more difficult to solve and analyze. However, because they are also based on the preferences of economic agents, DSGE models offer a natural benchmark for evaluating the effects of policy change.- MathWorks: Modeling the United States Economy

"... based on the preferences of economic agents, DSGE models offer a natural benchmark for evaluating the effects of policy change.

I think this is one of Syll's pet peeves! DSGE models are not "based on the preferences of" actual economic agents, but on simplified agents arising from "deductivist" assumptions....

The is a good illustration of "mindless math" aka GIGO. Mindless math presumes (hidden assumption) that quantification somehow guarantees outcomes regardless of conceptual logic that underlies the numbers.

For example, variables have arguments based on the conceptual definition of the variable in terms of a set. If the numbers do not match the defined membership of the set, then GIGO. This is all over the place in economic modeling, e.g., where homogeneity is assumed excessively, or where micro is extended to macro when the fallacy of composition applies.

Lars Syll assiduously points out these "freshman errors" in his blog. More economists should be paying attention.

I find it rather surprising that MathWorks would stumble over this.

The New Arthurian Economics

Grab a Barf Bag!

The Arthurian