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

Asad Zaman — Methodology of Modern Economics

My paper is a survey of the huge amount of solid empirical evidence against the utility maximization hypothesis that is at the core of all microeconomics currently being taught today in Economics textbooks at universities all over the world. It is obviously important, because if what it says is true, the entire field of microeconomics needs to be re-constructed from scratch. Nonetheless, it was summarily rejected by a large number of top journals, before being eventually published by Jack Reardon as: ” The Empirical Evidence Against Neoclassical Utility Theory: A Review of the Literature,” in International Journal of Pluralism and Economics Education, Vol. 3, No. 4, 2012, pp. 366-414. Speaking metaphorically, my paper documents the solid evidence that the earth is a round sphere in world where educational institutions teach the widely held belief that the earth is flat. Readers of RWER blog will recall that when challenged on the failure of macroeconomics after the Global Financial Crisis, economists retreated to the position that while macro theory may be in a bad shape, at least Microeconomics is solidly grounded. My paper blows this claim out of the water. As a result, nothing is left of Micro and Micro, and of economics as whole. This supports my earlier claim that a Radical Paradigm Shift is required to make progress — patching up existing theories cannot work...

The central question remains of what is to be done. A complex response which requires coordination on multiple fronts is required. The first step has to be the development of a coherent alternative. I have developed a two semester micro coursewhich starts with the Anti-Textbook of Hill & Myatt, and follows up by using two main tools OPPOSED to maximization and equilbrium. Maximization is replaced by behavioral heuristics, which allow operation in environments with genuine uncertainty. Maximization is actually IMPOSSIBLE in uncertain environments. If I have to choose between actions a and b but the outcome to me depends on unknown state of natures and unknown acts of other agents then maximization is not possible. I cannot calculate which of the two actions will yield greater utility because the outcome depends on many thing I do not know, and cannot learn. SIMILARLY, if we equip all agents with heuristic behavior and try to compute what will happen, this can only be done within an Agent Based Model using computer simulations — which will generally lead to disequilibrium outcomes. Using these two tools to replace the central micro tools, one can go quite far in replacing standard micro with sensible alternatives....

WEA Pedagogy Blog
Methodology of Modern Economics

Asad Zaman | Vice Chancellor, Pakistan Institute of Development Economics and former Director General, International Institute of Islamic Economics, International Islamic University Islamabad

Oleg Komlik — The Sociology of Quantification: Seeing like Numbers

Short and important.

Economic Sociology and Political Economy
The Sociology of Quantification: Seeing like Numbers
Oleg Komlik | founder and editor-in-chief of the ES/PE, Chairman of the Junior Sociologists Network at the International Sociological Association, a PhD Candidate in Economic Sociology in the Department of Sociology and Anthropology at Ben-Gurion University, and a Lecturer in the School of Behavioral Sciences at the College of Management Academic Studies

See also

Statistical Modeling, Causal Inference, and Social Science
Revisiting “Is the scientific paper a fraud?”

Andrew Gelman | Professor of Statistics and Political Science and Director of the Applied Statistics Center, Columbia University

Jason Smith — A list of macro meta-narratives

In my macro critique, I mentioned "meta-narratives" — what did I mean by that? Noah Smith has a nice concise description of one of them today in Bloomberg that helps illustrate what I mean: the wage-price spiral. The narrative of the 1960s and 70s was that the government fiscal and monetary policy started pushing unemployment below the "Non-Accelerating Inflation Rate of Unemployment" (NAIRU), causing inflation to explode. The meta-narrative is the wage-price spiral: unemployment that is "too low" causes wages to rise (because of scarce labor), which causes prices to rise (because of scarce goods for all the employed people to buy). In a sense, the meta-narrative is the mechanism behind specific stories (narratives). But given that these stories are often just-so stories, the "mechanism" behind them (despite often being mathematically precise) is frequently a one-off model that doesn't really deserve the moniker "mechanism". That's why I called it a "meta-narrative" (it's the generalization of a just-so story for a specific macro event).

Now just because I call them meta-narratives doesn't mean they are wrong. Eventually some meta-narratives become a true models. In a sense, the "non-equilibrium shock causality" (i.e macro seismographs) is a meta-narrative I've developed to capture the narrative of women entering the workforce and 70s inflation simultaneously with the lack of inflation today.

Below, I will give a (non-exhaustive) list of meta-narratives and example narratives that are instances of them. I will also list some problems with each of them. This is not to say these problems can't be overcome in some way (and usually are via additional just-so story elements). None have yielded a theory that describes macro observables with any degree of empirical accuracy, so that's a common problem I'll just state here at the top.

The difference among just-so stories, handwaving, modeling for effect, and data-based modeling....

Worth looking at for the weekend — and thinking about.

Information Transfer Economics
A list of macro meta-narratives
Jason Smith

Abandon Statistical Significance — Blakeley B. McShane, David Gal, Andrew Gelman, Christian Robert, and Jennifer L. Tacket

Abstract

In science publishing and many areas of research, the status quo is a lexicographic decision rule in which any result is first required to have a p-value that surpasses the 0.05 threshold and only then is consideration—often scant—given to such factors as prior and related evidence, plausibility of mechanism, study design and data quality, real world costs and benefits, novelty of finding, and other factors that vary by research domain. There have been recent proposals to change the p-value threshold, but instead we recommend abandoning the null hypothesis significance testing paradigm entirely, leaving p-values as just one of many pieces of information with no privileged role in scientific publication and decision making. We argue that this radical approach is both practical and sensible.

Uncritically adopting universal rules and criteria is a sign of lazy thinking and likely ideological thinking aka dogmatism as well.

This move would overturn the existing scientific publishing model, it is unlikely to happen without considerable opposition. This model is key in establishing reputational credibility and advancement in the profession. Players like set rules. This is especially true in formal subjects, where training focuses on producing "the right answer" based on customary application of formal methods. The downside is group think and imposition of a consensus reality.

Abandon Statistical Significance

Blakeley B. McShane, David Gal, Andrew Gelman, Christian Robert, and Jennifer L. Tackett

Daniel Little — Microfoundations 2.0?

Little considers to what degree microfoundations is a necessary condition for causal explanation in social science.

Understanding Society
Microfoundations 2.0?
Daniel Little | Chancellor of the University of Michigan-Dearborn, Professor of Philosophy at UM-Dearborn and Professor of Sociology at UM-Ann Arbor

Dani Rodrik — Good and Bad Inequality

In the pantheon of economic theories, the tradeoff between equality and efficiency used to occupy an exalted position. The American economist Arthur Okun, whose classic work on the topic is called Equality and Efficiency: The Big Tradeoff, believed that public policies revolved around managing the tension between those two values.… 

The belief that boosting equality requires sacrificing economic efficiency is grounded in one of the most cherished ideas in economics: incentives. Firms and individuals need the prospect of higher incomes to save, invest, work hard, and innovate. If taxation of profitable firms and rich households blunts those prospects, the result is reduced effort and lower economic growth.… 

In recent years, however, neither economic theory nor empirical evidence has been kind to the presumed tradeoff. Economists have produced new arguments showing why good economic performance is not only compatible with distributive fairness, but may even demand it.… 

Economics is a science that can claim to have uncovered few, if any, universal truths. Like almost everything else in social life, the relationship between equality and economic performance is likely to be contingent rather than fixed, depending on the deeper causes of inequality and many mediating factors. So the emerging new consensus on the harmful effects of inequality is as likely to mislead as the old one was.… 

It is good that economists no longer regard the equality-efficiency tradeoff as an iron law. We should not invert the error and conclude that greater equality and better economic performance always go together. After all, there really is only one universal truth in economics: It depends.

Economists like to compare a limited number of variables in order to discover patterns in an otherwise jumbled and confusing context of events. Economists especially like identifying patterns that can be expressed in terms of an independent variable and dependent variable. By assigning different quantitative values to the independent variable, the effect on the dependent variable can be expressed neatly as the result of a mathematical function.

This method requires a imposing level of abstraction using qualifying assumptions such as cet. par. This approach is the basis of the claim that economic behavior can be viewed in terms of "tradeoffs" that reveal the degree to which one thing must be sacrificed in order to gain the advantage of another that stand in inverse relationship. Opportunity cost is key to the economic notion of rationality based on utility maximization that underlies conventional economic, for example. Other tradeoffs operate similarly.

The "it depends" relates to the actual context that is independent of the stylization for modeling convenience and remains operative. This stylization assumes a homogenous background, which is a huge simplification in an economy embedded in a society as a complex system under uncertainty functioning as a network with a web of feedback loops.

The question is whether any can "iron laws" emerge from such a procedure?

Project Syndicate
Good and Bad Inequality
Dani Rodrik | Professor of Social Science at the Institute for Advanced Study, Princeton, New Jersey

Daniel Little — What is methodology?

Understanding Society
What is methodology?
Daniel Little | Chancellor of the University of Michigan-Dearborn, Professor of Philosophy at UM-Dearborn and Professor of Sociology at UM-Ann Arbor

Lars P. Syll — Economics departments — turning out generation after generation of idiot savants

 The rationality assumption grounds the ergodic axiom necessary to make economics appear similar to physics. However, this is just begging the question by assuming a priori what is needed to produce the desired result, which is anti-scientific. Samuelson's assumption of rationality is not much different from that of Mises in Human Action.

Karl Popper was willing to admit "the principle of rationality" as a heuristic device.

The 'principle of rationality' (or 'rationality principle') is coined by Karl R. Popper in his Harvard Lecture of 1963, published in his book Myth of Framework [1]. It is related with what he called the 'logic of the situation' in an Economica article of 1944/1945, published later in his book The Poverty of Historicism[2].

Following Popper the 'logic of the situation' is the result of reconstructing meticulously all circumstances if you are trying to understand a historical event. The 'principle of rationality' is the assumption that people try to reach their goals. Both the reconstruction of the 'logic of the situation' and the application of the 'principle of rationality' constitute an important method of understanding that seems to be useful in all social sciences. It is the method of creating theories due to our knowledge that men and women usually have goals and usually try to reach their goals. If this method is applied to a particular situation it results in a theory which can be proved as right or wrong. Although the 'principle of rationality' is not applicable to (natural) science there is no methodological difference between science and social sciences because both sciences are getting explanations by inventing theories which can be proved.

Popper called his 'principle of rationality' nearly empty (a technical term meaning without empirical content) and strictly speaking false, but nonetheless tremendously useful [3]. These remarks earned him a lot of criticism because seemingly he had swerved from his famous Logic of Scientific Discovery. — Wikipedia.

There is a great difference between a heuristic device and a self-evident principle logically and methodologically. The first is used constructively in both science and engineering, while the latter is the basis of philosophical reasoning that begins with "first principles."

Economics departments — turning out generation after generation of idiot savants
Lars P. Syll | Professor, Malmo University

David Glasner — Methodological Arrogance

Longish but thoroughly enjoyable. "Methodological arrogance." I love it.

No, the debate over economic method is not over in spite of how loudly the mainstream screams it is.

Uneasy Money
Methodological Arrogance
David Glasner

Lars P. Syll — How to make economics a realist and relevant science

As yours truly has reported repeatedly lately, university students all over Europe are increasingly beginning to question if the kind of economics they are taught — mainstream neoclassical economics — really is of any value. Some have even started to question if economics really is a science.

How to make economics a realist and relevant science
Lars P. Syll | Professor, Malmo University

Steve Keen — Why economists are almost always wrong

That verbose title is almost the reverse of a quintessentially arrogant statement of economic supremacy published in the UK’s Daily Telegraph - on the editorial page of the business section - by Andrew Lilico. Entitled “Economists are nearly always right about things, despite what you may think” in the print edition, its content and tone encapsulated everything about economic theory, and economists’ blind belief in it, that led me to write Debunking Economics over a decade ago....

The two main factors that made that book necessary were the capacity of economists to intimidate opponents with their apparent depth of knowledge of a difficult subject, and the reality that economists knowledge of their own subject was, to coin a phrase, not even shallow: it was frequently outright wrong. 

Business Spectator
Why economists are almost always wrong
Steve Keen

Lilico’s defence of economics despite its many empirical failings is the mark of a zealot. That is the real weakness of mainstream economic theory: that it engenders in its followers a manic belief that is impervious to empirical reality.

This was the thought — WTF? — that came to me as I read Lilico's article when it came out.

David Glasner — The Microfoundations Wars Continue

The microfoundations project is predicated on a gigantic leap of faith that the existing economy has an underlying structure that corresponds closely enough to the assumptions of the Arrow-Debreu model suitably adjusted for stochastic elements and a variety of frictions (e.g., Calvo pricing) that may be introduced into the models depending on the modeler’s judgment about what constitutes an allowable friction. This is classic question-begging with a vengeance: arriving at a conclusion by assuming what needs to be proved. Such question begging is not necessarily illegitimate; every research program is based on some degree of faith or optimism that results not yet in hand will justify the effort required to generate those results. What is not legitimate is the claim that ONLY the models based on such question-begging assumptions are genuinely scientific.

This question-begging mentality masquerading as science is actually not unique to the microfoundations school. It is not uncommon among those with an exaggerated belief in the powers of science, a mentality that Hayek called scientism. It is akin to physicalism, the philosophical doctrine that all phenomena are physical. According to physicalism, there are no mental phenomena. What we perceive as mental phenomena, e;g;l consciousness, is not real, but an illusion. Our mental states are really nothing but physical states. I do not say that physicalism is false, just that it is a philosophical position, not a proposition derived from science, and certainly not a fact that is, or can be, established by the currently available tools of science. It is a faith that some day — some day probably very, very far off into the future — science will demonstrate that our mental processes can be reduced to, and derived from, the laws of physics. Similarly, given the inability to account for observed fluctuations of output and employment in terms of microfoundations, the assertion that only microfounded models are scientific is simply an expression of faith in some, as yet unknown, future discovery, not a claim supported by any available scientific proof or evidence.

Uneasy Money
The Microfoundations Wars Continue
David Glasner

Peter Radford — Quote[s] Of The Day #2

Economists have made the study of economies more tractable – some would say they have simplified things – by sealing off all the exits and entrances so as to prevent novelty from disrupting their analysis. Even then they were forced to enforce ever more strict definitions of rationality and access to information on the participants in an economy in order to arrive at their chosen outcome: that market magic exists. This is why, in general terms, an economic equilibrium exists when there are no sources of change within the economy.

As the quotes above illustrate, and presumably there are thousands like them littering the literature outside of economics, the very concept of the economy being a closed system is absurd. The act of closure severs the link with reality, thus rendering conclusions from the subsequent analysis highly suspect if not outright irrelevant. Defending such analysis on the grounds of simplification places a great burden on the assumptions involved and on the ease of transference of whatever is learned back into an open system such as planet earth.

Such simplification may, indeed, prove useful, but of much greater use is any analysis that tackles an economy as it actually exists rather than as it might exist in the imagination of an economist unaware of the progress other sciences have made in tackling the complexity of highly entangled systems where the pull of entropy undoes order relentlessly.

Real-World Economics Review Blog

Quote[s] Of The Day #2
Peter Radford

Jeroen Van Bouwel — On microfoundations and macrofoundations

In his recent contributions on this blog (link, link), Daniel Little develops an interesting position advocating the legitimacy and “relative explanatory autonomy” of the meso-level, while maintaining a microfoundations requirement. I am grateful that Daniel invited me to comment on his views and I will try to do so in a concise way, discussing four issues:

1. There are more than two levels of social explanation
2. Levels of explanation are perspectival; neither absolute, nor unique 
3. Seeking for microfoundations and macrofoundations as good heuristics.
4. Social scientific practice and plurality as objects of study.

UnderstandingSociety
Guest post by Jeroen Van Bouwel: On microfoundations and macrofoundations
Jeroen Van Bouwel | post-doctoral fellow at Ghent University and a visiting scholar in philosophy at Uppsala University

Peter Radford — Simple model mania

...The point being that the obsession to reduce everything to simple ideas that can be put into simple models, condemns economics to misunderstand, and therefore not explain, reality. People are far too nuanced and unpredictable to be shoved completely into either PIH or RIH. They bounce about. The truth is that there are likely plenty more explanations as well. Perhaps there are twenty hypotheses each explaining a little bit. But, since that makes modeling complicated, economists stay well away from reality.

BTW, this is an underlying message of Ludwig Wittgenstein's investigation of the logic of ordinary language in his later work. Thinkers typically go awry in over-generalizing. This is the informal fallacy of hasty generalization, and it includes composition fallacies as well.

Economics is particularly susceptible of fallacies of composition in the chief methodological assumption of liberal economics is a representative individual acting in the vacuum of rational free choice, "rational" being defined as pursuit of maximum utility in making choices, presumed to be fully informed, and "free" meaning independent of external influences such as culture, institutions, affiliations, and personal relationships. The problem with this is that homo economicus is not homo sapiens sapientis, but rather an methodological and ideological construct that is non-representational in spite being asserted to be representative. Examining the logic of conventional economics, it cannot be correct.

Real-World Economics Review Blog

Simple model mania

Peter Radford

Philip Pilkington — Even the Statisticians Are Highly Dubious of Applying Their Methods in Economics!

Lars Syll just ran a rather amusing quote from a handbook on mathematical statistics in which the author — a mathematical statistician — lays out all the cop-out arguments used by those who apply these methods in a dubious manner in the social sciences. I looked up the original book and I think that it might be worthwhile outlining another quote which is, in a sense, even more damning to those who try to use these methods in socials sciences and, most especially, in economics.

Fixing the Economists
Even the Statisticians Are Highly Dubious of Applying Their Methods in Economics!
Philip Pilkington

Lars Syll — What is neoclassical economics – a rejoinder to Noahpinion

The debate continues and looks to be far from over. The problem is that most mainstream economists hold that the methodological debate is over, in "the profession" now has settled on a methodology. Those not using this methodology are considered heterodox, a euphemism for heretical. This debate is going nowhere as long as the mainstream refuses to debate methodology. Until this changes for the better, count on policy formulation based on mainstream methods to be disastrous and prepare for the worst.

What is neoclassical economics – a rejoinder to Noahpinion

Lars P. Syll | Professor of social Studies and Associate Professor of Economics, Malmo University

Unlearning Economics — Helping Economists Escape Economics

There are plenty of economists who will happily admit the limits of their discipline, and be nominally open to the idea of other theories. However, I find that when pushed on this, they reveal that they simply cannot think any other way than roughly along the lines of neoclassical economics. My hypothesis is that this is because economist’s approach has a ‘neat and tidy’ feel to it: people are ‘well-behaved’; markets tend to clear, people are, on average, right about things, and so forth. Therefore, economist’s immediate reaction to criticisms is “if not our approach, then what? It would be modelling anarchy!”

Unlearning Economics
Helping Economists Escape Economics

Greg Fisher — Chinese Thinking and Complexity

Last week I attended an excellent conference in Singapore, which had the intriguing title of “A Crude Look at the Whole”. The title was attributable to Murray Gell-Man who was one of the founding fathers of the Santa Fe Institute and also the winner of the 1969 Nobel Prize in Physics. Gell-Man is famous for a few things, including being the first to postulate the existence of quarks. Another is the idea of coarse-grained cognition. This is the (to me sensible) idea that reality is extremely fine-grained in terms of detail, like a ultra-high definition movie, whereas human cognition is very crude (or coarse) by comparison, like a blurry still picture. Gell-Man was at the conference as were two other giants of the complexity community, John Holland and Brian Arthur.
It was an excellent and wide-ranging conference, organised by Jan Vasbinder of the Complexity Programme of the Nanyang Technological Universoty (NTU). A thought occurred to me during the last session, which I thought warranted a blog article. Or, rather, it was more of a question: is the Chinese mind-set more conducive to understanding Complexity theory than the Western mind-set? There are good arguments to say that it is.

Don’t worry, my question is not based on some flimsy notion of Confucian group-think. In fact it emerges from some serious academic studies which show fascinating and important differences in how Westerners and Chinese think. Some of this material was presented at the conference by Professor Ying-Yi Hong of NTU’s business school but interested readers might look at the excellent book The Geography of Thought by Richard Nisbet.

Synthesis
Chinese Thinking and Complexity
Greg Fisher

This is significant in that it suggests that the preference for methodological individualism and microfoundations in Western social sciences, including economics, is cultural rather than universal. The dominant mode of Western thinking and mindset tends to be analytic rather than synthetic, and Oriental thinking and mindset, the opposite. The dominant mode of Western thinking and mindset also tends to be structural, while Oriental thinking and mindset, functional. The West tends to be reductionist and the East, holistic. I don't say this as a casual observation but as a scholar who has studied comparative philosophy for many years.

As Fisher observes, it is will be interesting to see how this plays out historically over this century.

All of this makes me think of a quote which one of my other colleagues shared with me a few months ago, which originated from the US defense establishment (specifically it was from Heinz Pagels, cited as the epigraph to the volume “Coping with the bounds: Speculation on nonlinearity in Military Affairs” (1998) National Defence University): 

“I am convinced that the nation and people who master the new sciences of complexity will become the economic, cultural and political superpowers of the next century.”