Home > methodology > On the value of theoretical models in economics

On the value of theoretical models in economics

from Lars Syll

Chameleons arise and are often nurtured by the following dynamic. First a bookshelf model is constructed that involves terms and elements that seem to have some relation to the real world and assumptions that are not so unrealistic that they would be dismissed out of hand. monocle_chameleon_2The intention of the author, let’s call him or her “Q,” in developing the model may be to say something about the real world or the goal may simply be to explore the implications of making a certain set of assumptions. Once Q’s model and results become known, references are made to it, with statements such as “Q shows that X.” This should be taken as short-hand way of saying “Q shows that under a certain set of assumptions it follows (deductively) that X,” but some people start taking X as a plausible statement about the real world. If someone skeptical about X challenges the assumptions made by Q, some will say that a model shouldn’t be judged by the realism of its assumptions, since all models have assumptions that are unrealistic …

Chameleons are models that are offered up as saying something significant about the real world even though they do not pass through the filter. When the assumptions of a chameleon are challenged, various defenses are made (e.g., one shouldn’t judge a model by its assumptions, any model has equal standing with all other models until the proper empirical tests have been run, etc.). In many cases the chameleon will change colors as necessary, taking on the colors of a bookshelf model when challenged, but reverting back to the colors of a model that claims to apply the real world when not challenged.

Paul Pfleiderer

Reading Pfleiderer’s article reminds me of what H. L. Mencken once famously said:

There is always an easy solution to every problem – neat, plausible and wrong.

Pfleiderer’s perspective may be applied to many of the issues involved when modeling complex and dynamic economic phenomena. Let me take just one example — simplicity.

When it come to modeling I do see the point emphatically made time after time by e. g. Paul Krugman in simplicity — as long as it doesn’t impinge on our truth-seeking. “Simple” macroeconomic models may of course be an informative heuristic tool for research. But if practitioners of modern macroeconomics do not investigate and make an effort of providing a justification for the credibility of the simplicity-assumptions on which they erect their building, it will not fulfill its tasks. Maintaining that economics is a science in the “true knowledge” business, I remain a skeptic of the pretences and aspirations of  “simple” macroeconomic models and theories. So far, I can’t really see that e. g. “simple” microfounded models have yielded very much in terms of realistic and relevant economic knowledge.

All empirical sciences use simplifying or unrealistic assumptions in their modeling activities. That is not the issue – as long as the assumptions made are not unrealistic in the wrong way or for the wrong reasons.

But models do not only face theory. They also have to look to the world. Being able to model a “credible world,” a world that somehow could be considered real or similar to the real world, is not the same as investigating the real world. Even though — as Pfleiderer acknowledges — all theories are false, since they simplify, they may still possibly serve our pursuit of truth. But then they cannot be unrealistic or false in any way. The falsehood or unrealisticness has to be qualified.

Explanation, understanding and prediction of real world phenomena, relations and mechanisms therefore cannot be grounded on simpliciter assuming simplicity. If we cannot show that the mechanisms or causes we isolate and handle in our models are stable, in the sense that what when we export them from are models to our target systems they do not change from one situation to another, then they – considered “simple” or not – only hold under ceteris paribus conditions and a fortiori are of limited value for our understanding, explanation and prediction of our real world target system.

The obvious ontological shortcoming of a basically epistemic – rather than ontological – approach, is that “similarity” or “resemblance” tout court do not guarantee that the correspondence between model and target is interesting, relevant, revealing or somehow adequate in terms of mechanisms, causal powers, capacities or tendencies. No matter how many convoluted refinements of concepts made in the model, if the simplifications made do not result in models similar to reality in the appropriate respects (such as structure, isomorphism etc), the surrogate system becomes a substitute system that does not bridge to the world but rather misses its target.

Constructing simple macroeconomic models somehow seen as “successively approximating” macroeconomic reality, is a rather unimpressive attempt at legitimizing using fictitious idealizations for reasons more to do with model tractability than with a genuine interest of understanding and explaining features of real economies. Many of the model assumptions standardly made by neoclassical macroeconomics – simplicity being one of them – are restrictive rather than harmless and could a fortiori anyway not in any sensible meaning be considered approximations at all.

If economists aren’t able to show that the mechanisms or causes that they isolate and handle in their “simple” models are stable in the sense that they do not change when exported to their “target systems”, they do only hold under ceteris paribus conditions and are a fortiori of limited value to our understanding, explanations or predictions of real economic systems.

That Newton’s theory in most regards is simpler than Einstein’s is of no avail. Today Einstein has replaced Newton. The ultimate arbiter of the scientific value of models cannot be simplicity.

As scientists we have to get our priorities right. Ontological under-labouring has to precede epistemology.

 

  1. Paul Schächterle
    March 24, 2015 at 11:19 am

    You simply cannot compare Newton to the neoclassical nonsense! That is actually outrageous. Neoclassical models are inconsistent, totally unrealistic in the sense that they use absolutely false and ridiculous assumptions, and obviously are not confirmed at all by any experience.

    How is that anywhere closely related to a physical model that is rather correct for most use cases?

    Let’s face it. Neoclassical economics is ideologically motivated garbage.

    Please don’t insult real scientists by comparing their work to neoclassical economics.

  2. March 24, 2015 at 4:13 pm

    In the natural sciences the target appears to be fixed, and successive approximations seem to be converging towards some ultimate truth, yielding better and better approximations. It seems to me that economies are similar, but from time to time undergo substantive change in a few aspects, so that simple successive approximations do not converge and do not get better. The neoclassicists essentially assume ‘the end of history’. Even if we suppose that they may eventually be right, it is hard to see how they could be certain. Thus we need to distinguish between actions that are short-term and those that commit generations on the assumption that nothing much will ever change. One the other hand, we might want to identify those things – such as gross inequality – that we might be able to change, and not just assume that we cant.

  3. BRUCE E. WOYCH
    March 24, 2015 at 7:07 pm

    Every theory has a purpose. A good deal of theory replaces ideology. A great deal of theory goes to defend that ideology and secure vested, nested interests. An emergent set of theory comes to dissent against the original theory, renovating or innovating on it through generative (generations) of recapitulations. Finally alternative theories object to the subjective interpolations and politicize the arena. Once or twice in a century, somebody speaks the truth and we get adversity and dissent to recapture the playing field.
    Bruce E. Woych

  4. BRUCE E. WOYCH
    March 24, 2015 at 7:16 pm

    Why do “schools’ of theory exist in the first place? Are their actually schools in reality?
    The “purpose’ of theory is not to identify reality, it is to identify the schools that process the selected / elected reality that fits their membership. Theory, for the most part, is recombinant DNA for ideological legitimation and operational methodology to keep it resilient.

  5. Paul Schächterle
    March 24, 2015 at 7:43 pm

    In the natural sciences, scientists observe and then make informed guesses about nature and causal relationships (models) and then test their models against further observations, including experiments.

    What I can see in mainstream economics is nothing like that. Economists just invent crazy assumptions about nature and the behaviour of people and then build inconsistent toy models out of those assumptions.

    No observation, no testing.

    They use assumptions that are clearly false. They can give no sane reasons for their assumptions. They hide their assumptions in misleading language and then extend even those crazy models to outside their scope or simply “forget” stated conditions.

    Some of the neoclassical assumptions are:

    – There is no time.
    – People can accurately predict the future.
    – All goods are infinitely divisible.
    – There are no economies of scale.
    – Workers prefer to starve in their spare time if wage rate get low enough.
    – Society consists of only one person.
    – Infinitesimally small amounts equate to zero.

    Give me a break! That is no science. That is madness. In a better world there we would have no reason to even discuss such models.

    • March 25, 2015 at 11:55 am

      Agree. Economists including Plfeiderer do not really understand what is science. Economics is not science because it has no agreed facts on which to base theories. Economics is just story-telling as Lucas was honest enough to admit.

  6. BRUCE E. WOYCH
    March 24, 2015 at 8:53 pm

    Economic theories and models are relationships between an invariable and variables. They have “utility” because as systems of arrangements variables may be predicted, manipulated and possibly controlled as long as the invariable remains constant.

    Intervening or controlling variables can be very profitable, and in that regard theoretical models are a form of cultural capital and industry since they produce a predictable course or outcome and fictive knowledge that impacts behavior and responses.

    Invariables, however, do not have to actually exist in the real natural world. Fictions that are most industrious must remain constant, and classical economic theory goes to great lengths and creative fictions to hold their “invariable” solidly defended and the status quo in tact; and all the variables follow in suit very nicely. It is built so that all the predictions come true.

    Good science and real theorems not withstanding, it is a process of sublimation and subjugation. Like conspiracies, when it is suitable to obscure reality everything else is “JUST” a theory.

  7. March 25, 2015 at 12:00 pm

    Unfortunately these are the type of works and models that get noticed and are celebrated in the field of economics.in fact economics is a celebration of complexity and non valuability

  8. March 25, 2015 at 5:19 pm

    Beyond methodological madness
    Comment on ‘On the value of theoretical models in economics’

    Economists are in the state of manifest self-delusion. They are convinced that what they do is science. Time to face reality.

    “Suffice it to say that, in my opinion, what we presently possess by way of so-called pure economic theory is objectively indistinguishable from what the physicist Richard Feynman, in an unflattering sketch of nonsense ‘science,’ called ‘cargo cult science’.” (Clower, 1994, p. 809)

    After summarizing the neoclassical premises Paul Schächterle concludes:
    “That is no science. That is madness. In a better world there we would have no reason to even discuss such models.” (Preceeding post)

    Indeed, no other conclusion is possible for everybody with a modicum of scientific intuition. Economics is a proto-science, at best on the level of medieval physics. That is bad enough, but it gets worse when economists start talking about methodology.

    How can anyone take seriously what Krugman, who cannot tell the difference between profit and income (2014), says about the significance of simplicity? Simplicity as such has never been a truth criterion.

    “A theory is the more impressive the greater the simplicity of its premises, the more different kinds of things it relates, and the more extended is its area of applicability.” (Einstein, quoted in Brown, 2011, p. 244)

    Note that Einstein talks about the area of applicability. How large is the area of applicability of neoclassical economics in all its current variants? Yes, exactly zero, and this has nothing to do with simplicity but with simple mindedness.

    Note also that it is the extent of applicability that makes the difference between Einstein’s and Newton’s theory. Newton is the limiting case of Einstein for low speeds. This has nothing to do with simplicity.

    Beginning with equilibrium, economists borrowed most of their concepts from physics and then misapplied them (Mirowski, 1995). The same holds for methodology. Neither Orthodoxy nor Heterodoxy understands until this day how the axiomatic-deductive method is to be applied correctly.

    As Einstein said: ‘A theory is the more impressive the greater the simplicity of its premises …’. It is Constructive Heterodoxy which displays the greatest simplicity of premises. These premises are objective and have no resemblance at all with the green cheese assumptionism of New Classicals or New Keynesians. The paradigm shift, which leaves theses approaches as well as traditional Heterodoxy behind, is already on the way. See the references:

    http://axecorg.blogspot.de/2015/02/essentials-cross-references.html

    Egmont Kakarot-Handtke

    References
    Brown, K. (2011). Reflections on Relativity. Raleigh, NC: Lulu.com.
    Clower, R. W. (1994). Economics as an Inductive Science. Southern Economic
    Journal, 60(4): 805–814.
    Kakarot-Handtke, E. (2014). Mr. Keynes, Prof. Krugman, IS-LM, and the End of
    Economics as We Know It. SSRN Working Paper Series, 2392856: 1–19. URL
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2392856.
    Mirowski, P. (1995). More Heat than Light. Cambridge: Cambridge University Press.

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