Home > methodology > Consistency and validity is not enough!

Consistency and validity is not enough!

from Lars Syll

Neoclassical economic theory today is in the story-telling business whereby economic theorists create make-believe analogue models of the target system – usually conceived as the real economic system. This modeling activity is considered useful and essential. Since fully-fledged experiments on a societal scale as a rule are prohibitively expensive, ethically indefensible or unmanageable, economic theorists have to substitute experimenting with something else. To understand and explain relations between different entities in the real economy the predominant strategy is to build models and make things happen in these “analogue-economy models” rather than engineering things happening in real economies.

Formalistic deductive “Glasperlenspiel” can be very impressive and seductive. But in the realm of science it ought to be considered of little or no value to simply make claims about the model and lose sight of reality. As Julian Reiss writes: 

errorineconomicsThere is a difference between having evidence for some hypothesis and having evidence for the hypothesis relevant for a given purpose. The difference is important because scientific methods tend to be good at addressing hypotheses of a certain kind and not others: scientific methods come with particular applications built into them … The advantage of mathematical modelling is that its method of deriving a result is that of mathemtical prof: the conclusion is guaranteed to hold given the assumptions. However, the evidence generated in this way is valid only in abstract model worlds while we would like to evaluate hypotheses about what happens in economies in the real world … The upshot is that valid evidence does not seem to be enough. What we also need is to evaluate the relevance of the evidence in the context of a given purpose.

Neoclassical economics has since long given up on the real world and contents itself with proving things about thought up worlds. Empirical evidence only plays a minor role in economic theory, where models largely function as a substitute for empirical evidence. Hopefully humbled by the manifest failure of its theoretical pretences, the one-sided, almost religious, insistence on axiomatic-deductivist modeling as the only scientific activity worthy of pursuing in economics will give way to methodological pluralism based on ontological considerations rather than formalistic tractability. To have valid evidence is not enough. What economics needs is sound evidence.

Discussing Paul Romer’s “mathiness” concept, Peter Dorman yesterday criticized economists’ belief that theories and models being “consistent with” data somehow make the theories and models a success story. And Chris Dillow elaborates on the weakness of this “consistent with” error in a post today:

If a man has no money, this is “consistent with” the theory that he has given it away. But if in fact he has been robbed, that theory is grievously wrong. Mere consistency with the facts is not sufficient.

ConsistencyThis is a point which some defenders of inequality miss. Of course, you can devise theories which are “consistent with” inequality arising from reasonable differences in choices and marginal products. Such theories, though, beg the question: is that how inequality really emerged?** And the answer, to put it mildly, is: only partially. It also arose from luck, inefficient selection, rigged markets, rent-seeking and outright theft …

The Duhem-Quine thesis warns us that facts under-determine theory: they are “consistent with” multiple theories. This is perhaps especially true when those facts are snapshots. For example, a Gini coefficient – being a mere snapshot of inequality – tells us nothing about how the inequality emerged.

So, how can we guard against the “consistent with” error? One thing we need is history: this helps tell us how things actually happened. And – horrific as it might seem to some economists – we also need sociology: we need to know how people actually behave and not merely that their behaviour is “consistent with” some theory. Economics, then, cannot be a stand-alone discipline but part of the social sciences and humanities – a point which is lost in the discipline’s mathiness.

Yes indeed, history helps. And if we’re not to ‘busy’ doing the things we do, but once in a while take a brake and do some methodological reflection on why we do what we do — well, that takes us a long way too.

  1. originalsandwichman
    May 23, 2015 at 7:45 pm

    too busy… take a break

  2. Paul Schächterle
    May 24, 2015 at 12:49 am

    Where in the world can you see “valid evidence” for neoclassical theory? What does that even mean. How can there be any “evidence” without factual basis?

    To have a formally “valid” argument does not mean *anything*. You can assume that the world is flat and that all swans are black.

    What if your initial argument is not valid? Just invent some crazy helper axiom:

    For example if someone tells you that even if a consumer’s preferences had the form assumed by neoclassical micro, the outcome would not be a downward sloping demand curve for a group of different consumers?
    Just “assume” that all consumers are clones with the same initial endowment and – yay – there is your “valid” argument.
    That is an anti-axiom i.e. a premise so evidently false that it should be accepted as false without controversy, but who cares?

    Even better: disguise and hide your crazy helper axioms by not making them explicit but implicit.

    For example assume that people choose between labour and leisure based on the “rate of exchange” between those two “goods” and – yay – you have just implicitly “assumed” that all people either have an income other than labour or that they prefer to starve in their spare time if the wage rate gets low enough.
    That is pure ideological nonsense. But it is a “valid” argument.

    Heterodox economists often still go far to easy on neoclassical theory.

  3. May 26, 2015 at 9:39 pm

    The intelligent layperson’s guide through vacuonomics
    Comment on ‘Consistency and validity is not enough!’

    “In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum, 1991, p. 30)

    Economists have no true theory.

    It is important to distinguish between political and theoretical economics. Quite similar on the surface, these are entirely different endeavors. The goal of political economics is to push an agenda; the goal of theoretical economics is to explain how the actual economy works. In political economics anything goes; in theoretical economics scientific standards are observed.

    Political economists cannot explain how the actual economy works. There is much opinion and storytelling but little knowledge. Theoretical economics, on the other hand, is virtually non-existent. The two criteria theoretical economics must satisfy are material and formal consistency.

    The reason why economics is a failed science is that it has followed the wrong guideline (in the old days this was not so unusual: physicists stubbornly followed the planets-must-move-in-circles guideline for a couple of centuries).

    “It is a touchstone of accepted economics that all explanations must run in terms of the actions and reactions of individuals. Our behavior in judging economic research, in peer review of papers and research, and in promotions, includes the criterion that in principle the behavior we explain and the policies we propose are explicable in terms of individuals, not of other social categories.” (Arrow, 1994, p. 1)

    Starting on the wrong foot, this program cannot do other than to apply a barrage of green-cheese assumptions like utility, optimization, perfect foreknowledge, production function, supply/demand function, perfect competition, capital, equilibrium, etcetera. Clearly, these conceptions are nonentities. The scientific content of all models that contain nonentities is nil — it is vacuousness wrapped in rhetoric or mathematics. Storytelling is more Keynesian, formalization is more Walrasian. There is nothing to choose between the two.

    That much is evident by now: no way leads from the explication of individual behavior to an explanation of how the actual monetary economy works. Apart from manifest evidence, there are compelling methodological reasons for the repudiation of the accustomed paradigm. This means that a paradigm shift is overdue.

    One problem, though, is this. In the discussion of real world issues like unemployment, debt, or bubbles it is not transparent that the respective arguments are either derived from a false underlying theory or simply ad hoc. A mass of practical details covers theoretical emptiness. The realisticness of historical/personal accounts covers the surrealism of foundational beliefs. Because of commonsensical examples and appeals political economics appears not so alien as it in fact is. In the last instance, however, it is decisive that the layperson rates an economic argument according to the subjective code like/dislike or credible/incredible and not to the objective code true/false. So the latter criterion regularly gets lost in the discussion.

    What is constantly overlooked is that since Walras most models describe explicitly or implicitly a zero profit economy. Or, when profit does make an appearance it is definitively not clear what it really is (2015). The great embarrassment of economics is: “A satisfactory theory of profits is still elusive.” (Desai, 2008, p. 10) This vaporizes the economist’s key competence.

    There is no need to be conversant with the details of various economic approaches, because from the fact alone that the representative economist cannot correctly specify the difference between profit and income every layperson can safely conclude that economics as a discipline has nothing to contribute to the understanding of actual market economies.

    Economists who cling to the accustomed paradigm cannot be taken more seriously than any smart journalist, no matter what the issue or the actual discussion is. The scientific content of a peer-reviewed article, an op-ed, an economist’s blog, a layperson’s opinion, or a sitcom is the same, that is, nil.

    Egmont Kakarot-Handtke

    Arrow, K. J. (1994). Methodological Individualism and Social Knowledge.
    American Economic Review, Papers and Proceedings, 84(2): 1–9. URL http:
    Desai, M. (2008). Profit and Profit Theory. In S. N. Durlauf, and L. E. Blume
    (Eds.), The New Palgrave Dictionary of Economics Online, pages 1–11. Palgrave
    Macmillan, 2nd edition. URL http://www.dictionaryofeconomics.com/article?id=
    Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Profit. SSRN
    Working Paper Series, 2575110: 1–18. URL http://papers.ssrn.com/sol3/papers.
    Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic
    Method in Economics and Econometrics. Cambridge, MA: MIT Press.

  4. Larry Motuz
    May 27, 2015 at 5:16 pm

    To: Egmont Kakarot-Handtke

    One could go on forever about there being no scientific standards in economics, and that is largely because all of its assumptions are clearly incorrect. Firms and people are both consumers of goods and services. They put them to different uses or ends.

    Economists have constructed a theory in which the ends to which goods are used are not significant. Both the micro-foundations and what passes for macro-foundations are totally inadequate because of this. I can construct an economics in which I can show you how to construct the proper foundations. Indeed, I have. I have just not written all of it down.

    That economics removes the chimera that firms are not consumers of goods to obtain benefits from their uses of those goods. Marshall realized that firms have no subjective utility as such, so he focused on firms covering costs and making profits [their benefits]. {He also suggested that there was a natural rate of profit which is nonsense.}

    Market prices reflect two essential matters: 1) the multiplicity of ends to which different consumers, including firms, put their goods-usage to; 2) how much each different consumer can allocate (i.e., actually afford to allocate) as budgets to purchase these goods for these purposes. This second very much means that the distribution of income shapes what is consumed and for what purposes.

    There is never an ‘equilibrium’ in markets.

    Now, if you are interested, write me at larry[dot]motuz at gmail[dot]com. I hope to rewrite the foundations no later than September this year, God-willing and the devil having no objections as an old proverb puts it.

    I’d like to gain by the give and take you are capable of.

    Thank you.

  5. May 31, 2015 at 2:56 pm

    At the Robinson Line
    Comment on ‘Consistency and validity is not enough!’

    There is political economics and theoretical economics. People see a problem or are shocked by a great evil and begin to move heaven and earth to improve the situation. This is political economics and nothing is wrong with it.

    Science is different — it tries to find out how things work from the universe via society and the economy to the quark — and nothing is wrong with this either.

    Confusion results when the realms of political and theoretical economics are not properly kept apart. What the history of economic thought from Smith, to Marx, to Hayek or Keynes shows is that political economics has more or less successfully tried to hijack theoretical economics. This is the main reason why economics is a failed science.

    The goal of theoretical economics is to understand how the actual economy works. Every theory has an architectural structure which can be described as follows (the keywords are fact and logic):
    “When we assemble the facts of a definite, more-or-less comprehensive field of knowledge, we soon notice that these facts are capable of being ordered. This ordering always comes about with the help of a certain framework of concepts …. The framework of concepts is nothing other than the theory of the field of knowledge. … If we consider a particular theory more closely, we always see that a few distinguished propositions of the field of knowledge underlie the construction of the framework of concepts, and these propositions then suffice by themselves for the construction, in accordance with logical principles, of the entire framework.” (Hilbert, 2005, p. 1107)

    This necessarily leads to J. S. Mill’s Starting Problem.
    “For it can fairly be insisted that no advance in the elegance and comprehensiveness of the theoretical superstructure can make up for the vague and uncritical formulation of the basic concepts and postulates, and sooner or later … attention will have to return to the foundations.” (Hutchison, 1960, p. 5)

    This, then, is the key question of theoretical economics:
    “What are the propositions which may reasonably be received without proof? That there must be some such propositions all are agreed, since there cannot be an infinite series of proof, a chain suspended from nothing. But to determine what these propositions are, is the opus magnum of the more recondite mental philosophy. (Mill, 2006, p. 746)

    The propositions which may reasonably be received without proof are called axioms. Orthodoxy starts with behavioral axioms (McKenzie, 2008). In order to go beyond failed Orthodoxy, behavioral axioms have to be replaced. This was Keynes’s most valuable methodological insight.

    “The classical theorists resemble Euclidean geometers in a non-Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straight — as the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required to-day in economics.” (Keynes, 1973, p. 16)

    Unfortunately, Keynes’s own formal foundations are also defective (2011), therefore there is nothing to choose between Walrasianism and Keynesianism. With regard to the accustomed approaches it incontrovertibly holds what Joan Robinson concluded: “Scrap the lot and start again.”

    Nobody accepts Orthodoxy because it is true beyond reasonable doubt but because traditional Heterodoxy is even more clueless.
    “The main reason for the considerable acceptance of the approach is that fundamental rule of scientific combat: it takes a theory to beat a theory.” (Stigler, 1983, p. 541)

    This leads back to Mill’s Starting Problem.

    The formal foundations of Constructive Heterodoxy consist in seven propositions* which can be reduced for a start to the following three axioms.

    Income of the household sector Y in period t is the product of wage rate W and working hours L: Y=WL

    Output of the business sector O is the product of productivity R and working hours: O=RL. The productivity R depends on the underlying production process. The 2nd axiom should therefore not be misinterpreted as a linear production function.

    Consumption expenditure C of the household sector is the product of price P and quantity bought X: C=PX.

    The first three STRUCTURAL axioms represent the pure consumption economy with one firm and one product, that is, no investment, no foreign trade, and no government. No nonentities like utility, optimization, rational expectation, supply/demand function, production function, equilibrium, etcetera are taken into the premises. This has always been the inexcusable methodological blunder. The three objective equations are the MINIMUM requirement of EVERY economic model whatsoever. They solve Mill’s Starting Problem and provide the rock-solid basis for a comprehensive theoretical superstructure that consists of testable propositions.

    Theoretical economics must satisfy the criteria of material and formal consistency. The Robinson Line demarcates science from non-science. To go on with the obsolete approaches is not an option.

    Egmont Kakarot-Handtke

    Hilbert, D. (2005). Axiomatic Thought. In W. Ewald (Ed.), From Kant to Hilbert. A Source Book in the Foundations of Mathematics, volume II, pages 1107–1115. Oxford, New York, NY: Oxford University Press. (1918).
    Hutchison, T.W. (1960). The Significance and Basic Postulates of Economic Theory. New York, NY: Kelley.
    Kakarot-Handtke, E. (2011). Keynes’s Missing Axioms. SSRN Working Paper Series, 1841408: 1–33. URL http://ssrn.com/abstract=1841408.
    Keynes, J. M. (1973). The General Theory of Employment Interest and Money. The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke: Macmillan.
    McKenzie, L. W. (2008). General Equilibrium. In S. N. Durlauf, and L. E. Blume (Eds.), The New Palgrave Dictionary of Economics Online, pages 1–18. Palgrave Macmillan, 2nd edition. URL http://www.dictionaryofeconomics.com/article?id=pde2008_G000023
    Mill, J. S. (2006). Principles of Political Economy With Some of Their Applications to Social Philosophy, volume 3, Books III-V of Collected Works of John Stuart Mill. Indianapolis, IN: Liberty Fund. URL http://www.econlib.org/library/Mill/mlP.html
    Stigler, G. J. (1983). The Process and Progress of Economics. Journal of Political Economy, 91(4): 529–545. URL http://www.jstor.org/stable/1831067.

    * The complete and consistent set of foundational equations — six structural axioms and one behavioral function — is given here

  6. June 1, 2015 at 11:43 pm

    I am reluctant to take Egmont’s axioms for granted because they are no more real than those he rejects. They are generalisations true of nothing, or summations in terms of quantifications of monetary symbols as unstable in meaning as the thinness of air and not true of economies which don’t rely on wages and the profiteering which (one way or another) provides the incomes of more than half the members of the household sector; nor except in terms of productivity (a term used ambiguously, either denoting profitability or real produce meeting biological and human needs) do they account for change including historically evident evolution of the form of economies.

    What I am willing to accept is the evolution of the universe revealed to us by advances in instrumentation and mathematical understanding enabling us to see further and further back in time: to reverse engineer evolution. My postulates are not the Euclidian, Newtonian, godless unchanging universe of Hume but the non-Euclidian, Einsteinian, energetic, expanding universe formally (and I can show, materially) consistent with a Big Bang and a Creator of trinitarian (Christian) form; with our looking back now from inside a Keynesian layer with spherical geometry enclosing the universe.

    Egmont’s science “tries to find out how things work from the universe [as it is now] via society and the economy to the quark”. Having done that, and gone a little further [to the universe as it originally was] my science is able to reverse that process and rebuild the economy on genuine foundations.

    Euclid’s having proved three points are necessary and sufficient to define a circle is suggestive of both a trinity and a group of quarks, and the atomic energy confirmation of Einstein’s postulated equivalence of matter and energy suggests the trapping of energy in particles and its release by God “dying so that we might live”. But how can we know this?

    Accepting Shannon’s definition of information, i.e. “a difference which makes a difference”, all we can distinguish in the picture so far is motion in all directions. Even to distinguish different directions we need to add Cartesian [mathematical] coordinates, in which absolutely different directions are represented by right angles and particular directions by some combination of these. At the surface of the Universe as in our World, N-S, E-W lines mark out four regions, and we can go to any point on the surface by paths (not necessarily straight) which pass through it. Thus we may distinguish differences of direction in the motion emanating from the Big Bang, but note that this is purely information: it neither derives from nor influences the position chosen, the motion, its energy or its power (i.e. rate of transmission of energy with time). If the power is used, this changes the situation, which evolves into something different. Power may be absorbed to become a particle, then two particles may orbit each other stably (to form neutrons), then combine with others stably (to form atoms) or unstably (to form molecules); but these then are particles in their own right and evolution recommences at a new level; and so on right up to the ecological level of bisexual cells, plants, animals and humans, the economic level of the direction of energy to produce livelihoods, biological provision, education and technology, from whence economic technology has become monetarised: its aim no longer livelihoods but money making by mis-information (chrematism disguised as economics) exacerbated by information technology: printing, radio and computing.

    So, the axioms of my economics are physical structures: directed energy, the bounded spherical surface of the world, circular paths, directional information and circulating energy, pointing finger and rotating clock numbers, new types of entity evolving through four phases of development until, ultimately, economic human provision by efficient use of power is not the same as chrematic misuse of monetarised information to acquire and/or withhold power over the means of economic provision.

    What follows for me is that a theory doesn’t tell you what you will see, it tells you how and where to look, and what for. See the economy as communications channels interconnecting humans at four levels of development and functional motivation: figuratively speaking, dependents (kids) supplied by workers and distributors (dads and mums) using technology (developed by e.g. older folk). Look inside it: what is circulating (power or information)? See at it whole (like a radio channel rather than a program content). So what is money? Is it like electricity carrying power and needing a battery to save power when it is not needed? Or merely a symbol in a ledger or computer, which people have been taught to react to as if it were power?

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