Home > Uncategorized > Limits of formalization in economics

Limits of formalization in economics

from Lars Syll

A complete modeling system which yields definitive predictions (or at least multiple equilibria) requires the following conditions: given structures with fixed (or at least predictably random) interrelations between separable parts (e.g., economic agents) and predictable (or at least predictably random) outside influences. Such a system is … a‘closed’ system. Such a system, correctly applied, promotes internal consistency but risks inconsistency with the nature of the economic system unless that too is closed …

phelpsfrydmanAn open system is not the opposite of a closed system, since there is a range of possibilities for openness, depending on which conditions are not met and to what degree … Deviating from a closed system, and thus from certainty or certainty equivalence, does not mean abandoning theory or formal models. On the contrary, Keynes was concerned to identify the logical grounds on which we habitually form beliefs, make judgments and take decisions (both as economists and as economic agents) in spite of uncertainty. The question was what view on probability would be logically justified, in relation to the evidence, within an open system …

Any formal model is a closed system. Variables are specified and identified as endogenous or exogenous, and relations are specified between them. This is a mechanism for separating off some aspect of an open-system reality for analysis. But, for consistency with the subject matter, any analytical closure needs to be justified on the grounds that, for the purposes of the analysis, it is not unreasonable to treat the variables as having a stable identity, for them to have stable interrelations and not to be subject to unanticipated influences from outside … But in applying such an analysis it is important then to consider what has been assumed away …

Keynes’s argument is that any formal model is bound to be an incomplete representation of an open-system reality … Models are inevitably partial representations, invoking closures which are both porous and provisional. They can only be approximated in reality and even then cannot be presumed to persist …

This methodology explains why Keynes’s general theory did not take the form of a single large model, including formal microfoundations … It was not that Keynes lacked a microeconomic analysis, but rather that his study of individual behavior concluded that it was organic rather than atomistic.

Sheila Dow

  1. Jorge Buzaglo
    September 30, 2015 at 2:51 pm

    A like-minded comment by Jorge Luis Borges:
    “In that Empire, the Art of Cartography attained such Perfection that the map of a single Province occupied the entirety of a City, and the map of the Empire, the entirety of a Province. In time, those Unconscionable Maps no longer satisfied, and the Cartographers Guilds struck a Map of the Empire whose size was that of the Empire, and which coincided point for point with it. The following Generations, who were not so fond of the Study of Cartography as their Forebears had been, saw that that vast map was Useless, and not without some Pitilessness was it, that they delivered it up to the Inclemencies of Sun and Winters. In the Deserts of the West, still today, there are Tattered Ruins of that Map, inhabited by Animals and Beggars; in all the Land there is no other Relic of the Disciplines of Geography.” From: “Del rigor en la ciencia” (1946).

  2. Larry Motuz
    September 30, 2015 at 5:24 pm

    The central problem with all of economic theory lies with theorizing about utility and marginal utilities while ignoring the material, emotional and other benefits from consumption.

    The ‘correction’ of the theory requires bringing values-in-use back into economics while also acknowledging that preference theorizing that ignores tastes as likes of dislikes conflates satisfaction with receiving any kind of benefit, as if these two very separate things were one and the same thing. I can consume goods that give me benefits but which don’t offer me ‘satisfaction’ because I am forced, by the price system, to consumer things I do not ‘like’ nor ‘want’ but must.

    I had hoped to have a paper entitled “A Reconstruction of the Foundations of Economic Thought” ready by the end of September but took ill so it will not be ready ’til the end of December.

    1. It sets aside the theorizing of the Marginalists –Jevons, Marshall, Menger — as largely irrelevant to consumer decision making.

    2. It re-introduces value-in-use as a materiually objective measure of benefit from consumption. It does this by specifying and measuring well-defined objective benefits.

    3. It removes equilibrium as a concept at all useful to the study of economic activity. It does so by establishing that the notion that any market ‘automatically’ clears as if guided by an invisible hand is an impossibility.

    4. It demonstrates that one can derive aggregate demand curves for individual commoditiesbut also that price changes for commodities introduce shocks which, on the assumption that markets were clearing before the price changes, show that market clearing is itself not the natural state of markets, much less equilibriums within markets.

    5. It establishes that consumption is ‘use’ to obtain a benefit. In so doing, it revises the theory of the ‘consumer’ to include the consumption activities of firms. This resetting of the meaning of consumption removes the core of existing consumer theory and characterizes the theory of the firm as without any foundation. Firms, as consumers, ‘use’ goods to obtain expected benefits measured in units of money whereas people need more than merely money to survive and be healthy. The firm competes with other consumers for the use of goods and may damage our common welfare when so doing.

    6. It establishes that monetized markets have inherent built-in rules for exchange that establish, for any two rivalrous goods x and y (but extendable to all goods) that trade of one for the other requires that y/x=px/py as the minimal condition for trade to occur.

    7. It shows that both the distribution of incomes and the distribution of preferences (when known) determine the aggregate growth paths in and between markets.

    Thank you.

  3. Paul Schächterle
    October 1, 2015 at 11:43 am

    Quote: “This methodology explains why Keynes’s general theory did not take the form of a single large model, including formal microfoundations”.

    Well if you use “micro-foundations” then your “model” is automatically absolutely false. And that has nothing to do with the level of formalisation.

    I don’t understand how in economics there are a lot of pseudo-philosophical discussions about “methodology” and “modelling” and almost no-one mentions how absurd and nonsensical a lot of the models are that are actually used and how absolutely unscientific the “methods” are that neoclassical economics employs.

    You wouldn’t start a discussion about modelling mills based on an M.C. Escher drawing, would you?

    So my take is: Choose your level of formalization freely! Use mathematics if you want to, don’t use it if you don’t think it feasible. Choose you level of abstraction (abstraction, not fiction!) as you like. Basically do whatever you think helpful in trying to understand the world. Just express yourself in an understandable manner, link your theories to observable facts.

    And don’t use quack assumptions!

  4. October 1, 2015 at 2:35 pm

    Coming to terms with formalization
    Comment on ‘Limits of formalization in economics’

    (i) First of all, one has to differentiate between formalization and formalism: “Now ‘formalism’ is not the same thing as ‘formalization’ or ‘mathematization’ because it is possible to express a theory mathematically and even axiomatically without necessarily degenerating into ‘formalism’, which simply means giving top priority to the formal structure of modelling irrespective of its content; …” (Blaug, 1994, p. 131). Orthodoxy is a failed approach because of its conceptual vacuousness, that is, because it deals with nonentities. Utility, clearly, is a nonentity, and because of this utility maximization is pure formalism.

    (ii) It is not admissible, to begin with, to take a specific behavioral assumption as an axiom. For example: “… HC2 agents individually optimize subject to constraints; …” (Weintraub, 1985, p. 147). The only acceptable general proposition about human behavior is that it is target-oriented (2015). It should be clear that if the formal foundations of an approach are defective then formalization is a pointless exercise. For good methodological reasons no behavioral proposition whatsoever can be taken into the formal foundations of a theory. In other words; there is no such thing as a behavioral axiom.

    (iii) Keynes’s approach is superior because it had not been based upon a shaky behavioral assumption but on objective structural relationships. The formal core of the General Theory is given with: “Income = value of output = consumption + investment. Saving = income – consumption. Therefore saving = investment.” (Keynes, 1973, p. 63). This formalization contains a conceptual error/mistake that relates to profit (2011). Without realizing it, Keynes implicitly formalized a zero profit economy.

    (iv) Both, the Walrasian and the Keynesian approach, got formalization wrong, albeit in different ways. From this does not logically follow that formalization is wrong, just the contrary: “I mean by this that formalization eliminates provincial and inessential features of the way in which a scientific theory has been thought about. … Formalization is a way of setting off from the forest of implicit assumptions and the surrounding thickness of confusion, the ground that is required for the theory being considered. … In areas of science where great controversy exists about even the most elementary concepts, the value of such formalization can be substantial.” (Suppes, 1968, pp. 654-655)

    (v) Both, Orthodoxy and Heterodoxy, got the most elementary concepts of economics, i.e. income and profit, badly wrong. For the correct formalization of economics see (2014).

    (vi) Formalization has worked everywhere, except in economics. Why? “My opinion continues to be that axiomatics, like every other tool of science, is no better than its user, and not all users are skilled.” (Clower, 1995, p. 308)

    Egmont Kakarot-Handtke

    References
    Blaug, M. (1994). Why I am Not a Constructivist. Confessions of an Unrepetant Popperian. In R. E. Backhouse (Ed.), New Directions in Economic Methodology, pages 109–136. London, New York, NY: Routledge.
    Clower, R. W. (1995). Axiomatics in Economics. Southern Economic Journal, 62(2): 307–319. URL http://www.jstor.org/stable/1060684.
    Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL http://ssrn.com/abstract=1966438.
    Kakarot-Handtke, E. (2014). Objective Principles of Economics. SSRN Working Paper Series, 2418851: 1–19. URL http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2418851
    Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Behavior. SSRN Working Paper Series, 2600523: 1–17. URL
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2600523.
    Keynes, J. M. (1973). The General Theory of Employment Interest and Money. The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke: Macmillan.
    Suppes, P. (1968). The Desirability of Formalization in Science. Journal of Philosophy, 65(20): 651–664.
    Weintraub, E. R. (1985). Joan Robinson’s Critique of Equilibrium: An Appraisal. American Economic Review, Papers and Proceedings, 75(2): 146–149. URL
    http://www.jstor.org/stable/1805586.

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