Home > Uncategorized > The most devastatingly important trade-off in mainstream economics

The most devastatingly important trade-off in mainstream economics

from Lars Syll

Using formal mathematical modeling, mainstream economists sure can guarantee that the conclusion holds given the assumptions. However, the validity we get in abstract model worlds does not warrantly transfer to real world economies. Validity may be good, but it isn’t enough. From a realist perspective both relevance and soundness are sine qua non.

broken-linkIn their search for validity, rigour and precision, mainstream macro modellers of various ilks construct microfounded DSGE models that standardly assume rational expectations, Walrasian market clearing, unique equilibria, time invariance, linear separability and homogeneity of both inputs/outputs and technology, infinitely lived intertemporally optimizing representative household/ consumer/producer agents with homothetic and identical preferences, etc., etc. At the same time the models standardly ignore complexity, diversity, uncertainty, coordination problems, non-market clearing prices, real aggregation problems, emergence, expectations formation, etc., etc.

Behavioural and experimental economics — not to speak of psychology — show beyond any doubts that “deep parameters” — peoples’ preferences, choices and forecasts — are regularly influenced by those of other participants in the economy. And how about the homogeneity assumption? And if all actors are the same – why and with whom do they transact? And why does economics have to be exclusively teleological (concerned with intentional states of individuals)? Where are the arguments for that ontological reductionism? And what about collective intentionality and constitutive background rules?

These are all justified questions – so, in what way can one maintain that these models give workable microfoundations for macroeconomics? Science philosopher Nancy Cartwright gives a good hint at how to answer that question:

Our assessment of the probability of effectiveness is only as secure as the weakest link in our reasoning to arrive at that probability. We may have to ignore some issues to make heroic assumptions about them. But that should dramatically weaken our degree of confidence in our final assessment. Rigor isn’t contagious from link to link. If you want a relatively secure conclusion coming out, you’d better be careful that each premise is secure going on.

On a deep level one could argue that the one-eyed focus on validity makes mainstream economics irrelevant, since its insistence on deductive-axiomatic foundations doesn’t earnestly consider the fact that its formal logical reasoning, inferences and arguments show an amazingly weak relationship to their everyday real world equivalents. Although the formal logic focus may deepen our insights into the notion of validity, the rigour and precision has a devastatingly important trade-off: the higher the level of rigour and precision, the smaller is the range of real world application. So the more mainstream economists insist on formal logic validity, the less they have to say about the real world. The time is due an over-due for getting the priorities right …

  1. Paul Davidson
    November 7, 2015 at 4:58 pm

    good luck at trying to get the economics profession Establishment getting the priorities right! I have been trying to get a more realistic set of basic assumptions adopted by the majority of economists since the 1960s!

    In the last 15 years I have published five books on the subject — and not one of these books has been reviewed by the Journal of Economic Literature, The Economics Journal, the Eastern Economics Journal or any other professional economics journal. If they will no review my books how are the majority of economists world wide going to know of the existence of this alternative realistic theory?

    My latest book is entitled POST KEYESIAN THEORY AND POLICY; A REALISTIC ANALYSIS OF THE MARKET ORIENTED CAPITALIST ECONOMY. What chance do you think tis will have of being reviewed?

  2. November 7, 2015 at 5:07 pm

    Correct. You can throw out virtually all of the delusion surrounding DSGE. Rational expectations, marginalism etc. etc. We have a monetary economy and money is basically accounting which basically rules the micro-economy. Splashing around on the surface level of debits and credits will also tend to make things appear DSGE-like. What you want to do is go to the cost accounting level of any and all enterprises which is the 3 and 4 dimensional real, on the ground/non-abstract level. There you will find the statistics to do the calculus on that will show economists where the disequilibrated state of our economies arises out of.

  3. November 7, 2015 at 7:29 pm

    A good place to start in helping economists understand their problem is to give them a baseline of modeling that does actually work. I’m referring to the IPCC modeling of world climate. Other than level of complexity these models must address many of the same questions and issues as economic models. So why do the IPCC models appear to give reasonable and testable results, as opposed to economic models that can do neither? I cannot of course force economists to consider these issues, especially if their concerns are solely with academic standing and raw, nonacademic power over world events.

  4. November 7, 2015 at 9:19 pm

    No trade-off, Kant said
    Comment on ‘The most devastatingly important trade-off in mainstream economics’

    “Research is in fact a continuous discussion of the consistency of theories: formal consistency insofar as the discussion relates to the logical cohesion of what is asserted in joint theories; material consistency insofar as the agreement of observations with theories is concerned.” (Klant, 1994, p. 31)

    Repeat: formal AND material consistency, BOTH! There is NO trade-off in science, never was, and never will be. The misleading idea that there could be a conflict between ‘theory and practice’ or ‘rigor and relevance’ is very old and immensely popular among laypersons. So much so that Kant bothered to refute it in an essay, first published in 1793, with the title ‘On the Old Saw: That May be Right in Theory But It Won’t Work in Practice.’

    Kant exploded the silly saw with the famous punch-line: “Es gibt nichts Praktischeres als eine gute Theorie“ or “There is nothing as practical as a good theory.”

    Hence, Lars Syll’s summary: “the higher the level of rigour and precision, the smaller is the range of real world application. So the more mainstream economists insist on formal logic validity, the less they have to say about the real world” has already been refuted in 1793.

    The devastating crux of Orthodoxy stems not from formal logic validity, but from the set of absolutely unacceptable premises. The intellectual catastrophe that is economics starts with the maximization-with-equilibrium assumption, which is sorta kinda common to the funny crowd of spacy DSGEers.

    As soon as Heterodoxy agrees on superior axioms Orthodoxy’s conceptual green cheese will be gone for good. And Heterodoxy will outperform Orthodoxy in logical consistency “… for he who contradicts himself proves nothing.” (Klant, 1988, p. 113)

    Egmont Kakarot-Handtke

    Klant, J. J. (1988). The Natural Order. In N. de Marchi (Ed.), The Popperian Legacy in Economics, pages 87–117. Cambridge: Cambridge University Press.
    Klant, J. J. (1994). The Nature of Economic Thought. Aldershot, Brookfield, VT: Edward Elgar.

    • November 9, 2015 at 2:06 pm

      This reminds me of Kant’s categorical imperative—which I interpret to mean ‘do as i say, not as i do’. If you look in the mirror you won’t see what others see (such as the back of your head) and also, due to the finiteness of the speed of light (tjhough that possibly could be taken to be a convention a la Poincare or A. Grunbaum, H Reichenbach, or ‘tired light’ and ‘variable radioactive decay constants’ theorists) you will onoly see yourself as you existed in the past. Most theories i currently study a bit (such as ‘quantum gravity’, ‘income inequality’, ‘interpretations of quantum theory’) seem to admit at least two theories each of which produce identical logic, as well as being consistant with known data or observations. (The same is also true for things like ‘genes’ versus ‘environment’ explanations of behavior — one can typically create models explaining phenomena based on either assumption and usually due to lack of a large sample size, or ways of characterizing relevant variables, one cannot distinguish which theory is true.)

      I happen to think that ‘categorical imperative’ is false, and very outdated. What ‘is’ likely will never conform to what ‘it’ ‘ought’ to be. “Get over it’. The world is non commutative—-ab/=ba. And might may not make it right (though of course ‘might’ admit many interpretations—is it goliath, or david? and perhaps the meek will inherit the earth rather than some legacy student. Of course using ‘hindsight bias’ (kahenemann (sic) and tversy) one can write the true history of events at all times or update it—history 1.0, history 2.0…

      ‘Klant says ‘he who contradicts himself proves nothing’, but equally he who never contradicts himself may prove something, maybe more about him or her self. (Look up satisficing by H Simon, who interestingly in the 50’s, long before modern econophysics, discussed the bose-einstein distribution, though apparently that is a probabilistic result independently discovered in that field, far from einstein, bose and planck physics Babies often have pretty good theories about the tooth fairy and santa claus. Others about how ‘its turtles all the way down’ for geophysics.

      Are there ‘superior axioms’? When i think of axioms, i think of the axiom of choice (check it out on wikipedia, and its amazing how many versions of that exist—though they could also be called disguises).

      The ‘well ordering principle’ may be a nice one (zermelo, of ZFC). “lets keep things well ordered, dont upset the setup ( as happenned to me recently when my landlord moved my computer since my music bothered my neighbor —took me quite a while to reassemble it and i may be on 30 day notice, tho i have an invitation for another place for much cheaper though the neighborhood may be rougher) , and make sure ‘the trains run on time’.

      (time is discussed in http://www.arxiv.org/abs/gr-qc/060549 — there is a sort of tradeoff between time and space, as epitiomized by the quantum uncertainty principle (which is also just a math result about fourier transforms. —cramer – rao inequality). (Godel showed AoC is independet of ZFC, P Cohen showed CH is also indepenedent —so you can choose the continuum (or real numbers) to have any cardinality you so desire; maybe even more than one as in some physics theories about light–maybe try a model with 3 different speeds of light) (Another question may be whether solution of Hilbert’s 10th problem is equivalent to Turing’s halting problem. I’d say so but maybe i’m wrong). .

      for further reading one can always look at ‘non-commutative worlds’ by louis kauffman (knot theorist and musician, some of whose politics i disagree with) , or s feferman (stanford, same place p cohen (CH) and k pribram worked (i met both of them but no consensus was achieved) on ‘does mathematics need new axioms’ (both free online). (i still have a sentimental attachement to g mackey’s ‘harmonic analyses as the exploitation of symmetry’ (also free), about the music of the hemi/spheres (mind/world) and class conflict.

  5. Geoff Davies
    November 8, 2015 at 6:24 am

    Putting Egmont’s point in a more straightforward way:

    I can make a logically rigorous rough approximation, and get a bit of guidance about the real world, if my assumptions are not too silly.

    Or, I can make a logically rigorous complicated calculation, and get possibly some more useful guidance about the real world (though not necessarily – those pesky assumptions again).

    Or, I can make a logically rigorous elaborate calculation base on ludicrous assumptions (e.g. DSGE) and get no useful guidance about the real world, because the real world is an entirely different kind of system (complex) than near-equilibrium DSGE.

    Or, I can make a logically rigorous simple calculation based on ludicrous assumptions and get no useful guidance …

    In other words, until you have a theory that bears some useful resemblance to the real world the elaborateness of your calculations is irrelevant.

    And the rigour of your deductions from your premises had better be there in all cases, because otherwise you are just making mistakes in your calculation.

    This is the kind of understanding that real scientists have, but seems to elude many economists, orthodox or not.
    Is the neoclassical theory scientific? https://betternature.wordpress.com/my-books/otherbooks/economia/neoclassical-scientific/

  6. rddulin
    November 8, 2015 at 12:49 pm

    The first thing that has to be done is to define what system is to be modeled. I suggest a fresh start at the simplest level. Barter, define its limitations. Does the simplest barter exchange property accurately? Lets assume it does. I hope we can agree that a common denominator such as money can facilitate trade in many ways. It is also hoped that we can agree that this money should accurately determine price value of the items to be traded as it’s most valuable property.
    How should money be created to determine prices accurately?
    Accurate prices.
    This is what we need to agree on.
    Many people today receive money they do not deserve by gaming the money system.
    This hurts the producers. The associated dead-weight loss hurts everyone
    Any further effort to mathematically model or manage the real world is relatively meaningless without accurate prices. Even if a mathematical model is magically discovered it cannot be tested in the real world because we do not have a system of money that gives accurate price data.

  7. November 9, 2015 at 2:23 pm

    I think that if Economists were to engage more with social/organizational theorists then they’d be better able to make the jump from the individual’s rational expectations towards a macro model of thousands of such individuals interacting. This contribution here sums up the main debate in that field: http://www.academia.edu/576759/Understanding_the_Structure_and_Agency_debate_in_the_Social_Sciences

    Economics is very biased towards the one side of ‘Agency’ here, as it allows for the ‘simple’ upwards movement of assumptions as the population size increases, ignoring the increasing diversity and complexity of this population (because ‘Agency’ dictates that it ultimately doesn’t matter). System thinking on the other hand does not revere the ability of the individual as much, and it would give economists a good rope to hold on to if we are ever to climb out of this slippery crevasse of assumptions.

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