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Shaky Assumptions

All models by necessity distort reality in one way or another.  A sculptor, when modelling in stone or clay, does not try to clone Nature; he highlights some things, ignores others, idealizes or abstracts some more, to achieve an effect. Likewise a scientist must necessarily pick and choose among various aspects of reality to incorporate into a model.  An economist makes assumptions about how markets work, how businesses operate, how people make financial decisions.  Any one of these assumptions, considered alone, is absurd.  There is a rich vein of jokes about economists and their assumptions.  Take the old one about the engineer, the physicist, and the economist. They find themselves shipwrecked on a desert island with nothing to eat but a can of beans.  How to get at them?  The engineer proposes breaking the can open with a rock.  The physicist suggests heating the can in the sun, until it bursts.  The economist’s approach: “First, assume we have a can opener. . . .”

The assumptions of orthodox financial theory are at least as absurd, if viewed in isolation.  Consider a few:

1) Assumption: People are rational and aim only to get rich.  . . . . 

2) Assumption: All investors are alike.  . . . . 

3) Assumption: Price change is practically continuous.  . . . . 

4) Assumption: Price changes follow a Brownian motion.

Benoit B. Mandelbrot 

  1. July 19, 2016 at 11:23 am

    And Mandelbrot did all this complex studying and mathematics with few equations such as seen in mainstream economics textbooks. I know some of the purposes of these equations – gate keeper, prestige builder, deflect criticisms, show relationships that don’t exist in the world — and none are related to education, enlightenment, and helping the peoples’ of the world cope with the resource and welfare questions they face each day. Unless one is interested in figuring out the psychological maladies that infect economics and economists I see no reason to waste the paper (or digital space if Ebooks) to create economics texts or the time and money to purchase let alone read such books. Economics is not a failed science. It is a never was science. And in most instance even the jokes based on economics are not that funny.

  2. July 19, 2016 at 1:58 pm

    Feeble minds, shaky assumptions, and the inevitable failure of economics
    Comment on Edward Fullbrook on ‘Shaky Assumptions’

    Every perceived event is a hard to unravel clew of unique space/time specifics, eternal laws/invariants, and free target-oriented human action. The flow of events is a clew of regularities, novelties, and apparent randomness. In order to think about a smaller or bigger section of reality it is imperative to simplify/abstract/idealize the perceived flow of events. This is known to every economist since J. S. Mill.

    “Since, therefore, it is vain to hope that truth can be arrived at, either in Political Economy or in any other department of the social science, while we look at the facts in the concrete, clothed in all the complexity with which nature has surrounded them, and endeavour to elicit a general law by a process of induction from a comparison of details; there remains no other method than the à priori one, or that of ‘abstract speculation’.” (1874, V.55)

    What we call ‘the economy’ is an abstract mental construct. Nobody can see or touch or experience ‘the economy’. From the history of science, though, it is known that simplification/abstraction/idealization can go badly wrong. This happened in economics as almost everybody has realized by now. To better see want went wrong, here is the famous prototype of how ‘abstract speculation’ is done and how it finally approaches the complexity of reality with the highest possible degree of perfection. The prototype comes from physics but the step-by-step process can be customized for other disciplines. Mindless one-to-one copying of the procedure is, of course, not such a good idea.

    “The Principia begins with an idealized world, a simple mental construct, a ‘system’ of a single mathematical particle and a centrally directed force in a mathematical space. Under these idealized conditions, Newton freely develops the mathematical consequences of the laws of motion that are the axioms of the Principia. At a later stage, after contrasting this ideal world with the world of physics, he will add further conditions to his intellectual construct ― for example, by introducing a second body that will interact with the first one and then exploring further mathematical consequences. … In this way he can approach by stages nearer and nearer to the condition of the world of experiment and observation, introducing bodies of different shapes and composition and finally bodies moving in variant types of resistant mediums rather than in free space.” (Cohen, 1994, p. 77)

    Orthodox economics, too, starts with an idealized world. There is NOTHING WRONG with that in general but ALL is wrong in particular because: “The program is organized around the following hard core propositions:
    HC1. There exist economic agents.
    HC2. Agents have preferences over outcomes.
    HC3. Agents independently optimize subject to constraints.
    HC4. Choices are made in interrelated markets.
    HC5. Agents have full relevant knowledge.
    HC6. Observable economic outcomes are coordinated, so they must be discussed with reference to equilibrium states.” (Weintraub, 1985, p. 109)

    The problem with this axiom set is NOT that it defines an idealized world but that it defines a world that does not and cannot possibly exist. HC3 or HC5 do not define limiting cases of reality like friction-free motion but introduce NONENTITIES, that is, entities like angels, unicorns, Spiderman, or the Easter Bunny. In addition, there is no such thing as an equilibrium in the economy. Methodologically, HC6 is what is known since antiquity as petitio principii. This is a quite primitive methodological blunder.

    Clearly, when only one of the foundational propositions fails the whole formal basis breaks apart and with it the whole theoretical superstructure. In general terms, the fatal fault of Orthodoxy is that it is based upon behavioral assumptions which can, as a matter of principle, not be other than shaky. In other words, Orthodoxy does not satisfy Aristotle’s definition of science: “When the premises are certain, true, and primary, and the conclusion formally follows from them, this is demonstration, and produces scientific knowledge of a thing.” There is no such thing as a ‘certain, true, and primary’ behavioral premise. The fatal mistake/error is to define economics as a behavioral science.

    Because of this, there is no other way out of the calamity than to reconstruct economics entirely WITHOUT the concepts of constrained optimization, rational expectations, equilibrium and other nonentities. In methodology this is called a paradigm shift: “There is another alternative: to formulate a completely new research program and conceptual approach. As we have seen, this is often spoken of, but there is still no indication of what it might mean.” (Ingrao et al., 1990, p. 362)

    Obviously, there is until this very day ‘no indication of what it might mean’ to do economics without nonentities. Traditionally, heterodox economists have always been very clear about that the neoclassical axioms are unacceptable but they have not come forward with a concrete proposal how to replace them.

    Just like Orthodoxy, traditional Heterodoxy could not solve the starting problem, which consists in defining the elementary monetary economy in simple/abstract/idealized and consistent terms. Many heterodox economists do not even understand the starting problem. J. S. Mill put it thus:

    “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.” (2006, p. 746)

    Krugman has clearly told the world “… most of what I and many others do is sorta-kinda neoclassical because it takes the maximization-and-equilibrium world as a starting point.”

    Traditional Heterodoxy has always been very outspoken that these premises are “unrealistic” or “shaky” but never told the world what the ‘certain, true, and primary’ premises of economics are. And this is how Heterodoxy has become part of problem and in fact one of the many obstacles for economics to become what it claims already since Adam Smith to be: a science. Both, orthodox and heterodox economics, is nothing more than storytelling and a more or less plausible myth.

    Egmont Kakarot-Handtke

    References
    Cohen, I. B. (1994). Natural Images in Economic Thought, chapter Newton and the Social Sciences, With Special Reference to Economics, or, the Case of the Missing Paradigm, pages 55–90. Cambridge: Cambridge University Press.
    Ingrao, B., and Israel, G. (1990). The Invisible Hand. Economic Equilibrium in the History of Science. Cambridge, MA, London: MIT Press.
    Mill, J. S. (1874). Essays on Some Unsettled Questions of Political Economy. On the Definition of Political Economy; and on the Method of Investigation Proper To It. Library of Economics and Liberty. URL http://www.econlib.org/library/
    Mill/mlUQP5.html#EssayV.OntheDefinitionofPoliticalEconomy.
    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. (1866).
    Weintraub, E. R. (1985). General Equilibrium Analysis. Cambridge, London, New York, NY, etc.: Cambridge University Press.

    • July 20, 2016 at 3:55 am

      You make some very interesting and it seems valid points. But then you go off the rails. I wish I knew why. For example your statements like the following can only be identified as nonsense – “What we call ‘the economy’ is an abstract mental construct. Nobody can see or touch or experience ‘the economy’.” The economy is indeed abstracted from other events and actions. But it is anything but just a mental construct. Every day peoples’ lives are impacted, changed, ruined, redirected by very tangible things like corporations, banks, bankruptcies, and of course economists. Very tangible. And last time I checked banks, economists, etc. can be seen, touched, and cursed out. Then there’s “Orthodox economics, too, starts with an idealized world.” Maybe it does. It certainly might try this path. Most times economics like any other science begins with notions about how the world works combined that with personal and experiences from research and some form of scientific rules about method, procedures, and publishing. And then you “conclude” that beginning with an idealized world is okay, just not the one economists have chosen. The obvious question is how did you determine that economists’ ideal world is wrong? The answer must be I think that you compared that idealization with actual events and things you have or others have observed. Then you critique heterodox economists by saying, “Traditional Heterodoxy has always been very outspoken that these premises are ‘unrealistic’ or ‘shaky’ but never told the world what the ‘certain, true, and primary’ premises of economics are.” I put it to you that there are no certain, true, and primary premises of economics, except perhaps that these are invented and re-invented by the actors, human and nonhuman who make economics, including economists. I also put it to you that it is on these processes of invention and re-invention that researchers like yourself need to focus.

      • July 20, 2016 at 11:49 pm

        Ken Zimmerman

        You say “I put it to you that there are no certain, true, and primary premises of economics, …”

        This is incorrect. The true economic axiom set is shown here:

        Egmont Kakarot-Handtke

      • Ken Zimmerman
        July 21, 2016 at 1:07 am

        Prove it empirically.

      • July 21, 2016 at 5:00 pm

        Ken Zimmerman

        (i) You made the assertion “… there are no certain, true, and primary premises of economics, …” without giving a proof or citing a proof.

        (ii) In direct refutation of your purely rhetorical assertion I gave you the certain, true, and primary structural axiom set as a replacement for the false Walrasian microfoundations and the false Keynesian macrofoundations.

        (iii) You now have two options either (a) to prove your unfounded assertion (i) ex post, or (b), to empirically disprove one of the many theorems that follow from the certain, true, and primary macrofoundations (ii) yourself or to follow the standard procedure and let econometricans do the test.*

        The ball is in your field. I am looking forward to the results of empirical testing.

        Egmont Kakarot-Handtke

        * I submit the rather complex structural Phillips curve eq. (33) in ‘Keynes’s Employment Function and the Gratuitous Phillips Curve Disaster’ (augmented with foreign trade and government) as an IDEAL object for testing
        http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2130421

      • July 22, 2016 at 4:38 am

        Just don’t get it do you. I don’t have to prove anything. You’re the one asserting that science is about truth and economics provides no certain, true, and primary premises and thus cannot be a science. The question that any social science must answer is “why is there durability?” How are things that continue from one time to another, one generation to another, one person to another created? How is durability achieved? And of course the corollary question – how is durability changed and destroyed? I have no anticipation that these questions will ever be answered fully, eternally, or with an unchangeable truth. That leaves us to do the best we can. To paraphrase Achilles, it is this about us that the gods envy the most.

      • July 22, 2016 at 11:54 pm

        Ken Zimmerman

        Science is special because it is the systematic attempt to establish truth which in turn is well-defined by material AND formal consistency. Scientific truth is double-checked, everything else is blather, storytelling, gossip, rhetoric, propaganda, sitcom, etcetera.

        The very characteristic of a scientific proposition/theory is that it is open to logical and empirical proof/disproof. In general terms, the sole task of the scientist is to produce logically and materially consistent propositions about a segment of reality: “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)

        You say: “The question that any social science must answer is ‘why is there durability?’”

        I say:
        (i) Economics is NOT a social science but a system science. Your specification of the subject matter is false to begin with.

        (ii) Economics has to answer the question of how the monetary economy works.

        (iii) Iron Law of methodology: No way leads from the understanding of human behavior to the understanding of how the economy system works.

        (iv) Orthodox economics is built upon subjective-behavioral axioms. Because of (iii) this is the false starting point. In addition: From green-cheese behavioral assumptions, e.g. utility maximization, no testable proposition ever follows. Second-guessing human behavior has always been and will always be a pointless exercise.*

        (v) Economics has to be built upon objective-structural axioms.

        (vi) From objective-structural axioms follow testable propositions about the relationships of measurable economic variables. The two most important of theses relationships are the Profit Law and the employment equation. There can be no doubt that it is of utmost importance for an economist to know the Profit Law. The actual situation is that the representative economist cannot even tell what profit is. This includes all Nobel Prize winners.

        (vii) All questions about human behavior have to be left to psychology, sociology, anthropology, political science, etcetera. Knowledge about human behavior is imported into economics from these disciplines IF NEEDED. Economics is NOT a science of behavior (2011).

        (viii) In order to become a science economics has to move from shaky subjective-behavioral microfoundations to solid objective-structural macrofoundations (2014) and to refrain entirely from political agenda pushing.

        Conclusion: Your clueless PsySoc philosophizing is irrelevant for economics.

        Egmont Kakarot-Handtke

        * “The disciplines that we currently call ‘social sciences’ may accumulate gossip or spot correlations, but Rosenberg believes they will never succeed in formulating laws and theories with the force and fruitfulness of those in the natural sciences.” (Hausman, 1992, p. 326). In other words, the term ‘social sciences’ is a misleading pretension. Feynman aptly called them cargo cult sciences.

        References
        Brown, K. (2011). Reflections on Relativity. Raleigh, NC: Lulu.com.
        Hausman, D. M. (1992). The Inexact and Separate Science of Economics. Cambridge: Cambridge University Press.
        Hudík, M. (2011). Why Economics is Not a Science of Behaviour. Journal of Economic Methodology, 18(2): 147–162.
        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.

      • July 25, 2016 at 4:51 am

        I can’t even begin to figure out what you’re talking about. Seems senseless to me. A good place to begin in attempting to understand science today is Fritjof Capra’s “The Systems View of Life: A Unifying Vision.” The chapter on ‘Science and Spirituality’ might be especially beneficial for you to read. Two statements by Capra in this book seem especially relevant regarding science and scientific methods. “Clearly a science ‘without soul’ would lead to disaster. Conversely, we cannot manage our complex modern world with a purely spiritual approach.” Capra explores this dynamic in great detail, including a chapter on economics. As to what science is and can achieve Capra says this, “What makes the scientific enterprise feasible is the realization that, although science can never provide complete and definitive explanations, limited and approximate scientific knowledge is possible.” As for economics Capra says, “All these models and theories are still deeply rooted in the Cartesian paradigm. Their approaches are fragmentary and reductionist, and today the flaws of contemporary economic thought are ever more apparent. Economists generally fail to recognize that the economy is merely one aspect of the whole ecological and social fabric. They neglect this social and ecological interdependence, treating all goods equally without considering the many ways in which these goods are related to the rest of the world, and reducing all values to the single criterion of private profit making.” You and Capra, one of the world’s leading scientists seem to have very different views of science generally and of economic science.

      • July 26, 2016 at 5:49 pm

        Ken Zimmerman

        I am on one page with Capra.
        (i) I say that economics is a systems science, he titles one of his books: “The Systems View of Life: A Unifying Vision.”
        (ii) He says: “What makes the scientific enterprise feasible is the realization that, although science can never provide complete and definitive explanations, limited and approximate scientific knowledge is possible.” I hasten to add that non-science cannot, as a matter of principle, provide any explanations at all.
        (iii) Capra enumerates the main deficiencies of orthodox economics (1983, ch. 7). I prove that economics is a failed science.
        (iv) Methodologically: “All of physics has to follow uniquely from the requirement that its components be consistent with one another and with themselves.” (1983, p. 92) This brings us directly to the shaky axiomatic foundations of economics.*

        Where things go awry is: Capra (a) does not understand how the economic system (= monetary economy works), (b) has no idea what profit is and how the profit mechanism works, (c) has not gotten the crucial point of a paradigm shift: “The moral of the story is simply this: it takes a new theory, and not just the destructive exposure of assumptions or the collection of new facts, to beat an old theory.” (Blaug, 1998, p. 703)

        Capra argues from the highest peaks of theoretical physics down to actual theoretical economics. The insights of quantum physics or relativity theory, though, are completely irrelevant for economics because economics is still at the proto-scientific level and has not even arrived at something like Archimedes’s Law of the Lever. It is lagging more than 2000 years behind: “Economics is simply still a million miles away from the state in which an advanced science is, such as physics.” (von Neumann, quoted in Ingrao et al. 1990, p. 197)

        For economists Descartes is NOT outdated. These confused blatherers and silly agenda pushers have still a long way to go until they arrive at Descartes’s level of rigorous thinking. Economists have no Cartesian clarté about their foundational concepts profit and income.

        To tell people who cannot even define the systemic relations of an elementary consumption economy (2012; 2014) that they need apply the tools of complexity theory is beyond absurd.

        Orthodoxy is false. But Orthodoxy bashing is not enough. It even becomes a bit comical when it is done by unqualified heterodox folks who recommend ‘Science and Spirituality’ but have never produced a testable economic proposition and insist: “I don’t have to prove anything.” (Zimmerman Jul 22)

        Note, the first rule of science says: If it cannot be proved it cannot be accepted to the corpus of scientific knowledge. It is just another repugnant instance of storytelling, cargo cult science, or economics.

        Egmont Kakarot-Handtke

        References
        Blaug, M. (1998). Economic Theory in Retrospect. Cambridge: Cambridge University Press, 5th edition.
        Capra, F. (1983). The Turning Point. Bantam.
        Ingrao, B., and Israel, G. (1990). The Invisible Hand. Economic Equilibrium in the History of Science. Cambridge, MA, London: MIT Press.
        Kakarot-Handtke, E. (2012). Geometrical Exposition of Structural Axiomatic Economics (I): Fundamentals. SSRN Working Paper Series, 2060073: 1–22. URL
        http://ssrn.com/abstract=2060073.
        Kakarot-Handtke, E. (2014). Economics for Economists. SSRN Working Paper Series, 2517242: 1–29. URL http://papers.ssrn.com/sol3/papers.cfm?abstract_id=
        2517242

        * For my take on formal and material consistency go to http://axecorg.blogspot.de/
        and enter ‘consistency’ into the search field

      • July 27, 2016 at 8:12 pm

        I support much of what you say. Economics is not scientific nor do economists show much sign of wanting to be scientists. And yes to fix this requires more than just bashing the existing set of arrangements. New alternatives are needed. I and many others have offered these on this and other blogs.

        But then you run off the rails again. Per Capra, “All of physics has to follow uniquely from the requirement that its components be consistent with one another and with themselves.” But you miss the really basic point before this one. That the components of physics have to be consistent with observations (with experience, experimental and otherwise). A logically, even mathematically self-consistent framework is useless and misleading if it is not consistent with observations. Capra makes this point again and again. And that’s where the rubber hits to road and the difficulties of science begin. How does one go about establishing this consistency? In physics it is difficult, sometimes impossible to do so. In economics, because of the complex, dense, and difficult the measure/assess of its events and actors it is often just plain impossible. So you do what many scientists have done before. You try indirect and multiple-focus assessment. But economists do little of this or any other real theory challenging. But you treat science just as badly. Science/scientists cannot “prove” anything. They can merely compare (over and over) and assess the comparisons. Sometimes the comparisons work well, but most times they do not. For example, when coal electric generation plants were first named the culprit in acid rain scientists studying the topic required 21 years before they would back this linkage. And even then all the backing statements were qualified because of the many other factors involved in creating acid rain. Science is always tentative. Get used to it. That’s the first thing that should alert us to economics is not a science. Economists are seldom tentative in their “scientific” statements. Just often mistaken.

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