Home > Uncategorized > The spectacular failure of DSGE models

The spectacular failure of DSGE models

from Lars Syll

In most aspects of their lives humans must plan forwards. They take decisions today that affect their future in complex interactions with the decisions of others. When taking such decisions, the available information is only ever a subset of the universe of past and present information, as no individual or group of individuals can be aware of all the relevant information. Hence, views or expectations about the future, relevant for their decisions, use a partial information set, formally expressed as a conditional expectation given the available information.

macroeconomics-14-638Moreover, all such views are predicated on there being no un-anticipated future changes in the environment pertinent to the decision. This is formally captured in the concept of ‘stationarity’. Without stationarity, good outcomes based on conditional expectations could not be achieved consistently. Fortunately, there are periods of stability when insights into the way that past events unfolded can assist in planning for the future.

The world, however, is far from completely stationary. Unanticipated events occur, and they cannot be dealt with using standard data-transformation techniques such as differencing, or by taking linear combinations, or ratios. In particular, ‘extrinsic unpredictability’ – unpredicted shifts of the distributions of economic variables at unanticipated times – is common. As we shall illustrate, extrinsic unpredictability has dramatic consequences for the standard macroeconomic forecasting models used by governments around the world – models known as ‘dynamic stochastic general equilibrium’ models – or DSGE models …

Many of the theoretical equations in DSGE models take a form in which a variable today, say incomes (denoted as yt) depends inter alia on its ‘expected future value’… For example, yt may be the log-difference between a de-trended level and its steady-state value. Implicitly, such a formulation assumes some form of stationarity is achieved by de-trending.

Unfortunately, in most economies, the underlying distributions can shift unexpectedly. This vitiates any assumption of stationarity. The consequences for DSGEs are profound. As we explain below, the mathematical basis of a DSGE model fails when distributions shift … This would be like a fire station automatically burning down at every outbreak of a fire. Economic agents are affected by, and notice such shifts. They consequently change their plans, and perhaps the way they form their expectations. When they do so, they violate the key assumptions on which DSGEs are built.

David Hendry & Grayham Mizon

A great article, not only showing on what shaky mathematical basis DSGE models are built, but also underlining that to understand real world ‘non-routine’ decisions and unforeseeable changes in behaviour, stationary probability distributions are of no avail. In a world full of genuine uncertainty — where real historical time rules the roost — the probabilities that ruled the past are not those that will rule the future.

Advocates of DSGE modeling want to have deductively automated answers to fundamental causal questions. But to apply ‘thin’ methods we have to have ‘thick’ background knowledge of what’s going on in the real world, and not in idealized models. Conclusions can only be as certain as their premises — and that also applies to the quest for causality and forecasting predictability in DSGE models.

  1. May 8, 2017 at 3:37 am

    Yes, DSGE is “a fire station automatically burning down at every outbreak of a fire.” Expectations are extremely fragile. The original sin of rational expectations lies in that rational expectations hold only in the time when economy is going in a stationary way. As Hendry and Mizon skillfully explain, it cannot be in its principle a theory of dynamic process when the expectations change rapidly. Financial crisis is just one of such dynamic states of the economy.

  2. May 8, 2017 at 3:43 am

    Yes, DSGE is “a fire station automatically burning down at every outbreak of a fire.” Expectations are extremely fragile. The original sin of rational expectations is that rational expectations hold only in the time when economy is going in a stationary way. As Hendry and Mizon skillfully explain, it cannot be in its principle a theory of dynamic process when the expectations change rapidly. Financial crisis is just one of such dynamic states of the economy.

  3. May 8, 2017 at 4:39 pm

    “In most aspects of their lives humans must plan forwards.”
    I would add this, which we all know: different interests make their plans with different future horizons and different abilities to power their plans to reality.
    Parents plan for children’s college up to 18 years hence. Homeowners plans can vary from a few years to a few decades. Manufacturer’s plans for new equipment can vary similarly. Politician’s plans tend to be four years or less. Predatory corporate finance’s plan is to be prepared at all times to seize opportunity for short-term gain.
    All this, it seems to me, plays equally with the reality of uncertainty. Not ot forget Keynes’ famous “in the long run we all are dead”.
    Thanks for bringing this article to my attention, and I shall read it.

  4. May 9, 2017 at 4:30 am

    We have to know how and in which situations our “predictions” work. All depend on the stationary nature of our world. Without it, it is impossible to make a reliable prediction for a being with limited capacities of information gathering and rational calculation, See my WP:
    Microfoundations of Evolutionary Economics

  5. May 10, 2017 at 9:21 am

    I’ve worked with strategic and integrated resource planning, engineering, biological, and various social science models for 40 years. Both linear and non-linear, both short- and long-term focused. Except for the simplest (e.g., linear time-series), none of these models includes the assumptions (axioms) you identify for DSGE models. In fact, all but the simplest assume the future in unknown and unpredictable. The models are ways to prepare for this unknown and unpredictable future, not make it known and predictable. If corporate planners, resource use planners, engineers, biologists, sociologists, physicists, political scientists, etc. understand this, why can’t economists?

  6. May 10, 2017 at 10:34 am

    Dear Ken Zimmeman,
    Your critique is extremely valuable. To make it more effective, you have to understand economics profession. You should understand how those mainstream economists are entrenched in an most extravagant way of thinking.

    What is necessary now is a paradigm shift. Many of serious economists know this. The present macroeconomics is a geocentric system just before Copernicus. The only difference is that, in the case of macroeconomics, their system is not as accurate as Ptolemy’s or Tycho Brahe’s systems.

    The most important thing at present is to find the new way of reconstructing economics. At this point, we are extremely diversified. Some talk we should go back to 1980’s. Some talk we should go back to Keynes of 1936 (General Theory) or 1930 (Treatise on Money). My opinion is to restart our economics from the very foundation of price theory.

    For that purpose, we should go back before the arrival of neoclassical economics (c. 1870). Of course, this does not mean that we accept all propositions of classical economics. We should select its rational core. I believe it lies in the Ricardo’s value theory. It is not labor theory of value as almost all students know it is. It should be named as cost-of-production theory of value. You may know the rough idea on how it can be reconstructed as a modern theory in my paper:
    The Revival of Classical Theory of Values

    • May 11, 2017 at 9:29 am

      A paradigm shift may not necessary. I give as examples sociology and anthropology. From 1920 until the 1970s a single theoretical framework dominated both sociology and anthropology. It is called structural-functionalism. It still has adherents within both sociology and anthropology but is no longer dominant. Since the 1980s there is no one single dominant framework in these sciences. There are five major frameworks and several less well known ones. Their relationship is at times competitive, at times cooperative, and at times amalgamative. Generally, the results have helped both sociology and anthropology expand and examine new ideas and observations. This history was not planned by sociologists or anthropologists. So, I’m not certain if economists want such a development or could benefit from it.

    • May 11, 2017 at 4:41 pm

      Dear Ken,
      You do not understand how an economic paradigm is binding. It is very very difficult to escape from it.

      Sociology and anthropology do not have a firm paradigm. Structural-functionalism is the name of metaphilosophy or trends of thought. It does not represent the theoretical core of those sciences. It is possible that DSGE fades away when the boom goes by. But another similar absurd “theory” comes in and make a boom. The history of economics since 1950 is a repetition of such replacement. A boom is replaced by another boom, but they are always within a neoclassical paradigm: optimization, equilibrium and a believe in the automatic adjustment mechanism of the economy.

      • May 13, 2017 at 10:47 am

        Yoshinori, why is an economic (or any other paradigm) binding? It is so if it is ontological. That is, it provides all the answers to all the questions about life, the universe and everything. Does the current economic paradigm provide this?
        If it does then yes it would be difficult for any human to escape it. After all, one’s entire life, security, sense of self, and sense of the world would be tied up in the paradigm. But again I ask, does the current economic paradigm provide these things?

        I agree that sociology and anthropology do not today have one predominant paradigm. However, you are incorrect about structural-functionalism. It is a detailed theory that dominated research, teaching, and promotions in sociology and anthropology for almost 40 years. It fell apart when it failed to either predict or provide ways to address things like the cold war, the arms race, the civil rights movement, mass unemployment during the 1970s, and the fall of the USSR. Right now theories are continuing to amalgamate in both sociology and anthropology. No overarching new theory has yet emerged and may not. But if it does it is likely to derive from one or more of these amalgamations.

        Boom and bust cycles are a result of crude capitalism. They go along with placing so much faith in individual decision making, without taking into account that individual is a way of life and category that is constantly being redefined. Capitalism also suffers from the same ugly disease as early science. It oversimplifies humans and human actions. It picks two or three observable forms for these and shaves down everything else to fit within these narrow constraints. It’s easy to offer explanations for everything when there are only 2-3 possible explanatory categories from which to choose – free markets, equilibrium, shareholder value maximization for economics. These explain while omitting 95% of what’s going on in humans and humans actions. Not really explanations at all.

    • May 17, 2017 at 4:36 pm

      Dear Ken,

      I have been reflecting for several days on what you mean by the word “ontology.” Do you mean by this word philosophical questions or system of concepts that we use to express something? People who work in computer science use the word in this second meaning.

      Whether you use ontology in the first or second meaning, I do not think that the binding power of a paradigm is not so ontological, because we have several paradigms in the case of economics. We are at least free to choose one of those paradigms. Of course, the mainstream paradigm is always strong and blind people and economists. It has still a power to make them believe that it is the unique truth or framework to understand the economy.

      However, if we are a bit conscious, we can know there are various heterodox economics. We can think another way. The most dangerous state of mind is to believe that we are free of any paradigm. We should be aware what economics we use when we think about economic questions. Once we become aware of this necessity, I am not so pessimistic in the possible paradigm change. DSGE is but a small part of the mainstream economics, which is revealing various flaws in all fields. Much more difficult work is to construct a theory that can replace the neoclassical economics.

      • May 18, 2017 at 1:11 pm

        I’m speaking of ontology in the only sense that matters to people. The shared comprehensive or total collective life that gives people place, personhood, the future and past, and a fixed point of reference for building societies. Information is not this ontology but merely one consequence of it. If economic theory (paradigm) is such a center of collective life then it is literally impossible to give it up without changing the entire collective life (the entire culture) built around the economics paradigm. One economic paradigm that came close was the globalized Mercantilism of the UK. It literally permeated every aspect of British life. Dissolving it would have meant a total reorganization of that collective life. That only occurred when World War I had already damaged that life. Forcing changes.

      • robert locke
        May 18, 2017 at 3:15 pm

        “One economic paradigm that came close was the globalized Mercantilism of the UK. It literally permeated every aspect of British life.”

        I think that this globalized Mercantilism gave birth to classical and neoclassical economics in the British mercantile imperium. — one aspect of this permeation of British life.

        Peoples outside this imperium, in continental Europe could not accept the classical economics or economics because the conditions of their collective existence involved the geopolitical calculations of the national state. Clausewitz made more sense in that environment than Smith or Ricardo. So did Friedrich List and institutional economists like Schmoller. Sombart, and Veblen.

        Only when the Americans globalized neoclassical economics in their own globalized economic imperium post1945, did the dominance of the historical and institutional approach in economic thought ended.

      • May 19, 2017 at 6:37 am

        Some of the history above is not accurate. It entirely omits what was first called “The New Economics” (title of an good 1946 collection memorializing its progenitor) or “The Age of Keynes” (title of a decent book by Robert Lekachman).
        And of course Keynes(ianism) was sympathetic with Institutional economics, the German historical school, etc.

        Yes, Keynesianism became “textbook ” Keynesian, progressively bastardized, until the neoclassical germs inside took over the host. But it is just wrong – an alternate history not in any history book – to consider neoclassical economics as particularly post-1945 American, or spread after 1945. Neoclassical (and related) economics was more dominant globally before 1945, especially before the 30s, and became less dominant for a while thereafter. Institutional and Keynesian economics, not neoclassical, clearly ruled the roost in the USA in the 30s & 40s – more so than many other places. The big changes, the counterrevolution were in the 60s & 70s, culminating in monetarism, Thatcher & Reagan in the 80s.

      • robert locke
        May 19, 2017 at 10:05 am

        “But it is just wrong – an alternate history not in any history book – to consider neoclassical economics as particularly post-1945 American, or spread after 1945. Neoclassical (and related) economics was more dominant globally before 1945, especially before the 30s, and became less dominant for a while thereafter.”

        When I studied and wrote about this subject in the WWII and immediate Cold War period, I was particularly interested in the influence that neo-classical economics and econometrics had on the development of business school MBA programs, the fastest growing part of higher education after the war. That influence was overwhelming. Don’t just consider neoclassical economics in terms of economics departments. Read Rakesh Khurana’s From Higher Aims to Hired Hands: The Social Transformation of American Business Schools…., especially ch 6, The Discipline of the Business School Faculty pp 233-90, to see how neoclassical economics spread its tenacles into us higher education 1940-1970.

      • May 19, 2017 at 10:53 am

        It can be argued that the period of the Napoleonic Wars, 1790-1815 set the pattern for the 19th and 20th centuries. The continent of Europe and the UK separated. The UK followed the classical and then neoclassical economists into free markets, equilibrium, restricted government, low taxes, and economic “freedom.” Later followed by the USA. The continent of Europe went a very different direction. Rejecting both classical and neoclassical economics. During this time the definitive book on strategic planning is Clausewitz’s “On War.” It would be used to fight wars for the next 200 years. But more than wars it provided guidance for the government, business, economics, and international relations on the continent of Europe until 1918. Macron and those like him taking control might mean neoclassical economics is finally conquering Europe, Recent actions of Germany suggest that even the anti-neoclassical Germans are finally beginning to bend.

      • robert locke
        May 19, 2017 at 7:47 pm

        Clausewitz On War is still being taught in American management schools, where strategic thinking and contingency analysis are valued in management thinking. People who think that the world has to be managed by people, won’t accept the view that markets determine outcomes.

      • robert locke
        May 20, 2017 at 8:46 am

        Calgacus, you might also look at a recent article on how “Neoclassical Economics corrupted business schools,” by Herbert Gintis and Rakesh Khurana, as it invaded the curriculum in business schools in the 1960s.” They write:
        “Since the mid-1970’s neoclassical economic theory has dominated business school thinking and teaching in dealing with business ethics. Neoclassical economic theory employs an incorrect model of human behavior that treats managers as selfish maximizers of personal wealth and power. This model, often referred to as Homo economicus, implies that a firm’s board of directors can best further stockholders’ interests by (a) selecting managerial personnel who are focussed virtually exclusively on personal financial gain, and (b) inducing them to act as agents of the stockholders by devising incentives that minimize the difference between the financial returns to stockholders and the firm’s leading managers. Moreover this theory, in the strong form of the efficient markets hypothesis, asserts that a firm’s stock price is the best overall measure of the firm’s long-term value. This suggests that managerial incentives should be tied to stock market performance, since this will best align the interests of managers and stockholders. However, this implication is invalid when managers can manipulate information flows that influence short term stock price movements.
        Neoclassical economic theory thus fosters a corporate culture that ignores the personal rewards and social responsibilities associated with managing a modern enterprise, and encourages an ethic of greedy materialism in which managers are expected to care only about personal financial reward, and in which such human character virtues as honesty and decency are completely ignored.”

        I also wrote about it in an article in the rwer, on “The reform of business school education” An historians perspective.”

      • robert locke
        May 20, 2017 at 9:04 am

        Calgacus, here is the rwer article: real-world economics review, issue no. 58 “Reform of finance education in US business schools: An historian’s view Robert R. Locke [University of Hawaii, USA]

      • May 20, 2017 at 12:23 pm

        Robert, homo Sapiens is the imagining species. This is its single most important evolutionary advantage. But as I’ve said elsewhere, it’s also the species’ weakness. Sapiens create such things as markets with elaborate stories, promises, and forecasts of wealth and success. Often the results of Sapiens’ imaginings spin out of control. Do not follow the predicted paths and threaten the species. Sapiens find themselves at the mercy of ways of collective life they created but don’t control, or sometimes even understand. Markets are an example of this process. Invented as devices for meeting and interacting for trade, closely monitored and controlled by civil limitations and government regulation, markets today not only don’t facilitate trade but force people into actions and commitments that have negative evolutionary advantage. The greatest threat to humans today is literally human culture.

      • May 21, 2017 at 4:28 am

        I was not speaking of business schools, or really even of economics departments, but the whole society, its culture and economic direction as a whole, and I don’t think there is anything to change with what I wrote. It is much more complicated than one country being neo-classical and another not.

        One generalization that I think holds up is that outside the UK/US center things tended more to extremes – continental Europeans tend to practice what the UK/US might preach, but often did not practice at home. For instance now, when macroeconomically, the EU is run far more “neo-classically”, far less pragmatically and far worse – than the UK and US are.

      • May 21, 2017 at 7:20 am

        Germany and Greece are, says the Zeit acting like an estranged husband and wife just before their divorce becomes final. But why is it like this? Why are Germany and Greece so angry with one another? Particularly, why is Germany so unwilling to help Greece as it suffers severe financial crisis? Crisis much like that which effected Germany in 2005. When we talk about German self-perception, its role in Europe and what Germany expects from other countries, the message, which has been sent out since the start of the current crisis, goes: “be as competitive as us.” Germany wants to build Europe according to its model and that alone. Germany is doing well from an economic perspective while other eurozone countries are suffering. However, combining one with the other – Germany’s prospering economy and the economic crisis in the other eurozone nations and the symptoms of that crisis – is rejected by Germany. It doesn’t fit in with national opinion. Although many German economists reject the notion that a trade surplus always signals competitiveness, German public opinion largely supports it. Germans are refusing to give up what they believe makes them the strongest economy in the eurozone. Most Germans support a Greek exit from the eurozone. This leaves Wolfgang Schäuble and the rest of the German government with a decision to make. Buck German public opinion and continue to help Greece, or push Greece out of the eurozone, one way or another. Germany’s “integration paradox” over incoming refugees adds more pressure. Since a society by and large follows a broad consensus, the arguments on the periphery tend to fray at the edges. The tone gets more heated and those opposed to integration consider themselves to be in the minority and thus start a shouting match to gain attention. Thus, we see the right-wing in Germany yelling its head off. Despite appearances, neoliberal idiocy is not it seems a big part of Germany’s mistreatment of Greece in the current dispute over debt repayment and austerity. According to the Zeit, anyway.

    • robert locke
      May 21, 2017 at 11:09 am

      Calgacus, you should have been considering business schools, because in the massive expansion of mba programs in them is where neoclassically trained economists were being hired.

      Ken, why are you so hard on the Germans. The whole European economic problem is a result of the incursion of US-UK bred finance capitalism into Europe. Look for culprits there, in investor capitalists, like Goldman Sachs. As for Germany, it managed to avoid the sort of real estate mortgage meltdown brought on by the subprime mortgage fiasco. You’ll look pretty much in vain for overheated real-estate markets in Germany. This does not mean that I am not upset with the German treatment of the Greeks. Arrogance is hardly the trait needed to lead the EU. But that sovereign debt crisis came from Anglo-Saxonia.

      • May 22, 2017 at 5:28 am

        Robert, I agree with you on Germany. I’ve been trying to figure out why Germany treated Greece so badly in the credit crisis. I found this attempt at an explanation by the Zeit interesting and at least partly convincing. It’s my view the lesson from it is that Germans suffer from some of the same foolish foibles as other humans. Germans are, contrary to what some of my Russian friends assert humans.

  7. May 17, 2017 at 8:36 pm

    Toshinori, I’m coming into this very interesting discussion very late, but from my own experience I think you spot on where you say to Ken: “You do not understand how an economic paradigm is binding”. I think you are both wrong about structural-functionalism, which combines static structure with dynamic functions and therefore histories, and as an old computer guy I would say that the point about ontology is not just that it is a system of concepts but that what it seeks to express is not every thing but the ability to express it.

    Whereas epistemology is about accounting for what things look like, ontology is about what things do, which includes change. I think you are seeing the point when you say “We have to know how and in which situations our “predictions” work. All depend on the stationary nature of our world. Without it, it is impossible to make a reliable prediction for a being with limited capacities of information gathering and rational calculation”.

    So we cannot reliably predict with epistemological theories. However, light travels faster than things happen, so we don’t just have to wait for what we expect to happen: if we take the trouble to look we can have advance warning of problems and we can learn what to do to avoid them or put them right if we can’t. In the early days of computing science this lesson from Shannon’s information science was at the heart of making unreliable computers work. These days this is all built into operating systems and I doubt it is being taught any more even to computer scientists; scientists are always right (or more right than anyone else), except that when they don’t correct their mistakes, they aren’t; and if their epistemological ontology doesn’t allow theme to see when they have gone wrong (“there is no such thing as truth; what you see is what you’ve got”), then that’s when we get methodologies like DSGE.

    Trying to get through to Ken on paradigm differences, it turns out Shannon worked alongside Alan Turing on code cracking, and his information science (about the trade-off between efficient encoding and using spare capacity for error correction) is not about the meaning of the messages: in fact it says in effect need to know the key word to understand it. Let us imagine two messages with the same meaning, one in Gaelic and the other in Russian. How do you know they are the same unless you recognise and can interpret the languages? Suppose Gaelic to name only things around before c.1200 ad, when Ireland was first invaded by the Norman English. How could the Gaelic message be a history of modern Eire? A daft, thought, I know, but isn’t this what a Ptolemist would have been like, knowing nothing about pre-Newtonian cosmology? Isn’t it what modern economists are like, knowing nothing (indeed being persistently mis-informed) about post-Shannon information science?

  8. May 18, 2017 at 4:28 am

    Thank you, Dave, for clarifying what ontology means for computer guys.

    I am happy that you have remarked my point on “predictability” and the stationary nature of our world. I have argued this theme longishly in my paper Microfoundations of Evolutionary Economics (still in a draft stage) that you can find in my ResearchGate page:
    I have discussed some topics which is related to computation complexity problems in which you may be interested. You are welcome to leave a comment, if you have anything to comment on it.

    I am not contending that epistemological arguments alone can arrive at a good or a better prediction. We must have a concrete science in this regard. Also we have to know that there are limits to the accuracy of our predictions. Milton Friedman claimed that any economics which predicts well is good. I believe his “positivist” (but in fact anti-positivist) philosophy of science degraded economics much.

    • May 19, 2017 at 8:46 am

      Yoshinori, I’m reading your book and finding it very interesting and helpful. I recommend it to others here. In the paper I’ve been working on, I’ve tried to stick to very simple examples rather than your elegant demolition of mathematical arguments involving impossibly long timescales, but that’s partly because I struggle to find words for what I can plainly see. To me it is obvious that you can’t measure the circumference of a circle with a linear measure, not least because the algorithm for calculating pi does not have a Turing halting point; but even the ancients had a word for the difference between rational and irrational numbers.
      I see Friedman as not merely not looking at the temporal complexity of flow control (involving a fixed aim but also corrective feedback from the present, past and near future), but retrogressing even from one-dimensional flow concepts by directing attention to zero dimensional (static) monetary quantities. This incidentally is not a criticism of your own approach, for you give readers time to absorb what you are saying whereas it seems I don’t.

  9. May 21, 2017 at 3:17 pm

    “I’m speaking of ontology in the only sense that matters to people.” (in a post by Ken Zimmerman, May 18, 2017 at 1:11 pm)

    If ontology means for Ken Zimmerman “sense that matters to people,” it would be more accurately phrased as “common sense.” I do not deny the importance of common sense of ordinary people or non-economists, but I want to talk about economics as a science or a discipline which is believed to be a science. The economics is also important, because it can influence the people’s common sense in the long run.

    Economic common sense of the people is composed of three parts: (1) (right and wrong) understanding on how economy works, (2) everyday experience and history, and (3) policies that we should adopt. Ken, Robert and Calgacus are interested in the part (3) and practically nothing on part (1). We cannot ignore any of (3), but almost of all policy analysis and discussion is based on (1) combined with (2).

    The principal aim of economics is to give right understanding on how economy works. I know that majority of economics is flawed or wrong. It is necessary to talk about economics itself, because it is full of flaws and errors. But you are only talking about (3), or at least mainly about (3) and very few about economics itself. It means you are ignoring part (1).

    We should distinguish epistemology and policy. If the classical economics was inspired by (the opposition) to Mercantilism, the theoretical core of classical economics should not be interpreted as a system of free trade thought or liberal capitalism. It is wrong to compare Ricardo and List only by their attitude on trade policy. Ricardo was a very profound theorist. Owing to him, economics became an exact science (although at a very low stage). List did not produce anything comparable on this aspect. We should find a right economics. Policy argument that is not based on correct understanding will not lead to a really powerful and influential policy.

    • robert locke
      May 21, 2017 at 8:25 pm

      Yoshinori, I feel compelled to say something in the defense of List. I feel you overrate Ricardo’s contribution and that of other classical and neoclassical thinkers in promoting our understand how economy works.

      Edward Fullbrook describes how the architects of neo-classical economics matched their new discipline isomorphically with Newtonian mechanics: “In Neoclassical economics, ‘bodies’ translates ‘individuals’ or agents,’ ‘motions’ translates ‘exchange of goods,’ ‘forces’ translates ‘desires’ or ‘preferences,’ which when summed become ‘supply and demand, ‘mechanical equilibrium’ becomes ‘market equilibrium,’ this being when the difference between supply and demand is zero, and ‘physical systems’ translates ‘markets.’ …All exchanges were said to magically take place at the prices that equated demand and supply.”
      It is the failure to make economics into such a science that is the point of this blog.

      Friedrich List saw this clearly and wrote about it in his writing during the age of classical economics. He was a first rate thinker, who made major contributions to understanding comparative economic growth. See, for information about him Daastøl, Arno Mong (2014). Friedrich List’s Heart, Wit, and Will: Mental Capital as the Productive Forces of Progress. Dissertation Erfurt University. Staatswissenschaftliche Faculty. Document 24133. Doctorate awarded 29 Nov. 2011, which is available online, and is a hefty piece that gives the reader a through appreciation of List’s work in his time and subsequently. Daastøl quotes the economist Christopher Freeman: “If we are really to understand international competitivity, then it is of no use to go back to Adam Smith and still less to Ricardo and the ‘school’ of neo-classical comparative advantage theory. …[W]e must go to the original source of the national competitivity school, “Read List in the original, and notice” that the first of his “fundamental points … [is] the importance of mental capital …:” (Quoted in Daastøl, 236)

    • May 22, 2017 at 7:24 am

      Yoshinori, what a philosopher might call ontology, sociologists and anthropologists call “total” institutions. The Roman Catholic Church at its height of power is an example of such an institution. These institutions control and direct the lives of a society or several societies. Per Albert Einstein, “Common sense is the collection of prejudices acquired by age eighteen.” This definition is generally consistent with the research of many social scientists. The word science comes from the Latin “scientia,” meaning knowledge. But science is more. According to the American Physical Society, “Science extends and enriches our lives, expands our imagination and liberates us from the bonds of ignorance and superstition. Science is the systematic enterprise of gathering knowledge about the universe and organizing and condensing that knowledge into testable laws and theories.” This definition can be used with all the sciences, including the social sciences. But historically humans guessed about how the world works and tested those guesses with experience long before science per se` was invented. So, science is better understood as an extension of common sense and everyday imagination, rather than a replacement for it. The two interact with and influence one another. And as Adam Smith notes 250 years ago no economy works without a moral order to sustain it. That moral order today is more like Herbert Spencer’s ludicrous notion of “survival of the fittest.” Possibly the most inaccurate representation of biological evolution ever put on paper. As a scientific discipline economics would tend to focus its work as described above. Something like this: Systematically examine with multiple tools and from multiple perspectives the creation and use by humans historically and in communities of the acquisition and use of the resources and arrangements of daily life necessary for the sustenance of human lives and human societies. Sounds like an important job. Not one economists presently are even attempting to perform.

  10. May 21, 2017 at 4:01 pm

    Dear Dave (DaveTaylor1),

    thank you for recommending my chapter that I am preparing with my colleagues. It will be the first chapter of a book with the same title with the first chapter.

    There are many papers and textbooks about evolutionary economics but I am thinking it still lacks a firm base. It is weak to insist that our behavior is a result of evolution. If we are against the maximization formulation of human economic behavior, then it is necessary to present a theory that can show the principles of our behavior and how they help to explain economic processes. My paper is an attempt for that. I am now preparing the second chapter, which is not going well. I have to stop it for along time. But I have to restart to work on it. The best critique of the neoclassical economics is, I believe, to present a new theory that can replace it.

    • May 22, 2017 at 10:12 am

      Yoshinori, when Ken starts pontificating about the Roman Catholic Church, be aware that he’s an outsider seeing the mirror image of what is going on within. What he (and even now some regrettably similar-minded RC clerics) sees as imposing total control, I see as advising on what is necessary for total freedom, i.e. the ability to recognise, accept and make good one’s own mistakes, but putting up and helping with other people’s mistakes too, for which the present Pope uses the word ‘mercy’. Maximisation is one such mistake. If you email me as dave at taylor dot to I will be able to send you a somewhat cryptic essay attempting just what you say is necessary.

      • May 22, 2017 at 10:26 am

        Dave, as I said “at the height of its power.” That includes the Inquisition and about as close to total control of family life as ever gained by a human institution. Add to that the multiple wars it created, including the Crusades and its systematic undermining of science. You are correct when you point out that RCC no longer exists. But that does not change the fact that it did at one time.

      • May 22, 2017 at 10:58 am

        Fair comment, Ken – you make many such – but notice too how I used the word “now” to anticipate it.

      • robert locke
        May 22, 2017 at 12:03 pm

        One of my favorite popes was Pius IX. I like him because he knew where he stood. Talk about “total,” in the Syllabus of Errors, 1864, the papacy stated that it was anathema to believe that “The Roman Pontiff can, and ought to, reconcile himself, and come to terms with progress, liberalism and modern civilization.—Allocution “Jamdudum cernimus,” March 18, 1861.

      • May 22, 2017 at 12:19 pm

        Dave, points taken. The point I did not make clearly is that today neoliberal capitalism is the nearest thing to a total institution. In some situations those involved can’t even imagine alternatives to the patterns of neoliberalism.

        Robert, Pius IX knew what he wanted the RCC to be and did all he could to make it so. No Popes like that lately.

  11. May 22, 2017 at 7:13 am

    Robert, I understand your objection, which is expected when I wrote “It is wrong to compare Ricardo and List only by their attitude on trade policy.” That is why I added that “List did not produce anything comparable on this aspect.” (theory of value and on how economy works.)

    I highly respect List. His “infant industry” argument is still a source of inspirations for development economics. I am not arguing that free trade is the best of all trade policies. I want to point to those economists who ignore the theory aspect and argue only by the orientation of economic policies that it is necessary to distinguish theory and policy. Condemning a set of economic policies may have some effects for the reconstruction of economics but they are superficial effects.

    If I return to economic theory proper, Robert is making a crucial error in considering two economics, one classical and the other neoclassical, if not as something identical but old and modern version of the same economic thought. I admit that the neoclassical economics inherited much from classical economics especially from Adam Smith, but the there are fundamental change of value theory between Ricardo’s theory of value and the neoclassical theory of prices. I am thinking that Ricardo’s theory of value can be the starting point of the reconstruction of economics.

    Keynes made a grave error in refusing Ricardo’s theory of value only because Ricardo approved Say’s law. Evidently in this point he was wrong, but Say’s law is not for Ricardo an essential core of his theory. It was not even a theoretical proposition. It is one of many erroneous opinions that Ricardo held. Other examples were for example, the subsistence theory of wage and some remnants of quantity theory of money, etc. The main reason of Keynes’s failure was that he adopted general equilibrium framework and tried to formulate his theory of effective demand. His principle of effective demand needed a totally different theory of prices. He had to abandon the rudimentary framework that prices are determined at the cross point of demand and supply curves.

    Ricardo had a totally different theory of prices which he usually called theory of value. If Keynes adopted Ricardian theory of value, it was not very difficult to define the effective demand at the firm level. For more details, pleas see my paper (already once cited) The revival of classical theory of values:

    I have to emphasize the importance of Ricardo, because he was a very unique theorist even among the writers in the time of classical political economy. Malthus and Jean- Baptiste Say never understood Ricardo’s theory of value. List did not distinguish the difference between Smith and Ricardo.

    You have cited Edward Fullbrook to point out that the neoclassical economics was much influenced by the general scientific thought of the time. I do not deny such influences but economics is also an independent science which has its own logic of development. It was John Stuart Mill who distorted Ricardo’s theory of value to the old framework of law of demand and supply and this opened the way to neoclassical theory of value. See for this regard:
    An Origin of the Neoclassical Revolution: Mill’s “Reversion” and its Consequences

    Those who are not interested in the logical structure of theory do not pay due attention to these differences and want to judge only by policy orientations. This is not the way that leads to a reconstruction of economics.

  12. May 22, 2017 at 8:28 am

    “So, science is better understood as an extension of common sense and everyday imagination, rather than a replacement for it. The two interact with and influence one another.” Ken Zimmerman’s post, May 22, 2017 at 7:24

    In a very broad and rough sense, Ken is right. Common sense and science interact with each other. It is more important than mere data fittings. Therefore, the criticism of non-economists on economics is to be heavily evaluated.

    However, we cannot simply return to common sense. A reconstruction of economics requires to overturn almost all common sense and the almost whole structure of economics. The present crisis of economics is so deep and simple effort to redress a better common sense does not bring a necessary change of economics. Economics needs a scientific revolution.

    If my idea of the revolution is correct, we needs to abandon first the common-sense picture that prices are determined at the cross point of demand and supply curves. There is no such entities like supply curves or functions. Prices function very differently from what is normally understood as price mechanism. For a majority of industrial products and services, what makes supply and demand equal is the quantity adjustment of production and inventories.

    If we criticize DSGE models, we should criticize it not at the apparent level of rational expectations, but from the very foundation of production function. Productions are not simple combination of labor and capital as production functions assume. Production function is an invention to give marginal productivity theory a general meaning.

    In short, economics needs a kind of Copernican revolution. At the time of Copernicus, common sense and the Church supported strongly the geocentric system. It was by virtue of long endured specialized study of Ptolemaic system that Copernicus could arrive at a heliocentric system.

    • May 22, 2017 at 12:47 pm

      Yoshinori, science is worthless if it loses touch with common, ordinary, everyday life. “All religions, arts and sciences are branches of the same tree. All these aspirations are directed toward ennobling man’s life, lifting it from the sphere of mere physical existence and leading the individual towards freedom.” ~Albert Einstein (1937) Scientists, moreover could not function if they spoke and lived only science. Science is a useful endeavor but only so long as it maintains contact with culture. This is not negotiable.

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