Home > Uncategorized > Econometric beasts of bias

Econometric beasts of bias

from Lars Syll

In an article posted earlier on this blog — What are the key assumptions of linear regression models? — yours truly tried to argue that since econometrics doesn’t content itself with only making ‘optimal’ predictions,” but also aspires to explain things in terms of causes and effects, econometricians need loads of assumptions — and that most important of these are additivity and linearity.

overconfidenceLet me take the opportunity to elaborate a little more on why I find these assumptions of such paramount importance and ought to be much more argued for — on both epistemological and ontological grounds — if at all being used.

Limiting model assumptions in economic science always have to be closely examined since if we are going to be able to show that the mechanisms or causes that we isolate and handle in our models are stable in the sense that they do not change when we ‘export’ them to our ‘target systems,’ we have to be able to show that they do not only hold under ceteris paribus conditions and a fortiori only are of limited value to our understanding, explanations or predictions of real economic systems.

Econometrics may be an informative tool for research. But if its practitioners do not investigate and make an effort of providing a justification for the credibility of the assumptions on which they erect their building, it will not fulfil its tasks. There is a gap between its aspirations and its accomplishments, and without more supportive evidence to substantiate its claims, critics will continue to consider its ultimate argument as a mixture of rather unhelpful metaphors and metaphysics. Maintaining that economics is a science in the ‘true knowledge’ business, yours truly remains a sceptic of the pretences and aspirations of econometrics. So far, I cannot really see that it has yielded very much in terms of relevant, interesting economic knowledge.

The marginal return on its ever higher technical sophistication in no way makes up for the lack of serious under-labouring of its deeper philosophical and methodological foundations that already Keynes complained about. The rather one-sided emphasis of usefulness and its concomitant instrumentalist justification cannot hide that neither Haavelmo, nor the legions of probabilistic econometricians following in his footsteps, give supportive evidence for their considering it “fruitful to believe” in the possibility of treating unique economic data as the observable results of random drawings from an imaginary sampling of an imaginary population. After having analyzed some of its ontological and epistemological foundations, I cannot but conclude that econometrics, on the whole, has not delivered ‘truth.’ And I doubt if it has ever been the intention of its main protagonists.

Our admiration for technical virtuosity should not blind us to the fact that we have to have a cautious attitude towards probabilistic inferences in economic contexts. Science, as Keynes said, should help us penetrate to “the true process of causation lying behind current events” and disclose “the causal forces behind the apparent facts.” We should look out for causal relations, but econometrics can never be more than a starting point in that endeavour since econometric (statistical) explanations are not explanations in terms of mechanisms, powers, capacities or causes. Firmly stuck in an empiricist tradition, econometrics is only concerned with the measurable aspects of reality, But there is always the possibility that there are other variables – of vital importance and although perhaps unobservable and non-additive, not necessarily epistemologically inaccessible – that were not considered for the model. Those who were can hence never be guaranteed to be more than potential causes, and not real causes. A rigorous application of econometric methods in economics really presupposes that the phenomena of our real world economies are ruled by stable causal relations between variables. A perusal of the leading econom(etr)ic journals shows that most econometricians still concentrate on fixed parameter models and that parameter-values estimated in specific spatio-temporal contexts are presupposed to be exportable to totally different contexts. To warrant this assumption one, however, has to convincingly establish that the targeted acting causes are stable and invariant so that they maintain their parametric status after the bridging. The endemic lack of predictive success of the econometric project indicates that this hope of finding fixed parameters is a hope for which there really is no other ground than hope itself.

Real world social systems are not governed by stable causal mechanisms or capacities. As Keynes wrote in his critique of econometrics and inferential statistics already in the 1920s (emphasis added):

The atomic hypothesis which has worked so splendidly in Physics breaks down in Psychics. We are faced at every turn with the problems of Organic Unity, of Discreteness, of Discontinuity – the whole is not equal to the sum of the parts, comparisons of quantity fails us, small changes produce large effects, the assumptions of a uniform and homogeneous continuum are not satisfied.Thus the results of Mathematical Psychics turn out to be derivative, not fundamental, indexes, not measurements, first approximations at the best; and fallible indexes, dubious approximations at that, with much doubt added as to what, if anything, they are indexes or approximations of.

The kinds of ‘laws’ and relations that econometrics has established, are laws and relations about entities in models that presuppose causal mechanisms being atomistic and additive. When causal mechanisms operate in real world social target systems they only do it in ever-changing and unstable combinations where the whole is more than a mechanical sum of parts. If economic regularities obtain they do it (as a rule) only because we engineered them for that purpose. Outside man-made ‘nomological machines’ they are rare, or even non-existant. Unfortunately that also makes most of the achievements of econometrics – as most of contemporary endeavours of mainstream economic theoretical modeling – rather useless.

  1. March 11, 2019 at 3:23 pm

    Thanks, Lars. Good observations, I think. I might go a little further, though. In my view most of the endeavors of mainstream economics itself are either useless or worse than useless. “Useless” refers to explanations that don’t explain anything or lead to constructive public policy decision making. “Worse than useless” refers to theories and concepts that confuse people and lead to bad public policy decisions. The problem here – and not only in econometrics – is that virtually all of the underlying assumptions of conventional economics are false. For example, the key purpose of economics is NOT the allocation of scarce resources an idea found on page 1 of almost every economics text ever printed. It is, or should be, the sharing of plentiful resources. That’s just the starting point for an economics that would be both true and useful.

  2. Frank Salter
    March 11, 2019 at 5:57 pm

    Von Hayek, in his Nobel lecture said it much more cogently:

    “I want to do this to avoid giving the impression that I generally reject the mathematical method in economics. I regard it in fact as the great advantage of the mathematical technique that it allows us to describe, by means of algebraic equations, the general character of a pattern even where we are ignorant of the numerical values which will determine its particular manifestation. We could scarcely have achieved that comprehensive picture of the mutual interdependencies of the different events in a market without this algebraic technique. It has led to the illusion, however, that we can use this technique for the determination and prediction of the numerical values of those magnitudes; and this has led to a vain search for quantitative or numerical constants. This happened in spite of the fact that the modern founders of mathematical economics had no such illusions.”

    • Rob Reno
      March 19, 2019 at 1:59 pm

      In his 1974 Nobel Lecture, Friedrich von Hayek denied that economics could meet the standards of science. ‘As a profession we have made a mess of things,’ he said, alluding to the dominant Keynesian macroeconomics. His criterion of scientific validity was Popper’s falsification. The Nobel Prize for economic science did not live up to it, and risked a descent into ‘scientism’, the mere pretence of scientific certainty. Hayek did not advocate better science—economics could never be a science, because its core variables could not be observed. It was better to be vaguely right than precisely wrong, he stated (although in different words), a view often attributed to his rival Keynes.82 Economics was indeterminate, like biology or gardening. True knowledge was innate, and could not be confirmed scientifically by observation. (The Nobel Factor: The Prize in Economics, Social Democracy, and the Market Turn” by Avner Offer, Gabriel Söderberg – http://a.co/gscWsW5)

  3. EDWARD K ROSS
    March 11, 2019 at 8:15 pm

    To me a non academic these particular blogs and posts along with observations of the real world are where the economic conversation needs to start,before debating theory. Ted

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