Home > Uncategorized > The data now used for “testing economic theories” provide no tests at all.

The data now used for “testing economic theories” provide no tests at all.

from Salim Rashid

It is plausible that economics slipped into its current difficulty because all earlier theory was framed with agriculture in mind. But we are not in an agricultural world anymore. The number of available products must have expanded a 1000-fold since the 1700s. Unless one looks, it is difficult to grasp the sheer amounts of data that are generated and potentially available – but perhaps impossible to digest because of their magnitude and complexity. Below are two examples, from Trade statistics and from Price indices.

  • Customs forms provide us with Trade data, one for each export shipment. There were about 22 million export shipments originating in the U.S. in 2005. This suggests that we have information on some 22 million individual decisions. However, there are 229 countries and 8,867 product codes with active trade, so a shipment can have more than 2 million possible classifications.
  • Next, consider the Consumer and Producer Price Indexes, the CPI and PPI. The Producer Price Index program collects monthly price data on about 128,000 individual items from about 32,000 establishments.  The CPI collects data on about 80,000 individual items. The larger number for the PPI is presumably due to the addition of many intermediate goods in the PPI.

Unless one accepts the hara-kiri assumption of perpetual equilibrium, the question of data relevance now revolves around speeds of convergence in each market. However, there are practically no studies of this question – the speed of convergence to equilibrium – for goods or services in microeconomics.

Recognising the complexity of the modern world leads me to return to the principal message of this paper in three sentences.

  1. Equilibrium economic theories can be tested only by equilibrium data
  2. Data being used for tests have no presumption of being equilibrium data.
  3. Hence, the data now used for “testing economic theories” provide no tests at all.

Are there any conditions which justify the current practice? Yes, a state of perpetual equilibrium will serve to justify current practice. However, such an assumption creates many subsequent difficulties, some of which have been described above.

http://www.paecon.net/PAEReview/issue88/Rashid88.pdf

  1. July 13, 2019 at 3:19 pm

    As a pedantic mathematician with an interest in economics, I quite get that real economies aren’t in equilibrium, but am concerned about some of your wording.

    It seems to me that we are in need of economic theories that don’t assume equilibria and in which your term “speeds of convergence” has no a priori meaning. Maybe prices etc just wander about? Any such theory would need to be considered as a hypothesis and tested. Such tests would be different in character to those for systems in equilibrium, and so any econometrics would need to apply statistics differently, and hence would presumably need to develop new statistics. But it seems to me that while such a theory will in all likelhood throw up the need for new raw data, it ought to be applicable to the data we have, as on trade.

    Some economists seem to think that one can only apply statistics to systems in equilibrium. But it seems to me that we ‘usefully’ apply statistically-based methods to systems that we know full well aren’t in equilibrium all the time and in this sense we do have ‘tests’. Its just that the statistics need to be developed and interpreted differently.

    It also seems to me that, in effect, some economists think that mathematical models are necessarily equilibrium models. But not so!

    (On ‘complexity’, I have commented on a related paper of Peter Allen at https://djmarsay.wordpress.com/decisions/study-guides/4129-2/ . You might find Peter’s original more accessible and immediately relevant than my maths!)

    • Frank Salter
      July 14, 2019 at 11:43 am

      Dave Marsay’s comments are absolutely true. Introducing equilibria is simply to avoid the use of calculus. However there is another factor, models need to be based on either an abstract understanding of the problem or must be marching solutions over time. Both imply the use of calculus and these necessary conditions are ignored in conventional economic analysis — garbage in garbage out.

      On complexity: Only the use of calculus in its ability to follow curves will the complexities of the real world be followed.

      • Ken Zimmerman
        July 21, 2019 at 11:09 am

        Frank, what if there are multiple curves in the system, none continuous? Each curve can be examined with calculus but how do we examine the entire system?

  2. July 15, 2019 at 4:17 pm

    Perhaps the problem is not with the concept of equilibrium per se if people view it a heuristic metaphor. In many cases, purchases match supplies and it is unusual for warehouses to bulge at the seems with unsold goods or for customers to face rationing of goods. In Macro, one of Keynes’ key points was that persistent underemployment could be an equilibrium outcome, by which Keynes meant there was no incentive for change. If equilibrium is just a metaphor for balance in a market, I don’t see the objection. If on the other hand economic analysis is reduced to equilibrium analysis and we assume all markets are always and everywhere in equilibrium, or worse, we associate equilibrium with social optimality then I agree equilibrium theorizing of that sort should be rejected.

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