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Radical uncertainty

from Lars Syll

61jCsB2gyQLIn Radical Uncertainty, John Kay and Mervyn King, two well-known British economists, state that rather than trying to understand the ever-changing, uncertain and ambiguous environment by trying to understand “what’s going on here”, the economics profession has become dominated by an approach to uncertainty that requires a comprehensive list of possible outcomes with well-defined numerical probabilities attached to them. Drawing widely on philosophy, anthropology, economics, cognitive science, and strategic management and organisation scholarship, the authors present an argument that probabilistic thinking gives us a false understanding of our power to make predictions and a false illusion of utility-maximising behaviour. Instead of trying to produce probability calculations to fill the unknown gaps in our knowledge, we should embrace uncertainty by adopting robust and resilient strategies and narratives to consider alternative futures and deal with unpredictable events …

The authors’ “radical uncertainty” is not about “long tails” (for example, imaginable and well-defined events whose low probability can be estimated). The authors emphasise the vast range of possibilities that lie in between the world of unlikely events which can nevertheless be described with the aid of probability distributions, and the world of the unimaginable. This is the world of uncertain futures and unpredictable consequences, about which there is necessary speculation and inevitable disagreement which often will never be resolved. In real life this is the world which we mostly encounter, and it extends to individual and collective decisions, as well as financial, economic and political ones.

Kay and King’s book is a thoughtful and welcome call for economists and policymakers to accept “radical uncertainty” and start rethinking their models.

IEA

The financial crisis of 2007-2008 hit most laymen and economists with surprise. What was it that went wrong with our macroeconomic models, since they obviously did not foresee the collapse or even made it conceivable?

There are many who have ventured to answer that question. And they have come up with a variety of answers, ranging from the exaggerated mathematization of economics to irrational and corrupt politicians.

0But the root of our problem goes much deeper. It ultimately goes back to how we look upon the data we are handling. In ‘modern’ macroeconomics — Dynamic Stochastic General Equilibrium, New Synthesis, New Classical and New ‘Keynesian’ — variables are treated as if drawn from a known “data-generating process” that unfolds over time and on which we, therefore, have access to heaps of historical time-series. If we do not assume that we know the ‘data-generating process’ – if we do not have the ‘true’ model – the whole edifice collapses. And of course, it has to. I mean, who honestly believes that we should have access to this mythical Holy Grail, the data-generating process?

‘Modern’ macroeconomics obviously did not anticipate the enormity of the problems that unregulated ‘efficient’ financial markets created. Why? Because it builds on the myth of us knowing the ‘data-generating process’ and that we can describe the variables of our evolving economies as drawn from an urn containing stochastic probability functions with known means and variances.

4273570080_b188a92980This is like saying that you are going on a holiday trip and that you know that the chance the weather being sunny is at least 30% and that this is enough for you to decide on bringing along your sunglasses or not. You are supposed to be able to calculate the expected utility based on the given probability of sunny weather and make a simple decision of either-or. Uncertainty is reduced to risk.

But as Keynes convincingly argued in his monumental Treatise on Probability (1921), this is not always possible. Often we simply do not know. According to one model the chance of sunny weather is perhaps somewhere around 10% and according to another – equally good – model the chance is perhaps somewhere around 40%. We cannot put exact numbers on these assessments. We cannot calculate means and variances. There are no given probability distributions that we can appeal to.

In the end, this is what it all boils down to. We all know that many activities, relations, processes, and events are of the Keynesian uncertainty-type. The data do not unequivocally single out one decision as the only ‘rational’ one. Neither the economist nor the deciding individual can fully pre-specify how people will decide when facing uncertainties and ambiguities that are ontological facts of the way the world works.

Some macroeconomists, however, still want to be able to use their hammer. So they decide to pretend that the world looks like a nail, and pretend that uncertainty can be reduced to risk. So they construct their mathematical models on that assumption. The result: financial crises and economic havoc.

How much better — how much bigger chance that we do not lull us into the comforting thought that we know everything and that everything is measurable and we have everything under control — if instead, we could just admit that we often simply do not know and that we have to live with that uncertainty as well as it goes.

Fooling people into believing that one can cope with an unknown economic future in a way similar to playing at the roulette wheels, is a sure recipe for only one thing — economic disaster.

  1. July 27, 2020 at 2:18 am

    What was it went wrong with the models? Many things, but two are raised here.

    1. Equilibrium. Real economies are full of instabilities and far from equilibrium. This is a radically different realm, complexity, and complex systems are fundamentally unpredictable – in detail. Just like life. Only economists find this difficult to understand.

    2. Money and debt are excluded from the models. Money is a form of debt, so debt is excluded. Clever people created debt upon debt upon debt. So much debt that some people could not repay, which triggered a cascade of default. It’s not rocket science folks. People stopped spending (either they had no money or were afraid to spend it), the economy tanked. Boom (spending the borrowed money), then bust (no money to spend).

    Gee, no fancy models there, just a bit of thinking things through.

  2. Kristian Rämö
    July 27, 2020 at 11:29 am

    “…rather than trying to understand the ever-changing, uncertain and ambiguous environment by trying to understand “what’s going on here”, the economics profession has become dominated by an approach to uncertainty that requires a comprehensive list of possible outcomes with well-defined numerical probabilities attached to them.”

    The latter is the definition of risk, not uncertainty.

  3. ghholtham
    July 27, 2020 at 6:03 pm

    Let’s be a bit more precise. Economics is, or should be, the study of behaviour. The sin in economics is not in assuming that the world’s uncertainties can be reduced to a risk calculus. It consists of assuming that people behave as if the world’s uncertainties can be reduced to a risk calculus. But of course people do not behave in that way because they are well aware of uncertainty and behave accordingly. Everyone knows the world is uncertain so why assume that people do not know that and act with “rational” irrationality? The assumption does not improve our ability to predict behaviour either in the normal course of events or in response to an emergency.
    To predict how people will behave it is necessary to study how they do behave instead of mischaracterising a situation and applying a cookie-cutter assumption of “rationality”. One reason for the error is a fear that studied behaviour will be diverse and culturally determined so that the discipline of economics dissolves. I think that is too pessimistic and economists should have the faith and confidence to treat their subject as an empirical one.

    • Meta Capitalism
      July 28, 2020 at 12:57 am

      What Gerald calls “precise” is really not precise at all but the illusion of precision for a rather narrow but unspoken purpose–to define economics to fit into the econophysics qua statistician box of mathematically tractable tricks. If one examines a broad collection of definitions of economics given by economists themselves (over time) one observers that Gerald’s definition fits into a rather narrow category.
      .
      Something similar happened to evolutional theory with the rise of the Modern Synthesis. It was hailed as great advancement in understanding, yet today, in light of recent modern discoveries in the fields of evolutionary developmental biology and epigenetics we now know from history that it was rather a great “constriction” of understanding that left much of theoretical biology and ignored vast areas of biological causes simply defining them out of the picture because we lacked the mathematical tools to turn insights and observations into a coherent research agenda grounded in quantification via statistics (i.e., mendalism and population genetics) that lead to bean-bag genetics.
      .

      The proximate cause of the unhappy situation in economics is that almost all the teachers of econometrics claim that statistical significance is the same thing as scientific significance. The econometrician David Hendry, for example, is famous for saying “test, test, test,” where the phrase means “Fisher, Fisher, Fisher,” and most statistical textbooks in any field, from advanced theoretical statistics down to the merest cookbook, recommend the same (Hendry 1980). (McCloskey, Deirdre Nansen; Ziliak, Steve. The Cult of Statistical Significance (Economics, Cognition, And Society) (Kindle Locations 2789-2793). University of Michigan Press. Kindle Edition.)

      .
      Here is a sampling of Gerald’s definition(s) of economics over time:

      Economics is the search for such regularities and valid generalisations in a subset of human activities related to making a living, getting and spending. (RWER 2/7/2020)
      .
      [W]hen it comes to test the generality of the hypothesis you need a lot of data given the complexity of social systems. And you cannot analyse that data except statistically.
      .
      Everything else is anecdote and literature. (RWER 28/2020) So let’s all give up and just believe what we want to believe. That’s what most economists seem to do anyway, not excepting contributors to this blog. [https://rwer.wordpress.com/2020/03/27/econometric-modelling-as-junk-science/#comment-166869]
      .
      I have come to think that macroeconomics must be seen as the study of emergent phenomena based on the behaviour of a large number of disparate individuals. Individual behaviour can only be understood probabilistically and macroeconomic phenomena are often the convolution of a large number of probability distributions. We can observe empirical regularities and the hope must be that we can find a combination of widespread behavioural tendencies (confirmed by observation at micro level) and statistical mechanics that will “explain” those regularities. Unlike physical systems, economies cannot generally be expected to be in statistical equilibrium. However statistical distributions (such as that characterising wealth distribution for example) generally evolve slowly so understanding could be possible. We shall learn more by computer simulation than by solving over-simplified models analytically. (RWER 4/6/2020)

      .
      What I find consistent in his definition(s) is a certain myopic econophyscist/statitician perspective. I say this because as I work through collecting definitions of economics from economists to compare them I am finding that in comparison to Gerald’s clearly very narrow definition, they have rather more interesting ones that include the study of, for example, institutions, history, etc., and they do not reduce ultimately (as Gerald does reduce economics) to “predicting” human behavior (as though that somehow becomes the Golden Calf of economics and solves humanities problems). I have to chuckle when I read such nonsense as statistical distributions of “wealth” are somehow telling us something we don’t already know regarding the root causes (e.g., their ability to use money as speech and influence political processes through lobbyists and buying votes). Sure, use statistics to check our assumptions, but when we start using statistics as the ONLY tool to check things we have ample evidence from other sources (e.g., history, case studies, etc.) then I think we are dealing with a fetish not science. Everything else really is not just “anedote and literature” as he asserts. This assertion itself is a rooted in a certain philosophical worldview that is open to critical reflection and is a kind of scientism.
      .
      Here are few other definitions:
      .

      Economics is about how people organise and manage the production of goods and services, as well as the resources that are used in the process of production. The subject matter of economics covers enormous range of issues, problems, and questions, including questions about how production is organised; why particular activities are undertaken and whether they should be; the nature and functions of the institutions that are associated with organising and carrying out production activities from banks and manufacturers to shipping and training; and the efficiency of the production process what criteria should be used to evaluate them, what purposes they serve, and so on. It is the task of economic theory to elucidate these problems and issues which all have to do with people’s activities and, at the root of their activities, their decisions and plans. (Addelson 1995, 3, Equilibrium Versus Understanding [Towards the Restoration of Economics as Social Theory])
      .
      Economics is the study of how societies use their resources — the land, coal, people and machines that are involved in making useful goods like bread and shoes…. Economics is a matter of life and death. A baby born today in a rich country has a tiny chance of dying before the age of five…. In the poorest countries of the world, though, more than 10 per cent of children never make it to the age of five because of the lack of food and medicine. Teenagers in those countries could count themselves lucky to have survived. (Kishtainy 2017, 1-2, A Little History of Economics.)
      .
      I hesitate to call the subject of this book economics because the discipline of economics has failed to maintain intellectual integrity and has abused both the trust of people and the bounty of Earth. The older term political economy would be more appropriate, but is still too limited. Any proper study of human economies must place them within and subordinate to human societies, as ‘political economy’ might imply, but it must also place human societies within and subordinate to the natural, living world…. Perhaps we need to dispense with economics. In its ancient Greek origins oikonomia meant the wise management of a household for the long-term benefit of its members. That would be an excellent word, were we able to rehabilitate it in some form. That was why my first venture into this topic was titled Economia (Davies, 2004). However it turns out that is just the word for economics in the Romance languages. Biosocionomy anyone? (Davies, Geoff. Economy, Society, Nature: An introduction to the new systems-based, life-friendly economics (World Economics Association Books Book 3) . World Economics Association. Kindle Edition.)
      .
      PRACTICAL ISSUES AND DEFINITIONS When we mention economics in this book, we mean the mainstream perception of it, perhaps as best represented by Paul Samuelson. By the term homo economicus, we mean the primary concept of economic anthropology. It comes from the concept of a rational individual, who, led by narrowly egotistical motives, sets out to maximize his benefit. We will avoid the question of whether economics is or is not, properly stated, a science. So although we may occasionally refer to it as a social science, we often only mean the field of economics. We understand “economics” to mean a broader field than just the production, distribution, and consumption of goods and services. We consider economics to be the study of human relations that are sometimes expressible in numbers, a study that deals with tradables, but one that also deals with nontradables (friendship, freedom, efficiency, growth). (Sedlacek, Tomas. Economics of Good and Evil (p. 14). Oxford University Press. Kindle Edition.)
      .
      We live in an age of philosophical and value pluralism that shows deep skepticism toward the claims of any group to possess unique truths. Indeed, this skepticism is found in the attitudes of the up-and-coming generation of economists. A survey in the mid-1980s found that 83 percent of Harvard graduate students in economics and 75 percent of MIT students no longer believed in the old distinctions between positive and normative economics, leading the surveyors to conclude that “the scientific status of economics is clearly in doubt among students.” 29 Yet if economics is not a form of science, few economists have undertaken to ask in a systematic way just what it is. (Nelson, Robert H.. Economics as Religion: From Samuelson to Chicago and Beyond . Penn State University Press. Kindle Edition.)
      .
      Economics is a cluster of doctrines, not always consistent with each other, which mean to provide a simplified but essentially correct model of social reality. Its claim to authority is twofold: that the theory is compelling in itself; and that it is confirmed by observation or consequences. Theory comes first: its simplified accounts of reality have an elegance, even beauty, that arises from their being at odds with everyday intuitions, while at the same time bringing order to the confusion of experience. Economics is not easy to master, but is easy to believe. Since the 1980s, economic methodologists (scholars who appraise the methods and purpose of economics) have largely been content to leave it at that and to focus on the internal validity of theory, the various ways in which it is meant to hang together and work.2 The main reason for this focus is that a good deal of economic theory is not borne out by either experience or results. (Offer, Avner. The Nobel Factor (p. 2). Princeton University Press. Kindle Edition.)

      .
      And my absolute favorite of all time:
      .

      In a word, Economics is an Impossible Science because by its own definition the determining conditions of the economy are not economic: they are “exogenous.” Supposedly a science of things, it is by definition without substance, being rather a mode of behavior: the application of scarce means to alternative ends so as to achieve the greatest possible satisfaction—neither means, ends, nor satisfaction substantially specified. Exogenous,” however, is the culture, all those meanings, values, institutions, and structures, from gender roles, race relations, food preferences, and ethnicities, to technical inventions, legal regulations, political parties, etc., etc. The effect is a never ending series of new theoretical breakthroughs, each an Economics du jour worthy of a Nobel prize, consisting of the discovery that some relevant little bit of the culture has something to do with it. Only to be soon superseded and forgotten since the continuous development and transformation of the culture, hence of the economy, leaves the Science in its wake. An impossible Science, by its own premises. (Professor Reality Check, George Kallas, Counterpunch.org, 2015, https://www.counterpunch.org/2020/02/04/why-economics-is-an-impossible-science-in-one-paragraph/print/ )

      .
      My point is the more I gather together definitions of economics put forward by economists (and historians of economics) the more we can see that there is no one singular definition (they don’t even agree whether economics is a science).

  4. Yoshinori Shiozawa
    July 28, 2020 at 1:05 am

    Lars Syll > Some macroeconomists, however, still want to be able to use their hammer.

    I agree with Lars Syll in this very point. But I wonder if Lars himself is not using the hammer to hit nails everywhere he finds them. In his case, the hummer is uncertainty.

    When we are aware of uncertainty, what kind of economic wisdom comes out? Lars Syll never explains and seems has no intention to do so. When we consider human economic behavior, Herbert A. Simon is more indicative than Keynes as ghholtham pointed it.
    See
    https://rwer.wordpress.com/2020/07/19/keynesian-vs-newtonian-economics/#comment-171154

    His argument is more concrete and each of his assertion can be put to empirical test.
    I believe it is time to shift our methodology argument more towards evidence-based economics and more towards strategy how to construct such an economics.

  5. ghholtham
    July 28, 2020 at 2:43 pm

    The study of institutions is an important part of economics. I am a great admirer of H A Simon and he spent a lot of time looking at behaviour within and of institutions. I have also served my time in applied economics, eg studying the effect of aid programmes with a view to policy recommendations, where it was necessary to take account of the politics and sociology of the recipient country as well as the politics of the aid agency. Much practical economics is of that specific, ad hoc kind where the boundary between “economics” and social studies more generally is blurred and porous. That may be the most useful kind of economics but it does not preclude the search for higher-level generalisations, which may or may not be successful. Such generalisations will be conditional, i.e. ceteris paribus, and will present themselves as stochastic. Testing them will usually involve statistical procedures. I accept that some people prefer not to test them but you don’t advance that way.
    I can’t comment on the parallel that MetaCapitalism draws with progress of evolutionary science in biology because I do not know enough about the latter.

    • Meta Capitalism
      July 29, 2020 at 11:30 pm

      I accept that some people prefer not to test them but you don’t advance that way. ~ Gerald Holtham

      .
      It isn’t either/or but rather a matter of complementarity of evidence & methodology:
      .

      One final point: statistical evidence is not the only type of evidence. Its role should be complemented by other types, e.g. the historical record, case studies, etc. The more qualitative approaches often help in elucidating the causal mechanism. (Michael Joffe, RWER, Baby & Bathwater, 4/27/2020)

  6. ghholtham
    July 30, 2020 at 12:45 am

    Nothing to argue about. We can all agree that evidence can take many forms. Case studies and historical studies are of specific situations and that may be sufficient for the purpose in hand. They may also suggest hypotheses about causal relations that apply more generally. When it comes to testing such hypotheses you always face the problem of inadequate data and then of extracting their effect from the plethora of other influences at work in real situations. It is difficult to do that but more difficult if you spurn econometrics. i am not sure that there is any disagreement here. Different methods are appropriate for different questions in different circumstances.

  7. Ken Zimmerman
    August 10, 2020 at 3:36 pm

    There are several versions of the social construction of “being rational,” “thinking rationally,” “rational action,” etc. In the west at least they often center around this, “A multi-step process for making logically sound decisions that aims to follow the orderly path from problem identification through solution.” This is clearly not the only social definition of rational or rationality. But it is a popular one in the western world. Particularly among academics, scholars, businesspersons, planners, etc. Which have successfully spread this view to many ordinary folks. First, we need to examine rationality as it is practiced estimating which construction is happening. Then we need to map the construction’s history. Finally, we need to appraise the consequences of the construction in our areas of concern. It is not about completeness or certainty, bur rather about what each kind of rationality does or does not perform in the lives of individuals and societies.

    • Craig
      August 10, 2020 at 5:42 pm

      Studying the world’s major wisdom traditions with the object of self actualizing the observations and states of being found there as opposed to latching on to the various pre-scientific dogmas that also attend it is, you’ll pardon the expression, the gold standard of both rationality and ethical achievement. Then one might also recognize that so in the individual, so with human systems whose policies are aligned with such wisdom.

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