Home > Uncategorized > Weekend read: Why economic models do not explain

Weekend read: Why economic models do not explain

from Lars Syll

Krugman on models (II) | LARS P. SYLLAnalogue-economy models may picture Galilean thought experiments or they may describe credible worlds. In either case we have a problem in taking lessons from the model to the world. The problem is the venerable one of unrealistic assumptions, exacerbated in economics by the fact that the paucity of economic principles with serious empirical content makes it difficult to do without detailed structural assumptions. But the worry is not just that the assumptions are unrealistic; rather, they are unrealistic in just the wrong way.

Nancy Cartwright

One of the limitations with economics is the restricted possibility to perform experiments, forcing it to mainly rely on observational studies for knowledge of real-world economies.

But still — the idea of performing laboratory experiments holds a firm grip of our wish to discover (causal) relationships between economic ‘variables.’If we only could isolate and manipulate variables in controlled environments, we would probably find ourselves in a situation where we with greater ‘rigour’ and ‘precision’ could describe, predict, or explain economic happenings in terms of ‘structural’ causes, ‘parameter’ values of relevant variables, and economic ‘laws.’

Galileo Galilei’s experiments are often held as exemplary for how to perform experiments to learn something about the real world. Galileo’s heavy balls dropping from the tower of Pisa, confirmed that the distance an object falls is proportional to the square of time and that this law (empirical regularity) of falling bodies could be applicable outside a vacuum tube when e. g. air existence is negligible.

The big problem is to decide or find out exactly for which objects air resistance (and other potentially ‘confounding’ factors) is ‘negligible.’ In the case of heavy balls, air resistance is obviously negligible, but how about feathers or plastic bags?

One possibility is to take the all-encompassing-theory road and find out all about possible disturbing/confounding factors — not only air resistance — influencing the fall and build that into one great model delivering accurate predictions on what happens when the object that falls is not only a heavy ball but feathers and plastic bags. This usually amounts to ultimately state some kind of ceteris paribus interpretation of the ‘law.’

Another road to take would be to concentrate on the negligibility assumption and to specify the domain of applicability to be only heavy compact bodies. The price you have to pay for this is that (1) ‘negligibility’ may be hard to establish in open real-world systems, (2) the generalisation you can make from ‘sample’ to ‘population’ is heavily restricted, and (3) you actually have to use some ‘shoe leather’ and empirically try to find out how large is the ‘reach’ of the ‘law.’

In mainstream economics, one has usually settled for the ‘theoretical’ road (and in case you think the present ‘natural experiments’ hype has changed anything, remember that to mimic real experiments, exceedingly stringent special conditions have to obtain).

In the end, it all boils down to one question — are there any Galilean ‘heavy balls’ to be found in economics, so that we can indisputably establish the existence of economic laws operating in real-world economies?

As far as I can see there some heavy balls out there, but not even one single real economic law.

Economic factors/variables are more like feathers than heavy balls — non-negligible factors (like air resistance and chaotic turbulence) are hard to rule out as having no influence on the object studied.

Galilean experiments are hard to carry out in economics, and the theoretical ‘analogue’ models economists construct and in which they perform their ‘thought-experiments’ build on assumptions that are far away from the kind of idealized conditions under which Galileo performed his experiments. The ‘nomological machines’ that Galileo and other scientists have been able to construct have no real analogues in economics. The stability, autonomy, modularity, and interventional invariance, that we may find between entities in nature, simply are not there in real-world economies. That’s are real-world fact, and contrary to the beliefs of most mainstream economists, they won’t go away simply by applying deductive-axiomatic economic theory with tons of more or less unsubstantiated assumptions.

By this, I do not mean to say that we have to discard all (causal) theories/laws building on modularity, stability, invariance, etc. But we have to acknowledge the fact that outside the systems that possibly fulfil these requirements/assumptions, they are of little substantial value. Running paper and pen experiments on artificial ‘analogue’ model economies is a sure way of ‘establishing’ (causal) economic laws or solving intricate econometric problems of autonomy, identification, invariance and structural stability — in the model world. But they are pure substitutes for the real thing and they don’t have much bearing on what goes on in real-world open social systems. Setting up convenient circumstances for conducting Galilean experiments may tell us a lot about what happens under those kinds of circumstances. But — few, if any, real-world social systems are ‘convenient.’ So most of those systems, theories and models, are irrelevant for letting us know what we really want to know.

To solve, understand, or explain real-world problems you actually have to know something about them — logic, pure mathematics, data simulations or deductive axiomatics don’t take you very far. Most econometrics and economic theories/models are splendid logic machines. But — applying them to the real world is a totally hopeless undertaking! The assumptions one has to make in order to successfully apply these deductive-axiomatic theories/models/machines are devastatingly restrictive and mostly empirically untestable– and hence make their real-world scope ridiculously narrow. To fruitfully analyse real-world phenomena with models and theories you cannot build on patently and known to be ridiculously absurd assumptions. No matter how much you would like the world to entirely consist of heavy balls, the world is not like that. The world also has its fair share of feathers and plastic bags.

The problem articulated by Cartwright is that most of the ‘idealizations’ we find in mainstream economic models are not ‘core’ assumptions, but rather structural ‘auxiliary’ assumptions. Without those supplementary assumptions, the core assumptions deliver next to nothing of interest. So to come up with interesting conclusions you have to rely heavily on those other — ‘structural’ — assumptions.

Whenever model-based causal claims are made, experimentalists quickly find that these claims do not hold under disturbances that were not written into the model. Our own stock example is from auction design – models say that open auctions are supposed to foster better information exchange leading to more efficient allocation. Do they do that in general? Or at least under any real world conditions that we actually know about? Maybe. But we know that introducing the smallest unmodelled detail into the setup, for instance complementarities between different items for sale, unleashes a cascade of interactive effects. Careful mechanism designers do not trust models in the way they would trust genuine Galilean thought experiments. Nor should they.

A. Alexandrova & R. Northcott

In physics, we have theories and centuries of experience and experiments that show how gravity makes bodies move. In economics, we know there is nothing equivalent. So instead mainstream economists necessarily have to load their theories and models with sets of auxiliary structural assumptions to get any results at all int their models.

So why do mainstream economists keep on pursuing this modelling project?

Mainstream ‘as if’ models are based on the logic of idealization and a set of tight axiomatic and ‘structural’ assumptions from which consistent and precise inferences are made. The beauty of this procedure is, of course, that if the assumptions are true, the conclusions necessarily follow. But it is a poor guide for real-world systems. As Hans Albert has it on this ‘style of thought’:

A theory is scientifically relevant first of all because of its possible explanatory power, its performance, which is coupled with its informational content …

Clearly, it is possible to interpret the ‘presuppositions’ of a theoretical system … not as hypotheses, but simply as limitations to the area of application of the system in question. Since a relationship to reality is usually ensured by the language used in economic statements, in this case the impression is generated that a content-laden statement about reality is being made, although the system is fully immunized and thus without content. In my view that is often a source of self-deception in pure economic thought …

The way axioms and theorems are formulated in mainstream economics often leaves their specification without almost any restrictions whatsoever, safely making every imaginable evidence compatible with the all-embracing ‘theory’ — and theory without informational content never risks being empirically tested and found falsified. Used in mainstream ‘thought experimental’ activities, it may, of course, ​be very ‘handy’, but totally void of any empirical value.

Some economic methodologists have lately been arguing that economic models may well be considered ‘minimal models’ that portray ‘credible worlds’ without having to care about things like similarity, isomorphism, simplified ‘representationality’ or resemblance to the real world. These models are said to resemble ‘realistic novels’ that portray ‘possible worlds’. And sure: economists constructing and working with that kind of models learn things about what might happen in those ‘possible worlds’. But is that really the stuff real science is made of? I think not. As long as one doesn’t come up with credible export warrants to real-world target systems and show how those models — often building on idealizations with known to be false assumptions — enhance our understanding or explanations about the real world, well, then they are just nothing more than just novels.  Showing that something is possible in a ‘possible world’ doesn’t give us a justified license to infer that it therefore also is possible in the real world. ‘The Great Gatsby’ is a wonderful novel, but if you truly want to learn about what is going on in the world of finance, I would recommend rather reading Minsky or Keynes and directly confront real-world finance.

Different models have different cognitive goals. Constructing models that aim for explanatory insights may not optimize the models for making (quantitative) predictions or deliver some kind of ‘understanding’ of what’s going on in the intended target system. All modelling in science have tradeoffs. There simply is no ‘best’ model. For one purpose in one context model A is ‘best’, for other purposes and contexts model B may be deemed ‘best’. Depending on the level of generality, abstraction, and depth, we come up with different models. But even so, I would argue that if we are looking for what I have called ‘adequate explanations’ (Syll, Ekonomisk teori och metod, Studentlitteratur, 2005) it is not enough to just come up with ‘minimal’ or ‘credible world’ models.

The assumptions and descriptions we use in our modelling have to be true — or at least ‘harmlessly’ false — and give a sufficiently detailed characterization of the mechanisms and forces at work. Models in mainstream economics do nothing of the kind.

Coming up with models that show how things may possibly be explained is not what we are looking for. It is not enough. We want to have models that build on assumptions that are not in conflict with known facts and that show how things actually are to be explained. Our aspirations have to be more far-reaching than just constructing coherent and ‘credible’ models about ‘possible worlds’. We want to understand and explain ‘difference-making’ in the real world and not just in some made-up fantasy world. No matter how many mechanisms or coherent relations you represent in your model, you still have to show that these mechanisms and relations are at work and exist in society if we are to do real science. Science has to be something more than just more or less realistic ‘story-telling’ or ‘explanatory fictionalism’. You have to provide decisive empirical evidence that what you can infer in your model also helps us to uncover what actually goes on in the real world. It is not enough to present your students with epistemically informative insights about logically possible but non-existent general equilibrium models. You also, and more importantly, have to have a world-linking argumentation and show how those models explain or teach us something about real-world economies. If you fail to support your models in that way, why should we care about them? And if you do not inform us about what are the real-world intended target systems of your modelling, how are we going to be able to value or test them? Without giving that kind of information it is impossible for us to check if the ‘possible world’ models you come up with actually hold also for the one world in which we live — the real world.

  1. May 29, 2021 at 11:15 am

    ” But the worry is not just that the assumptions are unrealistic; rather, they are unrealistic in just the wrong way”. Nancy Cartwright

    Sad to say I think that is still true of Lars. This BBC article not only says this may be true of environmental policy but illustrates the scientific method I’ve suggested: going back in time. The mathematics of logic, geometry and time still apply there, so by following what becomes possible with the evolution of structure, one sees what is relevant by looking the “right way”.


    • June 1, 2021 at 12:08 pm

      I’ve just been sent a splendid talk about Biblical pedagogy relevant to the Israeli-Palestinian conflict, which is saying much the same thing: “it pays to interpret childish language from the standpoint of the adult understanding”.

      • June 1, 2021 at 12:20 pm

        Apologies: this was not what I linked to, the reference for which was:

  2. Dominique
    May 29, 2021 at 5:04 pm

    I believe that modelling in economics, no matter how many addenda, will go nowhere. It’s like modelling quantum phenomena with Newtonian mechanics. After observing the evolution of market economies, it stands to reason to arrive at the conclusion that market economic phenomena should be analyzed as market signals. The spectrum of singularity of the signal could then be the background for efficient policies.

  3. Ken Zimmerman
    May 30, 2021 at 12:23 am

    Economists are fixated on a framework developed for relationships that are fixed and predictable. Relationships involving humans are neither fixed nor predictable. So the problem infecting economics is a simple one — it’s using the wrong framework. Which means of course economists can never reveal anything of importance or useful in understanding economic relationships. Economists need to rethink the foundations of their discipline.

    If, as I believe economics is a social science, here are some things economists need to consider in doing the make over of their discipline.

    The social sciences are about how society works. Social scientists examine institutions like the government, the economy, and family; they also study how individuals and groups interact with one another and the roots of human behavior.

    Some examples of social sciences include the following:

    Political science

    Social science differs from natural science in that it examines the human constructed world rather than the physical world. Fields like biology, chemistry, and physics use the original scientific method to propose hypotheses and theories. And then to test these empirically. Experimentally if possible. Social scientists rely on similar methods, such as quantitative data analysis, to study society. Proposing hypotheses and theories. Which are then tested through such means as surveys, observation (direct and indirect), interviews, etc.

    The social sciences also share some of the same methodological approaches as those used in the humanities, like qualitative research. Both the humanities and social sciences use analytical and interpretive approaches to learn more about the human world.

    The social sciences share some of the same methodological approaches as those used in the natural sciences and humanities. Such as mathematics and experimentation (quasi). For example, economists rely on statistics and forecasting to understand trends, while political scientists use surveys and polling to track political changes.

    Still the question sometimes arises whether certain fields — including anthropology, psychology, economics, history, sociology, and political science — fall under the umbrella of the humanities or social sciences. In my view they are clearly sciences. But sciences with a subject of study that demands a framework fundamentally different from the ‘natural ‘ sciences.

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