What’s the use of economics?
from Lars Syll
The simple question that was raised during a recent conference … was to what extent has — or should — the teaching of economics be modified … The simple answer is that the economics profession is unlikely to change. Why would economists be willing to give up much of their human capital, painstakingly nurtured for over two centuries? For macroeconomists in particular, the reaction has been to suggest that modifications of existing models to take account of ‘frictions’ or ‘imperfections’ will be enough to account for the current evolution of the world economy. The idea is that once students have understood the basics, they can be introduced to these modifications …
I would go further; rather than making steady progress towards explaining economic phenomena professional economists have been locked into a narrow vision of the economy. We constantly make more and more sophisticated models within that vision until, as Bob Solow put it, “the uninitiated peasant is left wondering what planet he or she is on” …
Every student in economics is faced with the model of the isolated optimising individual who makes his choices within the constraints imposed by the market. Somehow, the axioms of rationality imposed on this individual are not very convincing, particularly to first-time students. But the student is told that the aim of the exercise is to show that there is an equilibrium, there can be prices that will clear all markets simultaneously. And, furthermore, the student is taught that such an equilibrium has desirable welfare properties. Importantly, the student is told that since the 1970s it has been known that whilst such a system of equilibrium prices may exist, we cannot show that the economy would ever reach an equilibrium nor that such an equilibrium is unique.
The student then moves on to macroeconomics and is told that the aggregate economy or market behaves just like the average individual she has just studied. She is not told that these general models in fact poorly reflect reality. For the macroeconomist, this is a boon since he can now analyse the aggregate allocations in an economy as though they were the result of the rational choices made by one individual. The student may find this even more difficult to swallow when she is aware that peoples’ preferences, choices and forecasts are often influenced by those of the other participants in the economy. Students take a long time to accept the idea that the economy’s choices can be assimilated to those of one individual.
Alan Kirman What’s the use of economics?
An economic theory that does not go beyond proving theorems and conditional ‘if-then’ statements — and does not make assertions and put forward hypotheses about real-world individuals and institutions — is of little consequence for anyone wanting to use theories to better understand, explain or predict real-world phenomena.
Building theories and models on patently ridiculous assumptions we know people never conform to, does not deliver real science. Real and reasonable people have no reason to believe in ‘as-if’ models of ‘rational’ robot imitations acting and deciding in a Walt Disney world characterised by ‘common knowledge,’ ‘full information,’ ‘rational expectations,’ zero transaction costs, given stochastic probability distributions, risk-reduced genuine uncertainty, and other laughable nonsense assumptions of the same ilk. Science fiction is not science.
For decades now, economics students have been complaining about the way economics is taught. Their complaints are justified. Force-feeding young and open-minded people with unverified and useless theories and models cannot be the right way to develop a relevant and realist economic science.
Much work done in mainstream theoretical economics is devoid of any explanatory interest. And not only that. Seen from a strictly scientific point of view, it has no value at all. It is a waste of time. And as so many have been experiencing in modern times of austerity policies and market fundamentalism — a very harmful waste of time.
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Real-World Economics Review Blog 
I majored in economics in the 70’s and was disillusioned then about how the subject was taught and its relevance outside of academia. A sidetrack at that time was the great debate between monetarism (Friedman ) and Keynes. Subsequently, there was some hope with Keen’s Minsky model illuminating the role of banks in creating money and the role of private debt in creating upturns or downturns. Now we have MMT focusing on public debt and a different way of looking at its financing through QE/QT.
But as the author states, it seems a vain hope to expect a new model (school of thought) for economics to evolve any time soon.
I don’t mean to be rude, but it is far worse than a waste of time. The whole purpose of the so’called professiono of economics is to create and sustain a class of highly educated people who will not understand certain things and who will never ask certain questions. An economist who did understand how the real world works, how people’s needs actually interact with the economy, and who did ask questions like, “What combination of public policies would lead toward a healthier world and a more equitable distribution of resources and opportunities?” – such a person would have no future in the profession. Why has the system of education in economics been distorted toward this perverse end, you might ask? Well, drawing on your extensive coursewark and research in what motivates people and how they are likely to act in response to such motivations, I think you can probably answer that question yourself.
One problem with present economics is that it dumbs down body of economist. How can it possibly do that? Well, present economics is so stupid it puts off intelligent people from studying, leaving only dumb ones behind. People like Krugman.
Kirman’s is a disappointingly feeble critique for someone who has contributed some ideas actually relevant to the real world, including complexity.
The behaviour of complex models is radically different from equilibrium models. Real economies are clearly far from equilibrium. Conclusion: neoclassical (equilibrium) models are worse than a waste of time (as deshoebox says), they are deeply misleading. Gee, I wonder why the world is in such a mess.
Another post beating the dead horse. Try instead Economy, Society, Nature (right column). A useful new beginning.
This is beginning to sound like the cynical explanation about how the questions are chosen, that students of economics are asked in their examination papers. These questions are never needing to be changed, only from year to year it is the correct answers that are different!
More seriously, until some logic and sense has been found for explaining of what our social business system actually comprises and on how its parts are connected, enabling a logical theory to be developed for its realistic working, we have no hope of finding how to enable this topic to make good sense. You can’t have a variety of correct procedures giving different results that all work in a satisfactory manner.
So where is the proper model for this, if it is not mine? (Assuming of course that such a model is fundamental to the representation of the actual situation and that it is needed.)
The answer to Lars Sill’s question is as follows. The use of macroeconomics is to simulate the way that our social business system of macroeconomics works. This not only helps us to better understand its operation, but can be applied to forecast what any specific policy change will do. By experimentation with many of these, it will enable a sensible non-politically biased decision-making by government, to achieve the best wanted results and as an example, to cause the greatest rate of national progress.
Of course we have yet to agree on what this model should contain and how it should be arranged to be easily understood. I have previously proposed the most simple yet fully comprehensive model that I would use and it is on SSRN 2865571.
The brilliant political economist. Samir Amin, in his wonderful Spectres of Capitaism book calls neoclassical economics “paraeconomics” and likens it to parapsychology. John Kenneth Galbraith when asked how could neoclassical economists believe the absurd assumptions of perfect competition said that “the witch doctor must believe in the concept of the witch” (not to give indigenous medicine a bad name).
I remember after completing 2 years of basic economics courses for my PhD at Stanford University I took an economcs course in the busines school (I was in a joint program between the econ department and the B-school) from William Moffat and for one class we were introduced to second best theory. I remember being dumbfounded — just one deviationf from the assumptions of perfect competition — one monopoly in an otherwise perfectly competitive world — and the ripples in market prices meant the economy was no longer efficient and there was no idea of how far from efficiency we were. I asked another business econ prof, Alan McAdams, about this and his response was we don’t have perfect competition, we have “workable competition.” But when asked what this means for all the wonderful results of perfect competition (e.g., price = marginal social cost, pareto efficiency) I was met with silence. Neoclassical economics, both micro and macro, is a house of cards that falls apart when you look too close. PhD students in economics start with the ridiculous assumptions and by the time they finish 4 or 5 years of coursework based on them, they no longer think about looking too close. What a con game!
If you change any one of several assumptions, the house of cards collapses because equilibrium can no longer be assured: economies of scale (increasing returns to scale), social interaction, time flowing (without being able to predict the future, even statistically), debt (which brings in the unknown future and therefore risk), money (ditto), …
Economies of scale are pervasive in the real economy. QED. It is unscientific rubbish, pseudo-science, not worth discussing any further.
Why doesn’t everyone move on, instead of endlessly beating the dead horse?
Geoff, everyone has moved on or, rather, back. The article and comments seem unaware of the fact that there is a huge rift or schism in macroeconomics between what academics write in journals (and teach students ) and what the vast majority of practitioners do and believe. Practising economists in government departments, financial institutions or corporations do not use rational expectations, perfect competition or DSGE. For one thing they look at a range of data that are not accommodated by academic models. They have surveys of consumer confidence, investment intentions, purchasing manager surveys and expectations of all kinds. You can’t squeeze those into a DSGE model which assumes the answers anyway. Practitioners eclectically look at known leading indicators and, if they use any theory at all, it is of a simple income-expenditure kind. The practitioners have been abandoned by the academics who prefer to explore the characteristics of imaginary worlds, So things are both better and worse than this correspondence realises: better because most economists are not using silly theories, worse because there is no consensus around a coherent macroeconomic theory at all. It is all judgement based on a wealth of data which is not systematized and each practitioner emphasises her own favourite indicators.
Macroeconomic “theories” are not primarily about scientific elucidation. They are Aesopean fables with a moral. That moral historically has either been that the government should do more (Keynes) or else that the government should do less or even nothing (Friedman, Lucas, Kydland and Prescott). The models are all very simple because they want to draw a strong conclusion and make their point forcefully. They do not and cannot deal with complexity, which tends to dissolve strong, general conclusions. Practising economists are not usually in the business of persuading anyone but are trying to understand what is happening in the economy and where it might go next – either to make policy or to make money. Hence they have no use for current theory.
And yet the ‘free market’ dogma still reigns supreme in politics and in public policy, though it has no valid basis in theory or practice. And that gives licence to anarchic corporations who are destroying the world.
Steven and Geoff,
You seem to be very much focused on the academics. The US government is currently following highly protectionist polices with large subsidies to favoured industries and tariffs on Chinese imports. It is certainly capitalism but it is hardly ” neo-liberal free market”. European countries with more extensive benefit systems and higher taxes, like France and Germany also cannot be described as free market when public expenditure exceeds 40 per cent of GDP. I entirely share your impatience with the state of macroeconomic theory but if it doesn’t represent reality that means it doesn’t represent reality.
If 2008 did not convince US academics they are up the creek, nothing I or you say will do it. Better to focus on reality and try to understand it better. Moreover all macroeconomists do not really “show empirical support” for their positions. All DSRG models have comprehensively failed all rigorous statistical testing – unsurprisingly.
It follows that criticising macroeconomic theory as taught to graduate students serves little purpose. If the students are right-wingers who think government expansionism is the problem, they will embrace it; if left-wingers they will find ways to reject it. Practitioners ignore it anyway. If RWER provides insights that help economic practitioners, who no longer read RES or JPE, it will be doing something useful.
ghholtham,
You write, “All DSRG models have comprehensively failed all rigorous statistical testing – unsurprisingly.” I have a few questions.
Where you write the above, do you mean “failed all rigorous statistical analysis of empirical evidence from real economies (and their metrics)”? I assume you mean this. Forgive me , if I need the obvious spelled out.
Would you also say, “All GEUT (Generalized Expected Utility Theory – Rank dependent model) have also failed all empirical testing? I mean, if any has even been done.
I mean no disrespect to theorists if they put their theories in a testable form so that empirical confirmation-replicability or empirical refutation are possible (or if they are still working towards this). The point here being that untestable theories are still either metaphysics or at the very best proto-scientific natural philosophy which needs further development, if possible. Of course, I reveal my strong skepticism about conventional economics with such questions and remarks.
Ikonoclast: It is easier to test models when an attempt at empirical implementation has been made. There have been attempts to fit Real Business Cycle models to data. And a number of government agencies have so-called “New Keynesian” versions of Dynamic Stochastic General Equilibrium Models which they use in forecasting. These fail routinely and Hendry and Mizon have demonstrated how and why. The best reference is Katarina Juselius (Google her) who has tested DSGE models to destruction. Essentially you can construct a purely statistical model using the same variables but making no theoretical assumptions nor any a priori assumptions about the form of the stochastic processes involved. This model will encompass the theoretical one and you can then test whether the restrictions implied by the theory – on cointegration, functional form, the size and sign of coefficients and the nature of the error process are acceptable by the data. If statistical tests reject the restrictions the theory is not compatible with the data set. Juselius reports that this has generally been the case.
There have been numerous attempts to test the axioms of utility maximisation, which in practice boil down to finding consistency and transitivity in revealed preferences since the theory says nothing about the content of preferences. Certain anomalies were spotted decades ago, e.g. the Allais paradox. Herb Simon who got the Nobel prize in the 1970s pointed out the theory was inapplicable in conditions of uncertainty. More recently Tversky and Kahneman introduced psychological observations following laboratory experiments to develop an alternative, “prospect theory”. They got the Nobel in 2002, I think it was.
Much economic theory is driven by ideology and is slow to take feed-back from the field. But there is more to economics than the stuff you get in text books. Anyone working in the field, as opposed to being a pure academic, has to make their accommodations with reality. A lot of comments on this blog are rightly censorious of the text books but are just as innocent of real-world economics as the professors.
More recently Tversky and Kahneman got an e
Gerald, your comment on left- and right-wing students just using macroeconomics teaching to confirm their biases applies to their professors. Macroecononics is not a science — all possible policy positions are supported by some macroeconomists who show empirical support for their positions. And most macroeconomics still genuflects to a ridiculous perfectly competitive microeconomics core.
And, of course, Geoff is correct — neoliberal free market dogma still reigns supreme in politics and in public policy — in the U.S. and in many parts of the world, just witness the policies of the World Bank and IMF. And Geoff is also correct, our world is being destroyed by rapacious capitalism (is there any other kind?).