Chicago economics — nothing but pseudo-scientific cheating

from Lars Syll

Unlike anthropologists … economists simply invent the primitive societies we study, a practice which frees us from limiting ourselves to societies which can be physically visited as sparing us the discomforts of long stays among savages. This method of society-invention is the source of the utopian character of economics; and of the mix of distrust and envy with which we are viewed by our fellow social scientists. The point of studying wholly fictional, rather than actual societies, is that it is relatively inexpensive to subject them to external forces of various types and observe the way they react. If, subjected to forces similar to those acting on actual societies, the artificial society reacts in a similar way, we gain confidence that there are useable connections between the invented society and the one we really care about.

Robert Lucas

Neither yours truly, nor anthropologists, will recognise anything in Lucas’ description of economic theory even remotely reminiscent of practices actually used in real sciences, this quote still gives a very good picture of the methodology used by Lucas and other prominent Chicago economists.

All empirical sciences use simplifying or unrealistic assumptions in their modelling activities. That is not the issue – as long as the assumptions made are not unrealistic in the wrong way or for the wrong reasons.

The implications that follow from the kind of models that people like Robert Lucas — according to Ed Prescott, ‘the master of methodology’ — are always conditional on the simplifying assumptions used — assumptions predominantly of a rather far-reaching and non-empirical character with little resemblance to features of the real world. From a descriptive point of view, there is a fortiori usually very little resemblance between the models used and the empirical world. ‘As if’ explanations building on such foundations are not really any explanations at all, since they always conditionally build on hypothesized law-like theorems and situation-specific restrictive assumptions. The empirical-descriptive inaccuracy of the models makes it more or less miraculous if they should — in any substantive way — be able to be considered explanative at all. If the assumptions that are made are known to be descriptively totally unrealistic (think of e.g. ‘rational expectations’) they are of course likewise totally worthless for making empirical inductions. Assuming — as Lucas — that people behave ‘as if’ they were rational FORTRAN programmed computers doesn’t take us far when we know that the ‘if’ is false.

The obvious shortcoming of a basically epistemic — rather than ontological — approach such as ‘successive approximations’ and ‘as if’ modelling assumptions, is that ‘similarity’, ‘analogy’ or ‘resemblance’ tout court do not guarantee that the correspondence between model and target is interesting, relevant, revealing or somehow adequate in terms of mechanisms, causal powers, capacities or tendencies. No matter how many convoluted refinements of concepts are made in the model, if the successive ‘as if’ approximations do not result in models similar to reality in the appropriate respects (such as structure, isomorphism, etc), they are nothing more than ‘substitute systems’ that do not bridge to the world but rather misses its target.

Economics building on the kind of modelling strategy that Lucas represents does not produce science.

It’s nothing but pseudo-scientific cheating.

Contrary to what some überimpressed macroeconomists seem to argue, I would say the recent economic crises and the fact that Chicago economics has had next to nothing to contribute to understanding them, shows that Lucas and his New Classical economics — in Lakatosian terms — is a degenerative research program in dire need of replacement.

Mainstream economic theory has long been in the story-telling business whereby economic theorists create make-believe analogue models of the target system – usually conceived as the real economic system. This modelling activity is considered useful and essential. Since fully-fledged experiments on a societal scale as a rule are prohibitively expensive, ethically indefensible or unmanageable, economic theorists have to substitute experimenting with something else. To understand and explain relations between different entities in the real economy the predominant strategy is to build models and make things happen in these “analogue-economy models” rather than engineering things happening in real economies.

But how do we bridge the gulf between the model and the ‘target system’? According to Lucas, we have to be willing to “argue by analogy from what we know about one situation to what we would like to know about another, quite different situation” [Lucas 1988:5]. Progress lies in the pursuit of the ambition to “tell better and better stories” [Lucas 1988:5], simply because that is what economists do.

We are storytellers, operating much of the time in worlds of make believe. We do not find that the realm of imagination and ideas is an alternative to, or retreat from, practical reality. On the contrary, it is the only way we have found to think seriously about reality. In a way, there is nothing more to this method than maintaining the conviction … that imagination and ideas matter … there is no practical alternative” [Lucas 1988:6].

Lucas applies this mode of theorizing by constructing “make-believe economic systems” to the age-old question of what causes and constitutes business cycles. According to Lucas the standard for what that means is that one “exhibits understanding of business cycles by constructing a model in the most literal sense: a fully articulated artificial economy, which behaves through time so as to imitate closely the time series behavior of actual economies” [Lucas 1981:219].

The development of macro-econometrics has according to Lucas supplied economists with “detailed, quantitatively accurate replicas of the actual economy” thereby enabling us to treat policy recommendations “as though they had been experimentally tested” [Lucas 1981:220]. But if the goal of theory is to be able to make accurate forecasts this “ability of a model to imitate actual behavior” does not give much leverage. What is required is “invariance of the structure of the model under policy variations”. Parametric invariance in an economic model cannot be taken for granted, “but it seems reasonable to hope that neither tastes nor technology vary systematically” [Lucas 1981:220].

The model should enable us to posit contrafactual questions about what would happen if some variable was to change in a specific way. Hence the assumption of structural invariance, that purportedly enables the theoretical economist to do just that. But does it? Lucas appeals to “reasonable hope”, a rather weak justification for a modeller to apply such a far-reaching assumption. To warrant it one would expect an argumentation that this assumption – whether we conceive of it as part of a strategy of “isolation”, “idealization” or “successive approximation” – really establishes a useful relation that we can export or bridge to the target system, the “actual economy.” That argumentation is neither in Lucas nor – to my knowledge – in the succeeding neoclassical refinements of his “necessarily artificial, abstract, patently ‘unreal’” analogue economies [Lucas 1981:271]. At most, we get what Lucas himself calls “inappropriately maligned” casual empiricism in the form of “the method of keeping one’s eyes open.” That is far from sufficient to warrant any credibility in a model pretending to explain the complex and difficult recurrent phenomena we call business cycles. Providing an empirical “illustration” or a “story” to back up your model does not suffice. There are simply too many competing illustrations and stories that could be exhibited or told.

Applying a “Lucas critique” on Lucas’s own model, it is obvious that it too fails. Changing “policy rules” cannot just be presumed not to influence investment and consumption behaviour and a fortiori technology, thereby contradicting the invariance assumption. Technology and tastes cannot live up to the status of an economy’s deep and structurally stable Holy Grail. They too are part and parcel of an ever-changing and open economy. Lucas’ hope of being able to model the economy as “a FORTRAN program” and “gain some confidence that the component parts of the program are in some sense reliable prior to running it” [Lucas 1981:288] therefore seems – from an ontological point of view – totally misdirected. The failure in the attempt to anchor the analysis in the alleged stable deep parameters ‘tastes’ and ‘technology’ shows that if you neglect ontological considerations pertaining to the target system, ultimately reality kicks back when at last questions of bridging and exportation of model exercises are laid on the table. No matter how precise and rigorous the analysis is, and no matter how hard one tries to cast the argument in “modern mathematical form” [Lucas 1981:7] they do not push science forward one single millimetre if they do not stand the acid test of relevance to the target.

References

Lucas, Robert (1981), Studies in Business-Cycle Theory. Oxford: Basil Blackwell.

– (1988), What Economists Do.