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Re-examining economic laws

September 24, 2018 3 comments

from Lars Syll

In mainstream economics, there is a lot of talk about ‘economic laws.’ The crux of these laws that allegedly do exist in economics, is that they only hold ceteris paribus. That fundamentally means that these laws only hold when the right conditions are at hand for giving rise to them. Unfortunately, from an empirical point of view, those conditions are only at hand in artificially closed nomological models purposely designed to give rise to the kind of regular associations that economists want to explain. But — since these laws do not exist outside these socio-economic machines, what is the point in constructing thought experimental models showing these non-existent laws? When the almost endless list of narrow and specific assumptions necessary to allow the ‘rigorous’ deductions are known to be at odds with reality, what good do these models do?

Deducing laws in theoretical models is of no avail if you cannot show that the models — and the assumptions they build on — are realistic representations of what goes on in real life.

Conclusion? Instead of restricting our methodological endeavours at building ever more rigorous and precise deducible models, we ought to spend much more time improving our methods for choosing models!  Read more…

Tony Lawson vs Uskali Mäki

September 18, 2018 1 comment

from Lars Syll

We are all realists and we all — Mäki, Cartwright, and I — self-consciously present ourselves as such. The most obvious research-guiding commonality, perhaps, is that we do all look at the ontological presuppositions of economics or economists.

title-methodology-image_tcm7-198540Where we part company, I believe, is that I want to go much further. I guess I would see their work as primarily analytical and my own as more critically constructive or dialectical. My goal is less the clarification of what economists are doing and presupposing as seeking to change the orientation of modern economics … Specifically, I have been much more prepared than the other two to criticise the ontological presuppositions of economists—at least publically. I think Mäki is probably the most guarded. I think too he is the least critical, at least of the state of modern economics …

One feature of Mäki’s work that I am not overly convinced by, but which he seems to value, is his method of theoretical isolation (Mäki 1992). If he is advocating it as a method for social scientific research, I doubt it will be found to have much relevance—for reasons I discuss in Economics and reality (Lawson 1997). But if he is just saying that the most charitable way of interpreting mainstream economists is that they are acting on this method, then fine. Sometimes, though, he seems to imply more …

I cannot get enthused by Mäki’s concern to see what can be justified in contemporary formalistic modelling endeavours. The insights, where they exist, seem so obvious, circumscribed, and tagged on anyway …

As I view things, anyway, a real difference between Mäki and me is that he is far less, or less openly, critical of the state and practices of modern economics … Mäki seems more inclined to accept mainstream economic contributions as largely successful, or anyway uncritically. I certainly do not think we can accept mainstream contributions as successful, and so I proceed somewhat differently …

So if there is a difference here it is that Mäki more often starts out from mainstream academic economic analyses accepted rather uncritically, whilst I prefer to start from those everyday practices widely regarded as successful.

Tony Lawson

Read more…

Structural econometrics

September 12, 2018 2 comments

from Lars Syll

In the ongoing discussion on the ’empirical revolution’ in economics, some econometricians criticise — rightfully — the view that quasi-experiments and RCTs are the (only) true solutions to finding causal parameters. But — the alternative they put forward, structural models, have their own monumental problems.

Structural econometrics — essentially going back to the Cowles programme — more or less takes for granted the possibility of a priori postulating relations that describe economic behaviours as invariant within a Walrasian general equilibrium system. In practice, that means the structural model is based on a straightjacket delivered by economic theory. Causal inferences in those models are — by assumption — made possible since the econometrician is supposed to know the true structure of the economy. And, of course, those exact assumptions are the crux of the matter. If the assumptions don’t hold, there is no reason whatsoever to have any faith in the conclusions drawn, since they do not follow from the statistical machinery used!

 LierBy making many strong background assumptions, the deductivist [the conventional logic of structural econometrics] reading of the regression model allows one — in principle — to support a structural reading of the equations and to support many rich causal claims as a result. Here, however, the difficulty is that of finding good evidence for many of the assumptions on which the approach rests. It seems difficult to believe, even in cases where we have good background economic knowledge, that the background information will be sufficient​ to do the job that the deductivist asks of it. As a result, the deductivist approach may be difficult to sustain, at least in economics.

Read more…

Economic policy — a political matter

September 11, 2018 2 comments

from Lars Syll 

toozeWhat kind of financial system do we want? What function should it have? What kind of financial activity do we want to permit or even encourage? These are essential questions for the shaping of economic and social policy at a national and global level. If we leave these questions up to the private sector, we expose ourselves to enormous risks. On the basis of our experience of 2008, we know how to master a massive heart attack in the banking system. But we also know how high the costs of such an intervention are.

The chance for structural reform was missed in 2008 … What we must aim to do is tighten regulations, further raise capital requirements and bolster liquidity buffers to minimize the risk of a bank run. Furthermore, we must extend regulation to non-banks, such as the major asset managers. These are technical matters, but as the fate of Dodd-Frank shows, they cannot be separated from politics … The endless bickering over technicalities is the opposite of what we need: namely a real and powerful banking supervision that does not shy away from fundamental questions and public debate.

Unfortunately, no one with political authority on either side of the Atlantic seems prepared to pose these questions, let alone to take action. After 2008, we know what that means. When things get serious, we are all on the hook.

Adam Tooze

Economics needs a new Reformation

September 9, 2018 19 comments

from Lars Syll

A more pluralist approach would take account of the complexity of markets, the constraints imposed by nature and rising inequality. So what needs to be done?

luther-theses-painting-1080x675Firstly, listen to consumers, because it is pretty obvious that they are unimpressed with what they are getting. The failure of the economics establishment to predict the crisis and its insistence that austerity is the right response to the events of a decade ago has meant the profession has rarely been less trusted …

Secondly, we should stop treating economics as a science because it is nothing of the sort. A proper science involves testing a hypothesis against the available evidence. If the evidence doesn’t support the theory, a physicist or a biologist will discard the theory and try to come up one that does work empirically.

Economics doesn’t work like that. Theories can be shown to work only by making a series of highly questionable assumptions – such as that humans always behave predictably and rationally. When there is hard evidence that disputes the validity of the theory, there is no question of ditching the theory.

Larry Elliott/The Guardian

Secular stagnation and failed interpretations​ of Keynes

September 8, 2018 15 comments

from Lars Syll

Commenting on the Stiglitz-Summers debate on secular stagnation, Roger Farmer writes:

nk-2-2We cannot continue to make unfounded assertions about economic policy using the failed interpretation of the General Theory that evolved from John Hicks’ attempt to reconcile Keynes with the classics. The current manifestation of that approach is so-called New Keynesian Economics, which Summers himself has rightly rejected because it is inconsistent with secular stagnation. But it is not enough to assert that secular stagnation is possible. It is time to confront alternative theories of secular stagnation with empirical evidence, as I have done. The assertion that money wages are downwardly rigid is not, in my view, a credible explanation of persistent unemployment. Nor was it a credible explanation for Keynes, who asserted that his theory did not rely on the assumption of rigid wages …

In my work, expectations – or so-called animal spirits – are a new and independent fundamental that determines the steady-state unemployment rate. When we feel rich, we are rich. And if animal spirits are indeed fundamental, it becomes important to understand the factors that determine swings in confidence.

If a large dose of expansionary fiscal policy is not the answer, what is? My response is that the right way to respond to financial crises is with policies that restore the value of private assets. And the right way to prevent financial crises in the first place is to intervene in the financial markets to moderate swings in asset values and to head off recessions before they happen.

Maintaining that economics is a science in the ‘true knowledge’ business, I cannot but concur with Farmer. We have to remain skeptical of the pretences and aspirations of ‘New Keynesian’ macroeconomics. So far, I cannot really see that it has yielded very much in terms of realist and relevant economic knowledge. And there’s nothing new or Keynesian about it.  Read more…

The gross substitution axiom

September 7, 2018 4 comments

from Lars Syll

Economics is perhaps more than any other social science model-oriented. There are many reasons for this — the history of the discipline, having ideals coming from the natural sciences (especially physics), the search for universality (explaining as much as possible with as little as possible), rigour, precision, etc.

Mainstream economists want to explain social phenomena, structures and patterns, based on the assumption that the agents are acting in an optimizing (rational) way to satisfy given, stable and well-defined goals.

The procedure is analytical. The whole is broken down into its constituent parts so as to be able to explain (reduce) the aggregate (macro) as the result of the interaction of its parts (micro).

Building their economic models, modern mainstream economists ground their models on a set of core assumptions — describing the agents as ‘rational’ actors — and a set of auxiliary assumptions. Based on these two sets of assumptions, they try to explain and predict both individual (micro) and — most importantly — social phenomena (macro).   Read more…

How to cope with the behavioural challenge

September 5, 2018 5 comments

from Lars Syll

How would you react if a renowned physicist, say, ​Richard Feynman, was telling you that sometimes force is proportional to acceleration and at other times it is proportional to acceleration squared?

kickI guess you would be unimpressed. But actually, what most mainstream economists do amounts to the same strange thing when it comes to theory development and model modification.

In mainstream economic theory,​ preferences are standardly expressed in the form of a utility function. But although the expected utility theory has been known for a long time to be both theoretically and descriptively inadequate, mainstream economists all over the world gladly continue to use it, as though its deficiencies were unknown or unheard of.

What most mainstream economists try to do in face of the obvious theoretical and behavioural inadequacies of the expected utility theory, is to marginally mend it. But that cannot be the right attitude when facing scientific anomalies. When models are plainly wrong, you’d better replace them! Instead of mending the broken pieces it would be much better to concentrate on developing descriptively accurate models of choice under uncertainty.  Read more…

After the crisis — business as usual

September 3, 2018 28 comments

from Lars Syll

3monkeys6In contrast to the experience of the Great Depression, which led to the emergence and acceptance of novel theoretical concepts on a large scale, the financial crisis and its consequences have, by and large, been rationalized with reference to existing theoretical concepts. Although we do observe a slight shift away from the idea that financial markets are efficient by default and prices only follow random walks, the basic conceptualization of (financial) markets as being efficient and equilibrating in principle seems unquestioned. On the contrary, the rising prominence of the concept of “liquidity” – understood as the availability of funds to absorb financial assets to be sold – in the aftermath of the crisis indicates that the financial crisis is seen by economists as a major external shock, unforeseen because of the limits imposed on rational behavior by asymmetric information, and not as something intrinsic to the economic process. Similarly, our analysis of the reception of major crisis-related books shows an only temporary increase of interest in classic contributions dealing with financial and economic instability, which was even weaker for more distinguished journals. These observations signify a key difference in terms of the ‘lessons learned’ from past crises when compared to the Great Depression, which gave rise to a broad consensus that capitalist economies are not self-sustaining, a consensus that eventually helped to forge the mixed economies dominating the richer parts of the planet.

E Aigler, M Aistleitner, F Glötzl & J Kapeller

When did you last hear an economist​ say something like this?

September 1, 2018 47 comments

from Lars Syll

If the observations of the red shift in the spectra of massive stars don’t come out quantitatively​ in accordance with the principles of general relativity, then my theory will be dust and ashes.

Albert Einstein (1920)

Some common misunderstandings about randomization

September 1, 2018 13 comments

from Lars Syll

rcRandomization is an alternative when we do not know enough to control, but is generally inferior to good control when we do. We suspect that at least some of the popular and professional enthusiasm for RCTs, as well as the belief that they are precise by construction, comes from misunderstandings about … random or realized confounding on the one hand and confounding in expectation on the other …

The RCT strategy is only successful if we are happy with estimates that are arbitrarily far from the truth, just so long as the errors cancel out over a series of imaginary experiments. In reality, ​the causality that is being attributed to the treatment might, in fact, be coming from an imbalance in some other cause in our particular trial; limiting this requires serious thought about possible covariates.

Angus Deaton & Nancy Cartwright

The point of making a randomized experiment is often said to be that it ‘ensures’ that any correlation between a supposed cause and effect indicates a causal relation. This is believed to hold since randomization (allegedly) ensures that a supposed causal variable does not correlate with other variables that may influence the effect.  Read more…

Modern economics — a severe case of model Platonism

August 30, 2018 4 comments

from Lars Syll

That is the great thing about abstraction. Working with what can be called ‘flex price’ models does not imply that you think price rigidity is unimportant, but instead that it can often be ignored if you want to focus on other processes.

Simon Wren-Lewis

When applying deductivist thinking to economics, mainstream economists like Wren-Lewis usually set up ‘as if’ models based on a set of tight axiomatic assumptions from which consistent and precise inferences are made. The beauty of this procedure is, of course,​ that if the axiomatic premises are true, the conclusions necessarily follow. The snag is that if the models are to be relevant, we also have to argue that their precision and rigour still holds when they are applied to real-world situations. They often do not. When addressing real economies, the idealizations necessary for the deductivist machinery to work — as e. g. ‘flex price’ models — simply do not hold.

If the real world is fuzzy, vague and indeterminate, then why should our models build upon a desire to describe it as precise and predictable? The logic of idealization is a marvellous tool in mathematics and axiomatic-deductivist systems, but a poor guide for action in real-world systems, in which concepts and entities are without clear boundaries and continually interact and overlap.  Read more…

Technobabble economics

August 27, 2018 4 comments

from Lars Syll

ZJL-Head-In-Sand

Deductivist modelling​ endeavours and an overly simplistic use of statistical and econometric tools are sure signs of the explanatory hubris that still haunts mainstream economics.

In an interview Robert Lucas says

the evidence on postwar recessions … overwhelmingly supports the dominant importance of real shocks.

So, according to Lucas, changes in tastes and technologies should be able to explain the main fluctuations in e.g. the unemployment that we have seen during the last six or seven decades. But really — not even a Nobel laureate could in his wildest imagination come up with any warranted and justified explanation solely based on changes in tastes and technologies.

The Chicago übereconomist is simply wrong. But how do we protect ourselves from this kind of scientific nonsense? In The Scientific Illusion in Empirical Macroeconomics Larry Summers has a suggestion well worth considering — not the least since it makes it easier to understand how mainstream economics actively contribute to causing economic crises rather than to solve them:  Read more…

The cost of focusing on general equilibrium theory

August 25, 2018 18 comments

from Lars Syll

The largest problem with the economics profession’s focus on general equilibrium theory is the opportunity costs of that exploration. Important policy problems are not addressed. Consider Pareto optimality and the welfare theorems, which Fisher sees as the underpinnings of Western capitalism. In a world, such as ours, where property rights cannot be allocated effortlessly and costlessly, economist’s welfare theorems have little policy relevance. Does a policy maker care whether any Pareto efficient allocation can be decentralized as a competitive general equilibrium? The chance of discovering a real-world Pareto optimal policy that can be shown to harm no one in some infinitesimal way is essentially nil.

what ifBy focusing their theoretical policy analysis on Pareto optimal policies, economists avoid coming to grips theoretically with the messy value judgments that must be made in the policy space, which means that their theoretical models provide little guidance on how to deal with the messy problems of actual policy that are designed to achieve both efficiency and fairness. In its almost exclusive focus on efficiency, modern economists have moved away from Classical economist’s utilitarian moral philosophy that underlay Classical economist’s support of markets. Classical economists supported markets because they worked reasonably well in the real world, not because of any deductive proof of the benefits of markets.

Dave Colander

Reformulating the economics curriculum

August 23, 2018 6 comments

from Lars Syll

Having gone through a handful of the most frequently used textbooks of economics at the undergraduate level today, I can only conclude that the models that are presented in these modern mainstream textbooks try to describe and analyze complex and heterogeneous real economies with a single rational-expectations-robot-imitation-representative-agent.

madiThat is, with something that has absolutely nothing to do with reality. And — worse still — something that is not even amenable to the kind of general equilibrium analysis that they are thought to give a foundation for, since Hugo Sonnenschein (1972), Rolf Mantel (1976) and Gérard Debreu (1974) unequivocally showed that there did not exist any condition by which assumptions on individuals would guarantee neither stability nor uniqueness of the equilibrium solution.

So what modern economics textbooks present to students are really models built on the assumption that an entire economy can be modelled as a representative actor and that this is a valid procedure. But it is not, as the Sonnenschein-Mantel-Debreu theorem irrevocably has shown.

Of course one could say that it is too difficult on undergraduate levels to show why the procedure is right and to defer it to master and doctoral courses. It could justifiably be reasoned that way — if what you teach your students is true, if The Law of Demand is generalizable to the market level, and the representative actor is a valid modelling abstraction! But in this case, it is demonstrably known to be false, and therefore this is nothing but a case of scandalous intellectual dishonesty. It’s like telling your students that 2 + 2 = 5 and hope that they will never run into Peano’s axioms of arithmetics.

For almost forty years mainstream economics itself has lived with a theorem that shows the impossibility of extending the microanalysis of consumer behaviour to the macro level (unless making patently and admittedly insane assumptions). Still after all these years pretending in their textbooks that this theorem does not exist — none of the textbooks I investigated even mention the existence of the Sonnenschein-Mantel-Debreu theorem — is really outrageous.

Econophysics

August 21, 2018 11 comments

from Lars Syll

Unfortunately, nothing is more dangerous than dogmas donned with scientific feathers. The current crisis might offer an excellent occasion for a paradigm
change, previously called for by prominent economists like John Maynard Keynes, Alan Kirman and Steve Keen. They have forcefully highlighted the shortcomings
and contradictions of the classical economictheory, but progress has been slow. The task looks so formidable that some economists argue that it is better to stick with the implausible but well-corseted theory of perfectly rational agents than to venture into modelling the infinite number of ways agents can be irrational.

miracle_cartoonPhysicists, however, feel uncomfortable with theories not borne out by (or even blatantly incompatible with) empirical data. But could the methodology of physics really contribute to the much-awaited paradigm shift in economics? …

Econophysics is in fact a misnomer, since most of its scope concerns financial markets. To some economists, finance is a relatively minor subfield and any contribution, even the most significant, can only have a limited impact on economics science at large. I personally strongly disagree with this viewpoint: recent events confirm that hiccups in the financial markets can cripple the entire economy.  Read more…

“I never learned maths, so I had to think”

August 17, 2018 18 comments

from Lars Syll

Professors may find themselves ill-prepared for the macro classroom. To become academics they had to answer erudite questions posed by more senior members of the discipline. To become good teachers of introductory macro, they have to give clear answers to muddled students. That requires an intuitive feel for the subject. It is not enough to crank through the equations.

roweIndeed, Mr Rowe attributes part of his success as a teacher to his shortcomings as a mathematician. He quotes Joan Robinson, another clear expositor of macroeconomics: “I never learned maths, so I had to think.” Because the answers did not leap out at him from the equations, he had to dwell on the economic behaviour underneath the algebra.

Macroeconomics is difficult to teach partly because its theorists (classical, Keynesian, monetarist, New Classical and New Keynesian, among others) disagree about so much. It is difficult also because the textbooks disagree about so little.

The Economist

Easterlin’s paradox or why economic growth does not make us happier

August 15, 2018 14 comments

from Lars Syll

In Easterlin’s (1974) seminal paper, he finds that within any one country, in cross sectional studies, there was a strong correlation between income and happiness. One would easily conclude that money can buy happiness. However, looking at a cross section of countries, one comes to a different conclusion …

For 10 of the 14 countries surveyed, the happiness ranking is about the same, even though the income per capita changes by a factor of 30 from $140 to $2,000 …

easterlinThe finding of strong correlation between income and happiness disappears when comparisons are made across countries. Similarly, there is no correlation between happiness and income in the long run within a single country … Easterlin (2001) cites several studies which show that, despite tremendous increases in GNP per capita, the level of happiness in European and Latin American has remained virtually constant over decades.

The startling implication of these empirical findings is that the stress being placed on economic growth is entirely misplaced. Growth has no clear relation to happiness. The profession of economics, as well as policy makers all over the world are directly threatened by these findings, which suggest radical changes in how to organise economic affairs …

The implicit proposition of utility theory that the sole route to happiness is maximisation of consumption contradicts with the empirical evidence: this proposition is true only in the short run. This short run validity creates a dangerous illusion of long run validity; understanding this has dramatic policy implications. If happiness is determined by relative comparisons, then one can achieve greater happiness by reducing inequalities, and also by reducing the standards of living for everyone. This will lower the benchmark and make it easier for everyone on the planet to be happy in comparison with this benchmark.

Asad Zaman & Mehmet Karacuka

So much for value-free economics

August 15, 2018 9 comments

from Lars Syll

Back in 1992, New Jersey raised the minimum wage by 18 per cent while its neighbour state, Pennsylvania, left its minimum wage unchanged. Unemployment in New Jersey should — according to mainstream economics textbooks — have increased relative to Pennsylvania. However, when economists David Card and Alan Krueger gathered information on fast food restaurants in the two states, it turned out that unemployment had actually decreased in New Jersey relative to that in Pennsylvania. Counter to mainstream demand theory we had an anomalous case of a backward-sloping supply curve.

And, of course, all those non-ideological and value-free scientific economists out there were überjoyed and prepared to revise their theories …

jp-imgresI’ve subsequently stayed away from the minimum wage literature for a number of reasons. First, it cost me a lot of friends. People that I had known for many years, for instance, some of the ones I met at my first job at the University of Chicago, became very angry or disappointed. They thought that in publishing our work we were being traitors to the cause of economics as a whole.

David Card

Money in perspective

August 13, 2018 13 comments

from Lars Syll

keWhen the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals. We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues. We shall be able to afford to dare to assess the money-motive at its true value. The love of money as a possession — as distinguished from the love of money as a means to the enjoyments and realities of life — will be recognized for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease.