Oxford professor John Kay has a very interesting article on why economists have tended to go astray in their – as my old mentor Erik Dahmén used to say – tool sheds:
Consistency and rigour are features of a deductive approach, which draws conclusions from a group of axioms – and whose empirical relevance depends entirely on the universal validity of the axioms. The only descriptions that fully meet the requirements of consistency and rigour are completely artificial worlds, such as the “plug-and-play” environments of DSGE – or the Grand Theft Auto computer game.
For many people, deductive reasoning is the mark of science: induction – in which the argument is derived from the subject matter – is the characteristic method of history or literary criticism. But this is an artificial, exaggerated distinction. Scientific progress – not just in applied subjects such as engineering and medicine but also in more theoretical subjects including physics – is frequently the result of observation that something does work, which runs far ahead of any understanding of why it works.
Not within the economics profession. There, deductive reasoning based on logical inference from a specific set of a priori deductions is “exactly the right way to do things”. What is absurd is not the use of the deductive method but the claim to exclusivity made for it. This debate is not simply about mathematics versus poetry. Deductive reasoning necessarily draws on mathematics and formal logic: inductive reasoning, based on experience and above all careful observation, will often make use of statistics and mathematics.
Economics is not a technique in search of problems but a set of problems in need of solution. Such problems are varied and the solutions will inevitably be eclectic. Such pragmatic thinking requires not just deductive logic but an understanding of the processes of belief formation, of anthropology, psychology and organisational behaviour, and meticulous observation of what people, businesses and governments do.
The belief that models are not just useful tools but are capable of yielding comprehensive and universal descriptions of the world blinded proponents to realities that had been staring them in the face. That blindness made a big contribution to our present crisis, and conditions our confused responses to it. Economists – in government agencies as well as universities – were obsessively playing Grand Theft Auto while the world around them was falling apart.
The article is essential reading for all those who want to understand why mainstream – neoclassical – economists actively have contributed to causing todays’s economic crisis rather than to solving it.
Perhaps this becomes less perplexing to grasp when considering what one of its main proponents today – Robert Lucas – maintained already in 2003:
My thesis in this lecture is that macroeconomics in this original sense has succeeded: its central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades.
And this comes from an economist who has built his whole career on the assumption that people are hyper rational “robot imitations” with rational expectations and next to perfect ability to process information. Mirabile dictu!
James Heckman, winner of the “Nobel Prize” in economics (2000), did an inteview with John Cassidy in 2010. It’s an interest-ing read (Cassidy’s words in italics):
What about the rational-expectations hypothesis, the other big theory associated with modern Chicago? How does that stack up now?
I could tell you a story about my friend and colleague Milton Friedman. In the nineteen-seventies, we were sitting in the Ph.D. oral examination of a Chicago economist who has gone on to make his mark in the world. His thesis was on rational expectations. After he’d left, Friedman turned to me and said, “Look, I think it is a good idea, but these guys have taken it way too far.”
It became a kind of tautology that had enormously powerful policy implications, in theory. But the fact is, it didn’t have any empirical content. When Tom Sargent, Lard Hansen, and others tried to test it using cross equation restrictions, and so on, the data rejected the theories. There were a certain section of people that really got carried away. It became quite stifling.
What about Robert Lucas? He came up with a lot of these theories. Does he bear responsibility?
Well, Lucas is a very subtle person, and he is mainly concerned with theory. He doesn’t make a lot of empirical statements. I don’t think Bob got carried away, but some of his disciples did. It often happens. The further down the food chain you go, the more the zealots take over.
What about you? When rational expectations was sweeping economics, what was your reaction to it? I know you are primarily a micro guy, but what did you think?
What struck me was that we knew Keynesian theory was still alive in the banks and on Wall Street. Economists in those areas relied on Keynesian models to make short-run forecasts. It seemed strange to me that they would continue to do this if it had been theoretically proven that these models didn’t work.
What about the efficient-markets hypothesis? Did Chicago economists go too far in promoting that theory, too?
Some did. But there is a lot of diversity here. You can go office to office and get a different view.
[Heckman brought up the memoir of the late Fischer Black, one of the founders of the Black-Scholes option-pricing model, in which he says that financial markets tend to wander around, and don’t stick closely to economics fundamentals.]
[Black] was very close to the markets, and he had a feel for them, and he was very skeptical. And he was a Chicago economist. But there was an element of dogma in support of the efficient-market hypothesis. People like Raghu [Rajan] and Ned Gramlich [a former governor of the Federal Reserve, who died in 2007] were warning something was wrong, and they were ignored. There was sort of a culture of efficient markets—on Wall Street, in Washington, and in parts of academia, including Chicago.
What was the reaction here when the crisis struck?
Everybody was blindsided by the magnitude of what happened. But it wasn’t just here. The whole profession was blindsided. I don’t think Joe Stiglitz was forecasting a collapse in the mortgage market and large-scale banking collapses.
So, today, what survives of the Chicago School? What is left?
I think the tradition of incorporating theory into your economic thinking and confronting it with data—that is still very much alive. It might be in the study of wage inequality, or labor supply responses to taxes, or whatever. And the idea that people respond rationally to incentives is also still central. Nothing has invalidated that—on the contrary.
So, I think the underlying ideas of the Chicago School are still very powerful. The basis of the rocket is still intact. It is what I see as the booster stage—the rational-expectation hypothesis and the vulgar versions of the efficient-markets hypothesis that have run into trouble. They have taken a beating—no doubt about that. I think that what happened is that people got too far away from the data, and confronting ideas with data. That part of the Chicago tradition was neglected, and it was a strong part of the tradition.
When Bob Lucas was writing that the Great Depression was people taking extended vacations—refusing to take available jobs at low wages—there was another Chicago economist, Albert Rees, who was writing in the Chicago Journal saying, No, wait a minute. There is a lot of evidence that this is not true.
Milton Friedman—he was a macro theorist, but he was less driven by theory and by the desire to construct a single overarching theory than by attempting to answer empirical questions. Again, if you read his empirical books they are full of empirical data. That side of his legacy was neglected, I think.
When Friedman died, a couple of years ago, we had a symposium for the alumni devoted to the Friedman legacy. I was talking about the permanent income hypothesis; Lucas was talking about rational expectations. We have some bright alums. One woman got up and said, “Look at the evidence on 401k plans and how people misuse them, or don’t use them. Are you really saying that people look ahead and plan ahead rationally?” And Lucas said, “Yes, that’s what the theory of rational expectations says, and that’s part of Friedman’s legacy.” I said, “No, it isn’t. He was much more empirically minded than that.” People took one part of his legacy and forgot the rest. They moved too far away from the data.
(h/t Mark Buchanan)
1. The economy isn’t like an individual family that earns a certain amount and spends some other amount, with no relationship between the two. My spending is your income and your spending is my income. If we both slash spending, both of our incomes fall.
2. We are now in a situation in which many people have cut spending, either because they chose to or because their creditors forced them to, while relatively few people are willing to spend more. The result is depressed incomes and a depressed economy, with millions of willing workers unable to find jobs.
3. Things aren’t always this way, but when they are, the government is not in competition with the private sector. Government purchases don’t use resources that would otherwise be producing private goods, they put unemployed resources to work. Government borrowing doesn’t crowd out private borrowing, it puts idle funds to work. As a result, now is a time when the government should be spending more, not less. If we ignore this insight and cut government spending instead, the economy will shrink and unemployment will rise. In fact, even private spending will shrink, because of falling incomes.
4. This view of our problems has made correct predictions over the past four years, while alternative views have gotten it all wrong. Budget deficits haven’t led to soaring interest rates (and the Fed’s “money-printing” hasn’t led to inflation); austerity policies have greatly deepened economic slumps almost everywhere they have been tried.
5. Yes, the government must pay its bills in the long run. But spending cuts and/or tax increases should wait until the economy is no longer depressed, and the private sector is willing to spend enough to produce full employment.
All ekonomi är i slutändan summan av mänskliga handlingar, vars logik sällan ryms i ett Excelark …
Inte ens den matematiskt mest fulländade ekvation kan användas som ursäkt för att strunta i det viktigaste: en manuell rimlighetsbedömning. Om bilens GPS ger instruktioner om högersväng utför ett stup betyder det inte nödvändigtvis att det är en bra idé. Förklaringen till att den ortodoxa siffertron vinner allt mer terräng kanske snarare ligger i att det är en bekväm metod att få sin vilja igenom. Det är nämligen med ekonomisk statistik som med så mycket annat: vi väljer att se det vi vill se.
Andreas Cervenka, SvD Näringsliv
One of the most important tasks of social sciences is to explain the events, processes, and structures that take place and act in society. But the researcher cannot stop at this. As a consequence of the relations and connections that the researcher finds, a will and demand arise for critical reflection on the findings. To show that unemployment depends on rigid social institutions or adaptations to European economic aspirations to integration, for instance, constitutes at the same time a critique of these conditions. It also entails an implicit critique of other explanations that one can show to be built on false beliefs. The researcher can never be satisfied with establishing that false beliefs exist but must go on to seek an explanation for why they exist. What is it that maintains and reproduces them? To show that something causes false beliefs – and to explain why – constitutes at the same time a critique of that thing.
This I think is something particular to the humanities and social sciences. There is no full equivalent in the natural sciences, since the objects of their study are not fundamentally created by human beings in the same sense as the objects of study in social sciences. We do not criticize apples for falling to earth in accordance with the law of gravitation.
The explanatory critique that constitutes all good social science thus has repercussions on the reflective person in society. To digest the explanations and understandings that social sciences can provide means a simultaneous questioning and critique of one’s self-understanding and the actions and attitudes it gives rise to. Science can play an important emancipating role in this way. Human beings can fulfill and develop themselves only if they do not base their thoughts and actions on false beliefs about reality. Fulfillment may also require changing fundamental structures of society. Understanding of the need for this change may issue from various sources like everyday praxis and reflection as well as from science.
Explanations of societal phenomena must be subject to criticism, and this criticism must be an essential part of the task of social science. Social science has to be an explanatory critique. The researcher’s explanations have to constitute a critical attitude toward the very object of research, society. Hopefully, the critique may result in proposals for how the institutions and structures of society can be constructed. The social scientist has a responsibility to try to elucidate possible alternatives to existing institutions and structures.
In a time when scientific relativism is expanding, it is important to keep up the claim for not reducing science to a pure discursive level. We have to maintain the Enlightenment tradition of thinking of reality as principally independent of our views of it and of the main task of science as studying the structure of this reality. Perhaps the most important contribution a researcher can make is reveal what this reality that is the object of science actually looks like.
Science is made possible by the fact that there are structures that are durable and are independent of our knowledge or beliefs about them. There exists a reality beyond our theories and concepts of it. It is this independent reality that our theories in some way deal with. Contrary to positivism, I cannot see that the main task of science is to detect event-regularities between observed facts. Rather, that task must be conceived as identifying the underlying structure and forces that produce the observed events.
The problem with positivist social science is not that it gives the wrong answers, but rather that in a strict sense it does not give answers at all. Its explanatory models presuppose that the social reality is “closed,” and since social reality is fundamentally “open,” models of that kind cannot explain anything of what happens in such a universe. Positivist social science has to postulate closed conditions to make its models operational and then – totally unrealistically – impute these closed conditions to society’s real structure.
In the face of the kind of methodological individualism and rational choice theory that dominate positivist social science we have to admit that even if knowing the aspirations and intentions of individuals are necessary prerequisites for giving explanations of social events, they are far from sufficient. Even the most elementary “rational” actions in society presuppose the existence of social forms that it is not possible to reduce to the intentions of individuals.
The overarching flaw with methodological individualism and rational choice theory is basically that they reduce social explanations to purportedly individual characteristics. But many of the characteristics and actions of the individual originate in and are made possible only through society and its relations. Society is not reducible to individuals, since the social characteristics, forces, and actions of the individual are determined by pre-existing social structures and positions. Even though society is not a volitional individual, and the individual is not an entity given outside of society, the individual (actor) and the society (structure) have to be kept analytically distinct. They are tied together through the individual’s reproduction and transformation of already given social structures.
With a non-reductionist approach we avoid both determinism and voluntarism. For although the individual in society is formed and influenced by social structures that he does not construct himself, he can as an individual influence and change the given structures in another direction through his own actions. In society the individual is situated in roles or social positions that give limited freedom of action (through conventions, norms, material restrictions, etc.), but at the same time there is no principal necessity that we must blindly follow or accept these limitations. However, as long as social structures and positions are reproduced (rather than transformed), the actions of the individual will have a tendency to go in a certain direction.
What makes knowledge in social sciences possible is the fact that society consists of social structures and positions that influence the individuals of society, partly through their being the necessary prerequisite for the actions of individuals but also because they dispose individuals to act (within a given structure) in a certain way. These structures constitute the “deep structure” of society.
We have to acknowledge the ontological fact that the world is mind-independent. This does not in any way reduce the epistemological fact that we can only know what the world is like from within our languages, theories, or discourses. But that the world is epistemologically mediated by theories does not mean that it is the product of them.
Our observations and theories are concept-dependent without therefore necessarily being concept-determined. There is a reality existing independently of our knowledge and theories of it. Although we cannot apprehend it without using our concepts and theories, these are not the same as reality itself. Reality and our concepts of it are not identical. Social science is made possible by existing structures and relations in society that are continually reproduced and transformed by different actors.
Social science is relational. It studies and uncovers the social structures in which individuals participate and position themselves. It is these relations that have enough continuity, autonomy, and causal power to endure in society and be the real object of knowledge in social science. It is also only in their capacity as social relations and positions that individuals can be given power or resources (or the lack of them). To be a chieftain, a capital-owner, or a slave is not an individual property of an individual, but can come about only when individuals are integral parts of certain social structures and positions. Social relations and contexts cannot be reduced to individual phenomena – just as a cheque presupposes a banking system and tribe-members presuppose a tribe.
Explanations and predictions of social phenomena require theory constructions. Just looking for correlations between events is not enough. One has to get under the surface and see the deeper underlying structures and mechanisms that essentially constitute the social system.
Contrary to the well-known symmetry hypothesis, I would also maintain that explanation and prediction are not the same. To explain something is to uncover the generative mechanisms behind an event, while prediction only concerns actual events and does not have to say anything about the underlying causes of the events in question. The barometer may be used for predicting today’s weather changes. But these predictions are not explanatory, since they say nothing of the underlying causes.
Methodologically, this implies that the basic question one has to pose when studying social relations and events is what are the fundamental relations without which they would cease to exist. The answer will point to causal mechanisms and tendencies that act in the concrete contexts we study. Whether these mechanisms are activated and what effects they will have in that case it is not possible to predict, since these depend on accidental and variable relations. Every social phenomenon is determined by a host of both necessary and contingent relations, and it is impossible in practice to have complete knowledge of these constantly changing relations. That is also why we can never confidently predict them. What we can do, through learning about the mechanisms of the structures of society, is to identify the driving forces behind them, thereby making it possible to indicate the direction in which things tend to develop.
If we want the knowledge we produce to have practical relevance, our the knowledge we aspire to and our methods have to adapt to our object of study. In social sciences – such as economics, history, or anthropology – we will never reach complete explanations. Instead we have to aim for satisfactory and adequate explanations.
As is well known, there is no unequivocal criterion for what should be considered a satisfactory explanation. All explanations (with the possible exception of those in mathematics and logic) are fragmentary and incomplete; self-evident relations and conditions are often left out so that one can concentrate on the nodal points. Explanations must, however, be real in the sense that they “correspond” to reality and are capable of being used.
The relevance of an explanation can be judged only by reference to a given aspect of a problem. An explanation is then relevant if, for example, it can point out the generative mechanisms that rule a phenomenon or if it can illuminate the aspect one is concerned with. To be relevant from the explanatory viewpoint, the adduced theory has to provide a good basis for believing that the phenomenon to be explained really does or did take place. One has to be able to say: “That’s right! That explains it. Now I understand why it happened.”
While positivism tries to develop a general a priori criterion for evaluation of scientific explanations, it would be better to realize that all we can try for is adequate explanations, which it is not possible to disconnect from the specific, contingent circumstances that are always incident to what is to be explained. I think we have to be modest and acknowledge that our models and theories are time-space relative.
Besides being an aspect of the situation in which the event takes place, an explanatory factor ought also to be causally effective; that is, one has to consider whether the event would have taken place even if the factor did not exist. And it also has to be causally deep. If event e would have happened without factor f, then this factor is not deep enough. Triggering factors, for instance, often do not have this depth. And by contrasting different factors with each other we may find that some are irrelevant (without causal depth).
Without the requirement of depth, explanations most often do not have practical significance. This requirement leads us to the nodal point against which we have to take measures to obtain changes. If we search for and find fundamental structural causes for unemployment, we can hopefully also take effective measures to remedy it.
Scientific theories (ought to) do more than just describe event-regularities. They also analyze and describe the mechanisms, structures, and processes that exist. They try to establish what relations exist between these different phenomena and the systematic forces that operate within the different realms of reality.
Explanations are important within science, since the choice between different theories hinges in large part on their explanatory powers. The most reasonable explanation for one theory’s having greater explanatory power than others is that the mechanisms, causal forces, structures, and processes it talks of, really do exist.
When studying the relation between different factors, a social scientist is usually prepared to admit the existence of a reciprocal interdependence between them. One is seldom prepared, on the other hand, to investigate whether this interdependence might follow from the existence of an underlying causal structure. This is really strange. The actual configurations of a river, for instance, depend of course on many factors. But one cannot escape the fact that it flows downhill and that this fundamental fact influences and regulates the other causal factors. Not to come to grips with the underlying causal power that the direction of the current constitutes can only be misleading and confusing.
All explanations of a phenomenon have preconditions that limit the number of alternative explanations. These preconditions significantly influence the ability of the different potential explanations to really explain anything. If we have a system where underlying structural factors control the functional relations between the parts of the system, a satisfactory explanation can never disregard this precondition. Explanations that take the parts (micro-explanations) as their point of departure may well describe how and through which mechanisms something takes place, but without the structure we cannot explain why it happens.
But could one not just say that different explanations – such as individual and structural – are different, without a need to grade them as better or worse? I think not. That would be too relativistic. For although we are dealing with two different kinds of explanations that answer totally different questions, I would say that the structural most often answers the more relevant questions. In social sciences we often search for explanations of events because we want to be able to avoid or change certain outcomes. Giving individualistic explanations does not make this possible, since they only state sufficient but not necessary conditions. Without knowing the latter we cannot prevent or avoid these undesirable social phenomena.
All kinds of explanations in empirical sciences are pragmatic. We cannot just say that one type is false and another is true. Explanations have a function to fulfill, and some are better and others worse at this. Even if individual explanations can show the existence of a pattern, the pattern as such does not constitute an explanation. We want to be able to explain the pattern per se, and for that we usually require a structural explanation. By studying statistics of the labor market, for example, we may establish the fact that everyone who is at the disposal of the labor market does not have a job. We might even notice a pattern, that people in rural areas, old people, and women are often jobless. But we cannot explain with these data why this is a fact and that it may even be that a certain amount of unemployment is a functional requisite for the market economy. The individualistic frame of explanation gives a false picture of what kind of causal relations are at hand, and a fortiori a false picture of what needs to be done to enable a change. For that, a structural explanation of the kind mentioned above is required.