Econometric model specification

30 May, 2014 at 08:11 | Posted in Statistics & Econometrics | Comments Off on Econometric model specification

 

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Why rational expectations is such a joke

29 May, 2014 at 19:47 | Posted in Economics | Comments Off on Why rational expectations is such a joke

 

How to prove discrimination

29 May, 2014 at 18:40 | Posted in Statistics & Econometrics | Comments Off on How to prove discrimination

 

Statistics and correlation

27 May, 2014 at 14:37 | Posted in Statistics & Econometrics | Comments Off on Statistics and correlation

 

Macroeconomics textbooks — how about checking the facts …

26 May, 2014 at 21:58 | Posted in Economics | 5 Comments

chadAmong a couple of really good intermediate – neoclassical – macroeconomics textbooks, Chad Jones textbook Macroeconomics (3rd ed, W W Norton, 2014) stands out as perhaps the best alternative, by combining more traditional short-run macroeconomic analysis with a marvellously accessible coverage of the Romer model – the foundation of modern growth theory.

Unfortunately it also contains some utter nonsense!

In chapter 7 – on “The Labor Market, Wages, and Unemployment” – Jones writes (p. 181):

 

The point of this experiment is to show that wage rigidities can lead to large movements in employment. Indeed, they are the reason John Maynard Keynes gave, in The General Theory of Employment, Interest, and Money (1936), for the high unemployment of the Great Depression.

But this is pure nonsense. For although Keynes in General Theory devoted substantial attention to the subject of wage rigidities, he certainly did not hold the view that wage rigidities were “the reason … for the high unemployment of the Great Depression.”

What Keynes actually did argue in General Theory, was that the classical proposition that lowering wages would lower unemployment and ultimately take economies out of depressions, was ill-founded and basically wrong.

To Keynes, flexible wages would only make things worse by leading to erratic price-fluctuations. The basic explanation for unemployment is insufficient aggregate demand, and that is mostly determined outside the labor market.

Unfortunately, Jones macroeconomics textbook is not the only one containing this kind of utter nonsense on Keynes. Similar distortions of Keynes views can be found in , e. g., the economics textbooks of the “new Keynesian” – a grotesque misnomer – Greg Mankiw. How is this possible? Probably because these economists have but a very superficial acquaintance with Keynes own works, and rather depend on second-hand sources like Hansen, Samuelson, Hicks and the likes.

But the problems don’t end here. The rather embarrassing history revision on Keynes is followed up a couple of pages later with the following gobsmacking remark:

In recent years, different countries in Europe have sought to reform their labor market institutions. As a result, unemployment rates in Spain, Ireland, and the Netherlands, for example, have decreased substantially from levels in the 1980s.

Checking up on Spain I get the following graph:
unemployment spain2

Hardly consistent with the textbook’s “have decreased substantially” …

 

Chicago economics out of touch with the real world

25 May, 2014 at 20:44 | Posted in Economics | 6 Comments

new classicalTom Sargent is a bit out of touch with the real world up there in his office … Certain people have a capacity for ignoring facts which are patenty obvious, but are counter to their view of the world; so they just ignore them …

Sargent is a sort of tinkerer, playing an intellectual game. He looks at a puzzle to see if h ecan solve it in a particular way, exercising these fancy techniques.

Alan Blinder

Do you think this is too harsh? Well, then I suggest you read the following excerpt from the interview with Sargent in Arjo Klamer’s The New Classical Macroeconomics (1984):

People say that many of your assumptions are unrealistic.

It is true that these assumptions are unrealistic.

Do you feel comfortable with them?

Yes, about certain matters. I’m aware of all the problems with them. There are philosophical contradictions about using this methodoology. Deep down I don’t believe in them, but I don’t have a better method of understanding what’s going on out there.

But if the best is not good enough? Wittgenstein’s dictum in Tractatus Logico-Philosophicus comes to mind:

Wovon man nicht sprechen kann, darüber muss man schweigen.

Léo Ferré — tout simplement merveilleux

25 May, 2014 at 17:12 | Posted in Varia | Comments Off on Léo Ferré — tout simplement merveilleux

 

Human dogs

25 May, 2014 at 15:39 | Posted in Varia | Comments Off on Human dogs

 

The appropriate use of hypothesis testing

25 May, 2014 at 09:44 | Posted in Theory of Science & Methodology | 2 Comments

Hypothesis testing and p-values are so compelling in that they fit in so well with the Popperian model in which science advances via refutation of hypotheses. For both theoretical and practical reasons I am supportive of a (modified) Popperian philosophy of science in which models are advanced and then refuted (Gelman and Shalizi 2013). But a necessary part of falsificationism is that the models being rejected are worthy of consideration. significant-p-valueIf a group of researchers in some scientific field develops an interesting scientific model with predictive power, then I think it very appropriate to use this model for inference and to check it rigorously, eventually abandoning it and replacing it with something better if it fails to make accurate predictions in a definitive series of experiments. This is the form of hypothesis testing and falsification that is valuable to me. In common practice, however, the “null hypothesis” is a straw man that exists only to be rejected. In this case, I am typically much more interested in the size of the effect, its persistence, and how it varies across different situations. I would like to reserve hypothesis testing for the exploration of serious hypotheses and not as in indirect form of statistical inference that typically has the effect of reducing scientific explorations to yes/no conclusions.

Andrew Gelman

Assumptions in scientific theories/models are often based on (mathematical) tractability (and so necessarily simplifying) and used for more or less self-evidently necessary theoretical consistency reasons. But one should also remember that assumptions are selected for a specific purpose, and so the arguments (in economics shamelessly often totally non-existent) put forward for having selected a specific set of assumptions, have to be judged against that background to check if they are warranted.

This, however, only shrinks the assumptions set minimally – it is still necessary to decide on which assumptions are innocuous and which are harmful, and what constitutes interesting/important assumptions from an ontological & epistemological point of view (explanation, understanding, prediction). Especially so if you intend to refer your theories/models to a specific target system — preferably the real world. To do this one should start by applying a real world filter in the form of a Smell Test: Is the theory/model reasonable given what we know about the real world? If not, why should we care about it? If not – we shouldn’t apply it (remember time is limited and economics is a science on scarcity & optimization …)

On math and economics — a feeble-minded pseudo debate

24 May, 2014 at 14:45 | Posted in Economics | 8 Comments

Many mainstream economists have the unfounded and ridiculous idea that because heterodox people like yours truly often criticize the application of mathematics in mainstream economics, we are critical of math per se.

I don’t know how many times I’ve been asked to answer this straw-man objection to heterodox economics, but here we go again.

No, there is nothing wrong with mathematics per se.

No, there is nothing wrong with applying mathematics to economics.

Mathematics is one valuable tool among other valuable tools for understanding and explaining things in economics.

What is, however, totally wrong, are the utterly simplistic beliefs that

• “math is the only valid tool”

• “math is always and everywhere self-evidently applicable”

• “math is all that really counts”

• “if it’s not in math, it’s not really economics”

• “almost everything can be adequately understood and analyzed with math”

So — please — let’s have no more of this feeble-minded pseudo debate where heterodox economics is described as simply anti-math!

A common mistake amongst Ph.D. students is to place too much weight on the ability of mathematics to solve an economic problem.  They take a model off the shelf and add a new twist. A model that began as an elegant piece of machinery designed to illustrate a particular economic issue,  goes through five or six amendments from one paper to the next. By the time it reaches the n’th iteration it looks like a dog designed by committee.

amathMathematics doesn’t solve economic problems. Economists solve economic problems. My advice: never formalize a problem with mathematics until you have already figured out the probable answer. Then write a model that formalizes your intuition and beat the mathematics into submission. That last part is where the fun begins because the language of mathematics forces you to make your intuition clear. Sometimes it turns out to be right. Sometimes you will realize your initial guess was mistaken. Always, it is a learning process.

Roger Farmer

Good advice — coming from a professor of economics and fellow of the Econometric Society and research associate of the NBER — well worth following.

Beat A Dead Horse Award

24 May, 2014 at 10:35 | Posted in Economics | Comments Off on Beat A Dead Horse Award

beat2If I ask myself what I could legitimately assume a person to have rational expectations about, the technical answer would be, I think, about the realization of a stationary stochastic process, such as the outcome of the toss of a coin or anything that can be modeled as the outcome of a random process that is stationary. I don’t think that the economic implications of the outbreak of World war II were regarded by most people as the realization of a stationary stochastic process. In that case, the concept of rational expectations does not make any sense. Similarly, the major innovations cannot be thought of as the outcome of a random process. In that case the probability calculus does not apply.

Robert Solow

“Modern” macroeconomic theories are as a rule founded on the assumption of  rational expectations — where the world evolves in accordance with fully predetermined models where uncertainty has been reduced to stochastic risk describable by some probabilistic distribution.

The tiny little problem that there is no hard empirical evidence that verifies these models — cf. Michael Lovell (1986) & Nikolay Gertchev (2007) — usually doesn’t bother its protagonists too much. Rational expectations überpriest Thomas Sargent has the following to say on the epistemological status of the rational expectations hypothesis (emphasis added):

Partly because it focuses on outcomes and does not pretend to have behavioral content, the hypothesis of rational epectations has proved to be a powerful tool for making precise statements about complicated dynamic economic systems.

Precise, yes, in the celestial world of models. But relevant and realistic? I’ll be dipped!

And a few years later, when asked if he thought “that differences among people’s models are important aspects of macroeconomic policy debates”, Sargent replied (emphasis added):

The fact is you simply cannot talk about their differences within the typical rational expectations model. There is a communism of models. All agents within the model, the econometricians, and God share the same model.

Building models on rational expectations either means we are Gods or Idiots. Most of us know we are neither. So, God may share Sargent’s and Lucas’s models, but they certainly aren’t my models.

On the use and misuse of theories and models in economics

24 May, 2014 at 08:59 | Posted in Theory of Science & Methodology | Comments Off on On the use and misuse of theories and models in economics

 
reality checkMy presentation on Microfoundations — the use and misuse of theories and models in economics at the Aalborg conference yesterday.

Post-Keynesian Conference

21 May, 2014 at 12:50 | Posted in Economics | Comments Off on Post-Keynesian Conference

nordicpostkeynesianconference

Yours truly is off to a conference in Aalborg on 22-23 May. Only sporadic blogging until the weekend.

How to reform the teaching of economics

20 May, 2014 at 08:47 | Posted in Economics | 13 Comments

To what extent has – or should – the teaching of economics be modified in the light of the current economic crisis? … 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 …

However, other economists such as myself feel that we have finally reached the turning point in economics where we have to radically change the way we conceive of and model the economy … 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 … 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 …

We owe it to our students to point out difficulties with the structure and assumptions of our theory. Although we are still far from a paradigm shift, in the longer run the paradigm will inevitably change. We would all do well to remember that current economic thought will one day be taught as history of economic thought.

Alan Kirman 

With wings on their heels

18 May, 2014 at 09:42 | Posted in Varia | Comments Off on With wings on their heels

 

On the importance of filtering nonsense economics

17 May, 2014 at 11:54 | Posted in Economics | 3 Comments

Commenting on the “neo-Fisherite” view that lower interest rates lead to lower inflation, Paul Krugman writes:

Yes, if you work hard enough at it you can produce a model for perverse outcomes (that’s pretty close to a theorem). But what empirical motivation is there for doing all of this?

What I think happened here was actually that some economists said something silly, not out of deep conviction, but because they weren’t really thinking about what their equations meant; and that rather than back off, they have now spent the past few years trying to justify their initial claims. But there’s no reason to take this stuff seriously.

This makes me come to think of — again — Robert Solow.

smellFollowing the greatest economic depression since the 1930s, Robert Solow in  2010 gave a prepared statement on “Building a Science of Economics for the Real World” for a hearing in the U. S. Congress. According to Solow modern macroeconomics has not only failed at solving present economic and financial problems, but is “bound” to fail. Building microfounded macromodels on “assuming the economy populated by a representative agent” — consisting of “one single combination worker-owner-consumer-everything-else who plans ahead carefully and lives forever” – do not pass the smell test: does this really make sense? Solow surmised that a thoughtful person “faced with the thought that economic policy was being pursued on this basis, might reasonably wonder what planet he or she is on.”

Conclusion: an economic theory or model that doesn’t pass the real world smell-test is just silly nonsense that doesn’t deserve our attention and therefore belongs in the rubbish-heap.

I sit and talk to God and he just laughs at my plans (private)

17 May, 2014 at 09:30 | Posted in Varia | Comments Off on I sit and talk to God and he just laughs at my plans (private)

Solow telling Chicago economists some home truths

17 May, 2014 at 08:44 | Posted in Economics | 7 Comments

4703325Suppose someone sits down where you are sitting right now and announces to me that he is Napoleon Bonaparte. The last thing I want to do with him is to get involved in a technical discussion of cavalry tactics at the battle of Austerlitz. If I do that, I’m getting tacitly drawn into the game that he is Napoleon. Now, Bob Lucas and Tom Sargent like nothing better than to get drawn into technical discussions, because then you have tacitly gone along with their fundamental assumptions; your attention is attracted away from the basic weakness of the whole story. Since I find that fundamental framework ludicrous, I respond by treating it as ludicrous – that is, by laughing at it – so as not to fall into the trap of taking it seriously and passing on to matters of technique.

Robert Solow

friedmancash_625-620x396Everything reminds Milton of the money supply. Well everything reminds me of sex, but I keep it out of my papers.
 

Robert Solow

When I was in advanced middle age, I suddenly woke up to the fact that my colleagues in macroeconomics, the ones I most admired, thought that the fundamental problem of macro theory was to understand how nominal events could have real consequences. This is just a way of stating some puzzle or puzzles about the sources for sticky wages and prices. This struck me as peculiar in two ways.

First of all, when I was even younger, nobody thought this was a puzzle. You only had to look around you to stumble on a hundred different reasons why various prices and factor prices should be much less than perfectly flexible. I once wrote, archly I admit, that the world has its reasons for not being Walrasian. robert-lucasOf course I soon realized that what macroeconomists wanted was a formal account of price stickiness that would fit comfortably into rational, optimizing models. OK, that is a harmless enough activity, especially if it is not taken too seriously. But price and wage stickiness themselves are not a major intellectual puzzle unless you insist on making them one.

Robert Solow 

Naked Capitalism

16 May, 2014 at 09:51 | Posted in Economics, Politics & Society | 7 Comments

Dismissing involuntary unemployment on methodological grounds

14 May, 2014 at 16:49 | Posted in Economics, Theory of Science & Methodology | 4 Comments

What explains the difficulty of constructing a theory of involuntary unemployment? Is it, as argued by Lucas, that the “thing” to be explained doesn’t exist, or is it due to some deeply embedded premise of economic theory? My own view tilts towards the latter. Economic theory is concerned with fictitious parables. The premises upon which it is based have the advantage of allowing tractable, rigorous theorising, but the price of this is that important facts of life are excluded from the theoretical universe. Non-chosen outcomes is one of them. The underlying reason lies in the trade technology and information assumptions upon which both the Walrasian and the Marshallian (and the neo-Walrasian and neo-Marshallian) approaches are based. This is a central conclusion of my inquiry: the stumbling block to the introduction of involuntary unemployment lies in the assumptions about trade technology that are usually adopted in economic theory.

Foregoing the involuntary unemployment claim may look like a high price to pay, particularly if it is admitted that good reasons exist for believing in its real world relevance. But would its abandonment really be so dramatic? …

First of all, the elimination of this concept would only affect the theoretical sphere. Drawing conclusions from this sphere about the real world would be a mistake. No jumps should be made from the world of theory to the real world, or vice-versa … The fact that solid arguments can be put forward as to its real world existence is not a sufficient condition to give involuntary unemployment theoretical legitimacy.

Michel De Vroey

nonsequitur090111

I have to admit of being totally unimpressed by this rather defeatist methodological stance. Is it really a feasible methodology for economists to make  a sharp divide between theory and reality, and then treat the divide as something recommendable and good? I think not.

Models and theories should — if they are to be of any real interest — have to look to the world. Being able to construct “fictitious parables” or build models of a “credible world,” is not enough. No matter how many convoluted refinements of concepts made in the theory or model, if they do not result in “things” similar to reality in the appropriate respects, such as structure, isomorphism etc, the surrogate system becomes a substitute system — and why should we care about that? Science has to have higher aspirations.

Mainstream economic theory today is in the story-telling business whereby economic theorists create mathematical make-believe analogue models of the target system – usually conceived as the real economic system. This modeling activity is considered useful and essential. Formalistic deductive “Glasperlenspiel” can be very impressive and seductive. But in the realm of science it ought to be considered of little or no value to simply make claims about the theory or model and lose sight of reality. Insisting — like De Vroey — that “no jumps should be made from the world of theory to the real world, or vice-versa” is an untenable methodological position.

 

Robert Lucas — a madman with ‘trained incapacity’

14 May, 2014 at 11:07 | Posted in Economics | 7 Comments

lucIn summary, it does not appear possible, even in principle, to classify individual unemployed people as either voluntarily or involuntarily unemployed depending on the characteristics of the decision problems they face. One cannot, even conceptually, arrive at a usable definition of full employment as a state in which no involuntary unemployment exists.

The difficulties are not the measurement error problems which necessarily arise in applied economics. They arise because the “thing” to be measured does not exist.

MancurOlsonThere are, of course, large numbers of people who voluntarily choose not to work for pay (such as the voluntarily retired, the idle rich, those who prefer handouts to working at jobs, those who stay at home full time to care for children, and so on)… But common sense and the observations and experiences of literally hundred millions of people testify that there is also involuntary unemploymnetr and that it is by no means an isolated or rare phenomenon … Only madmen — or an economist with both ‘trained incapacity’ and doctrinal passion — could deny the reality of involuntary unemployment.
 

Sweden’s neoliberal counter-revolution

12 May, 2014 at 22:43 | Posted in Economics | 3 Comments

Compared to 1998 Sweden’s tax system is far less progressive, with much less wealth going from rich to poor via the tax system.

People in Sweden on low and middle incomes now pay relatively high taxes, says professor Daniel Waldenström to Swedish public television SVT. This is mostly due to the local council tax, but also because of the element of employer fees that is taken as tax.

The change is partly because of the lower tax on capital earnings, and that more people on high incomes have managed to get their money paid in this way.

14s26-tiggare-33Plus tax changes made by the centre-right government since 2006 have meant people on high incomes have paid less tax on property and wealth. Professor Waldenström says there is a ”conscious political aim to make the tax system less progressive.”

In 1998 Sweden had one of the most progressive tax systems, number four in the EU. Ten years later, in 2008, it has the least progressive system of the 15 core EU countries.

The survey of EU tax systems was published in April by the tax cooperation agency Euromod.

Radio Sweden

Bad economics affects us all

12 May, 2014 at 15:38 | Posted in Economics | 3 Comments

Reform of economics teaching is resisted so strongly by mainstream economists because they find it threatening. It is like asking the medieval Catholic clergy to teach their new recruits different interpretations of Christianity, to stop teaching them exclusively in Latin and teach more in the local vernacular, and to encourage them to challenge the intellectual and the moral authority of the Holy See. No wonder it is so strongly resisted by most mainstream economists, even by those who claim to be interested in reform.

economistsBut what does this have to do with everyone outside the academic bubble? Why does it matter that those nerds doing economics degrees are made to jump through one set of hoops rather than another?

Reform of economics education is not just a matter for university economists. The current curriculum frustrates thousands of bright young students who started studying economics thinking that they would learn something useful for making the world a better place and find themselves learning an ersatz theory of “everything” instead. Cynicism about the purpose of economics leads some of the smartest students to careers in investment banking. For employers who recruit economists with first-class degrees, only to find that they possess very narrow skill sets, lack communication skills, and have little knowledge of real economies, the current curriculum hurts their bottom line.

Above all, the future of economics education is ultimately a matter for all of us, because what economists learn in their degree influences what they do later when they make important policy decisions that fundamentally affect our lives – financial deregulation, welfare cuts, gas prices, and healthcare reform. It is time that everyone gets involved in this debate.

Ha-Joon Chang & Jonathan Aldred

The microfoundational illusion

11 May, 2014 at 22:23 | Posted in Economics | 3 Comments

Most modern neoclassical macroeconomists think that microfoundations do have merits. The standard argument underpinning this view usually goes like the one put forward by Tony Yates:

The merit in any economic thinking or knowledge must lie in it at some point producing an insight, a prediction, a prediction of the consequence of a policy action, that helps someone, or a government, or a society to make their lives better.

Microfounded models are models which tell an explicit story about what the people, firms, and large agents in a model do, and why.  What do they want to achieve, what constraints do they face in going about it?  My own position is that these are the ONLY models that have anything genuinely economic to say about anything.

Macroeconomists of the ‘New Keynesian’ ilk — as e. g.  Simon Wren-Lewis — basically agrees:

microfoundations have done a great deal to advance macroeconomics. It is a progressive research program, and a natural way for macroeconomic theory to develop. That is why I work with DSGE models.

The one economist/econometrician/methodologist who has thought most on this issue — writing om microfoundations for now more than 25 years — is without any doubts Kevin Hoover. It’s actually quite interesting to compare his qualified and methodologically founded assessment on the representative-agent-rational-expectations microfoundationalist program with the more or less apologetic views of Yates and Wren-Lewis:

hoovGiven what we know about representative-agent models, there is not the slightest reason for us to think that the conditions under which they should work are fulfilled. The claim that representative-agent models provide microfundations succeeds only when we steadfastly avoid the fact that representative-agent models are just as aggregative as old-fashioned Keynesian macroeconometric models. They do not solve the problem of aggregation; rather they assume that it can be ignored. While they appear to use the mathematics of microeconomis, the subjects to which they apply that microeconomics are aggregates that do not belong to any agent. There is no agent who maximizes a utility function that represents the whole economy subject to a budget constraint that takes GDP as its limiting quantity. This is the simulacrum of microeconomics, not the genuine article …

[W]e should conclude that what happens to the microeconomy is relevant to the macroeconomy but that macroeconomics has its own modes of analysis … [I]t is almost certain that macroeconomics cannot be euthanized or eliminated. It shall remain necessary for the serious economist to switch back and forth between microeconomics and a relatively autonomous macroeconomics depending upon the problem in hand.

Instead of just methodologically sleepwalking into their models, modern followers of the Lucasian microfoundational program ought to do some reflection and at least try to come up with a sound methodological justification for their position.  Just looking the other way won’t do. Writes Hoover:

garciaThe representative-­agent program elevates the claims of microeconomics in some version or other to the utmost importance, while at the same time not acknowledging that the very microeconomic theory it privileges undermines, in the guise of the Sonnenschein­Debreu­Mantel theorem, the likelihood that the utility function of the representative agent will be any direct analogue of a plausible utility function for an individual agent … The new classicals treat [the difficulties posed by aggregation] as a non-issue, showing no apprciation of the theoretical work on aggregation and apparently unaware that earlier uses of the representative-agent model had achieved consistency wiyh theory only at the price of empirical relevance.

Where ‘New Keynesian’ and New Classical economists think that they can rigorously deduce the aggregate effects of (representative) actors with their reductionist microfoundational methodology, they have to put a blind eye on the emergent properties that characterize all open social and economic systems. The interaction between animal spirits, trust, confidence, institutions, etc., cannot be deduced or reduced to a question answerable on the individual level. Macroeconomic structures and phenomena have to be analyzed also on their own terms.

Post-hoc reasoning and academic racism

11 May, 2014 at 10:58 | Posted in Economics | 5 Comments

 
Vegetarians-linked-to-higher-brain-power

Let’s use the term “academic racism” to mean ““a belief that race is the primary determinant of human traits and capacities and that racial differences produce an inherent superiority of a particular race” …

Basically, academic racism has a problem, and that problem is overfitting.

Here’s how academic racism generally works. Suppose you see two groups that have an observable difference: for example, suppose you note that Hungary has a higher per capita income than Romania. Now you have a data point. To explain that data point, you come up with a theory: the Hungarian race is more industrious than the Romanian race. But suppose you notice that Romanians generally do better at gymnastics than Hungarians. To explain that second data point, you come up with a new piece of theory: The Romanian race must have some genes for gymnastics that the Hungarian race lacks.

You can keep doing this. Any time you see different average outcomes between two different groups, you can assume that there is a genetic basis for the difference. You can also tell “just-so stories” to back up each new assumption – for example, you might talk about how Hungarians are descended from steppe nomads who had to be industrious to survive, etc. etc. As new data arrive, you make more assumptions and more stories to explain them …

There’s just one little problem with this strategy. Each new assumption that you make adds a parameter to your model. You’re overfitting the data – building a theory that can explain everything but predict nothing … If you use some sort of goodness-of-fit criterion that penalizes you for adding more parameters, you’ll find that your model is useless … This is one form of a more general scientific error known as “testing hypotheses suggested by the data“, or “post-hoc reasoning”.

Noah Smith

Economics departments — turning out generation after generation of idiot savants

10 May, 2014 at 23:37 | Posted in Economics | 9 Comments

Paul Samuelson once claimed that the ergodic hypothesis is essential for advancing economics from the realm of history to the realm of science.

That view on what constitutes economics doesn’t please neither yours truly nor Nassim Taleb, who writes (emphasis added):

However, if you believe in free will you can’t truly believe in social sci­ence and economic projection. You cannot predict how people will act. Except, of course, if there is a trick, and that trick is the cord on which neoclassical economics is suspended. You simply assume that individuals will be rational in the future and thus act predictably. There is a strong link between rationality, predictability, and mathematical tractability …

In orthodox economics, rationality became a straitjacket … This led to mathematical techniques such as “maximization,” or “optimization,” on which Paul Samuelson built much of his work … This optimization set back social science by reducing it from the intellectual and reflective discipline that it was becoming to an attempt at an “exact science.” By “exact science,” I mean a second-rate engineering problem for those who want to pretend that they are in the physics department— so-called physics envy. In other words, an intellectual fraud …

uesc_09_img0509The tragedy is that Paul Samuelson, a quick mind, is said to be one of the most intelligent scholars of his generation. This was clearly a case of very badly invested intelli­gence. Characteristically, Samuelson intimidated those who questioned his techniques with the statement “Those who can, do science, others do methodology.” If you knew math, you could “do science” … Alas, it turns out that it was Samuelson and most of his followers who did not know much math, or did not know how to use what math they knew, how to apply it to reality. They only knew enough math to be blinded by it.

Tragically, before the proliferation of empirically blind idiot savants, interesting work had been begun by true thinkers, the likes of J . M . Keynes, Friedrich Hayek, and the great Benoît Mandelbrot, all of whom were displaced because they moved economics away from the precision of second-rate physics. Very sad.

This may sound harsh, but in fact already back in 1991, Journal of Economic Literature published a study by the Commission on Graduate Education in Economics (COGEE) of the American Economic Association (AEA) — chaired by Anne Krueger and including people like Kenneth Arrow, Edward Leamer, Robert Lucas, Joseph Stiglitz, and Lawrence Summers — focusing on “the extent to which graduate education in economics may have become too removed from real economic problems.” The COGEE members reported from own experience “that it is an underemphasis on the ‘linkages’ between tools, both theory and econometrics, and ‘real world problems’ that is the weakness of graduate education in economics,”  and that both students and faculty sensed “the absence of facts, institutional information, data, real-world issues, applications, and policy problems.” And in conclusion they wrote (emphasis added):

The commission’s fear is that graduate programs may be turning out a generation with too many idiot savants skilled in technique but innocent of real economic issues.

Sorry to say, not much is different today. Economics education is still in dire need of a remake!

Gary Becker — father of ‘economics of everything’

9 May, 2014 at 10:49 | Posted in Economics | 1 Comment

Becker

The death of Gary Becker, the father of the “economics of everything” set me wondering: could it be that basic neoclassical economics does a better job of explaining “non-economic” behaviour than it does of economic phenomena?

Take three examples where basic neoclassical is, at best, questionable:

 – A theory of distribution. The idea that wages are equal to workers’ marginal product is deeply questionable. It seems instead that power, rent-seeking and institutional frameworks also matter enormously; the fact that there’s no correlation between patterns of income inequality and of human capital inequality should be awkward for neoclassicals. And the idea of a marginal product of capital is just close to meaningless, which gives neoclassical economics little idea of where profits come from.

 – The Solow-Swan growth model found that most economic growth was due to exogenous technical progress, which is pretty much no explanation of growth at all. The difficulty of relating growth to human capital suggests that augmented theories do little better. And the fact that governments in developed economies can do little to change long-term growth rates suggests that growth theory hasn’t (yet?) had a useful policy influence.

 – The neoclassical explanation of unemployment stresses wage inflexibility and “rigidities”. But this fails to account for why unemployment was high in the 19th century.

By contrast, Beckerian economics has given us some useful insights into crime, family life and racial discrimination …

What I’m saying here might earn me the wrath of both heterodox and orthodox economists, but it is in a sense trivial.Different theories can explain different things. The idea that one theory fits all owes more to fanaticism and tribalism than to the data.

Chris Dillow

Nice article — although I guess one could rightly question if there has ever existed an economic approach owing more to fanaticism and tribalism than Gary Becker’s imperialist approach, that basically says that everything in social sciences that isn’t firmly based on the idea that human beings are supernatural optimizing robots is worthless …

Great news from Kingston University

8 May, 2014 at 18:27 | Posted in Economics | 3 Comments

I have just accepted an offer to become Head of the School of Economics, History and Politics at Kingston University in London. I will take up the appointment in time for the Autumn term, which starts on September 23rd.

Kingston will respond positively to calls from students for genuine reform of economics education—like those made by the Post-Crash Economics Society in Manchester, and the International Student Initiative for Pluralism in Economics (which was launched only days ago).

These student calls for genuine reform are timely, because though there are some initiatives for reform, academic economics has, if anything, become more hostile to criticism of the mainstream and to presentation of alternative perspectives than it was before the crisis.

Kingston is different. It already has a curriculum that teaches both mainstream and non-orthodox approaches. We will develop this further in the coming years to provide an education that is mindful of the need for economics to be humble after its many failures.

These include not merely the failure of Neoclassical economics to foresee the financial crisis—and its contribution to that crisis by championing the financial products that made the crisis so severe—but also the failure of Marxian economics to foresee the many problems that led to the collapse of centrally planned economies two decades earlier.

The guiding principles in developing Kingston’s approach will be, firstly, that there is no “right” school of economic thought today, so that all schools of thought deserve to be taught; and secondly, that nothing in economics is sacred, so that different approaches should be taught “warts and all”—with their weaknesses noted as well as their strengths …

So if you want a crit­i­cal, plu­ral­ist edu­ca­tion in eco­nom­ics (whether as an under­grad­u­ate or post­grad­u­ate), and one which puts eco­nom­ics in the con­text of his­tory and pol­i­tics, join me in Kingston.

Steve Keen

News that really makes me happy.

I can only congratulate Steve and the economics students at Kingston University.

Keynes vs. ‘New Keynesians’ on unemployment

8 May, 2014 at 18:09 | Posted in Economics | 3 Comments

There are unfortunately a lot of mainstream economists out there who still think that price and wage rigidities are the prime movers behind unemployment. What is even worse — I’m totally gobsmacked every time I come across this utterly ridiculous misapprehension — is that some of them even think that these rigidities are the reason John Maynard Keynes gave for the high unemployment of the Great Depression. This is of course pure nonsense. For although Keynes in General Theory devoted substantial attention to the subject of wage and price rigidities, he certainly did not hold this view.

Since unions/workers, contrary to classical assumptions, make wage-bargains in nominal terms, they will – according to Keynes – accept lower real wages caused by higher prices, but resist lower real wages caused by lower nominal wages. However, Keynes held it incorrect to attribute “cyclical” unemployment to this diversified agent behaviour. During the depression money wages fell significantly and – as Keynes noted – unemployment still grew. Thus, even when nominal wages are lowered, they do not generally lower unemployment.

In any specific labour market, lower wages could, of course, raise the demand for labour. But a general reduction in money wages would leave real wages more or less unchanged. The reasoning of the classical economists was, according to Keynes, a flagrant example of the “fallacy of composition.” Assuming that since unions/workers in a specific labour market could negotiate real wage reductions via lowering nominal wages, unions/workers in general could do the same, the classics confused micro with macro.

Lowering nominal wages could not – according to Keynes – clear the labour market. Lowering wages – and possibly prices – could, perhaps, lower interest rates and increase investment. But to Keynes it would be much easier to achieve that effect by increasing the money supply. In any case, wage reductions was not seen by Keynes as a general substitute for an expansionary monetary or fiscal policy.

Even if potentially positive impacts of lowering wages exist, there are also more heavily weighing negative impacts – management-union relations deteriorating, expectations of on-going lowering of wages causing delay of investments, debt deflation et cetera.

So, what Keynes actually did argue in General Theory, was that the classical proposition that lowering wages would lower unemployment and ultimately take economies out of depressions, was ill-founded and basically wrong.

To Keynes, flexible wages would only make things worse by leading to erratic price-fluctuations. The basic explanation for unemployment is insufficient aggregate demand, and that is mostly determined outside the labor market.

The classical school [maintains that] while the demand for labour at the existing money-wage may be satisfied before everyone willing to work at this wage is employed, this situation is due to an open or tacit agreement amongst workers not to work for less, and that if labour as a whole would agree to a reduction of money-wages more employment would be forthcoming. If this is the case, such unemployment, though apparently involuntary, is not strictly so, and ought to be included under the above category of ‘voluntary’ unemployment due to the effects of collective bargaining, etc …
The classical theory … is best regarded as a theory of distribution in conditions of full employment. So long as the classical postulates hold good, unemploy-ment, which is in the above sense involuntary, cannot occur. Apparent unemployment must, therefore, be the result either of temporary loss of work of the ‘between jobs’ type or of intermittent demand for highly specialised resources or of the effect of a trade union ‘closed shop’ on the employment of free labour. Thus writers in the classical tradition, overlooking the special assumption underlying their theory, have been driven inevitably to the conclusion, perfectly logical on their assumption, that apparent unemployment (apart from the admitted exceptions) must be due at bottom to a refusal by the unemployed factors to accept a reward which corresponds to their marginal productivity …

Obviously, however, if the classical theory is only applicable to the case of full employment, it is fallacious to apply it to the problems of involuntary unemployment – if there be such a thing (and who will deny it?). The classical theorists resemble Euclidean geometers in a non-Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straight – as the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required to-day in economics. We need to throw over the second postulate of the classical doctrine and to work out the behaviour of a system in which involuntary unemployment in the strict sense is possible.

J M Keynes General Theory

People calling themselves ‘New Keynesians’ ought to be rather embarrassed by the fact that the kind of microfounded dynamic stochastic general equilibrium models they use, cannot incorporate such a basic fact of reality as involuntary unemployment!

Of course, working with microfunded representative agent models, this should come as no surprise. If one representative agent is employed, all representative agents are. The kind of unemployment that occurs is voluntary, since it is only adjustments of the hours of work that these optimizing agents make to maximize their utility. Maybe that’s also the reason prominent ‘New Keynesian’ macroeconomist Simon Wren-Lewis can write

I think the labour market is not central, which was what I was trying to say in my post. It matters in a [New Keynesian] model only in so far as it adds to any change to inflation, which matters only in so far as it influences central bank’s decisions on interest rates.

In the basic DSGE models used by most ‘New Keynesians’, the labour market is always cleared – responding to a changing interest rate, expected life time incomes, or real wages, the representative agent maximizes the utility function by varying her labour supply, money holding and consumption over time. Most importantly – if the real wage somehow deviates from its “equilibrium value,” the representative agent adjust her labour supply, so that when the real wage is higher than its “equilibrium value,” labour supply is increased, and when the real wage is below its “equilibrium value,” labour supply is decreased.

In this model world, unemployment is always an optimal choice to changes in the labour market conditions. Hence, unemployment is totally voluntary. To be unemployed is something one optimally chooses to be.

The final court of appeal for macroeconomic models is the real world, and as long as no convincing justification is put forward for how the inferential bridging de facto is made, macroeconomic modelbuilding is little more than “hand waving” that give us rather little warrant for making inductive inferences from models to real world target systems. If substantive questions about the real world are being posed, it is the formalistic-mathematical representations utilized to analyze them that have to match reality, not the other way around.

To Keynes this was self-evident. But obviously not so to ‘New Keynesians’.

Gary Becker and toothbrushing economics

8 May, 2014 at 10:10 | Posted in Economics | 3 Comments

The ever-growing literature on human capital has long recognized that the scope of the theory extends well beyond the traditional analysis of schooling and on-the-job training … Yet economists have ignored the analysis of an important class of activities which can and should be brought within the purview of the theory. A prime example of this class is brushing teeth.

BeckerGaryCartoon2009_07_10The conventional analysis of toothbrushing has centered around two basic models. The “bad taste in mouth” model is based on the notion that each person has a “taste for brushing,” and the fact that brushing frequencies differ is “explained” by differences in tastes. Since any pattern of human behavior can be rationalized by such implicit theorizing, this model is devoid of empirically testable predictions, and hence uninteresting.

The “mother told me so” theory is based on differences in cultural upbringing. Here it is argued, for example, that thrice-a-day brushers brush three times daily because their mothers forced them to do so as children. Of course, this is hardly a complete explanation. Like most psychological theories, it leaves open the question of why mothers should want their children to brush after every meal …

In a survey of professors in a leading Eastern university it was found that assistant professors brushed 2.14 times daily on average, while associate professors brushed only 1.89 times and full professors only 1.47 times daily. The author, a sociologist, mistakenly attributed this finding to the fact that the higher-ranking professors were older and that hygiene standards in America had advanced steadily over time. To a human capital theorist, of course, this pattern is exactly what would be expected from the higher wages received in the higher professorial ranks, and from the fact that younger professors, looking for promotions, cannot afford to have bad breath.

Alan Blinder

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