Paul Krugman has a piece up on his blog arguing that the ‘discipline of modeling’ is a sine qua non for tackling politically and emotionally charged economic issues:
You might say that the way to go about research is to approach issues with a pure heart and mind: seek the truth, and derive any policy conclusions afterwards. But that, I suspect, is rarely how things work. After all, the reason you study an issue at all is usually that you care about it, that there’s something you want to achieve or see happen. Motivation is always there; the trick is to do all you can to avoid motivated reasoning that validates what you want to hear.
In my experience, modeling is a helpful tool (among others) in avoiding that trap, in being self-aware when you’re starting to let your desired conclusions dictate your analysis. Why? Because when you try to write down a model, it often seems to lead some place you weren’t expecting or wanting to go. And if you catch yourself fiddling with the model to get something else out of it, that should set off a little alarm in your brain.
So when Krugman and other ‘modern’ mainstream economists use their models — standardly assuming rational expectations, Walrasian market clearing, unique equilibria, time invariance, linear separability and homogeneity of both inputs/outputs and technology, infinitely lived intertemporally optimizing representative agents with homothetic and identical preferences, etc. — and standardly ignoring complexity, diversity, uncertainty, coordination problems, non-market clearing prices, real aggregation problems, emergence, expectations formation, etc. — we are supposed to believe that this somehow helps them ‘to avoid motivated reasoning that validates what you want to hear.’
Yours truly is, to say the least, far from convinced. The alarm that sets off in my brain is that this, rather than being helpful for understanding real world economic issues, sounds more like an ill-advised plaidoyer for voluntarily taking on a methodological straight-jacket of unsubstantiated and known to be false assumptions.
Let me just give two examples to illustrate my point.
In 1817 David Ricardo presented — in Principles — a theory that was meant to explain why countries trade and, based on the concept of opportunity cost, how the pattern of export and import is ruled by countries exporting goods in which they have comparative advantage and importing goods in which they have a comparative disadvantage.
Ricardo’s theory of comparative advantage, however, didn’t explain why the comparative advantage was the way it was. In the beginning of the 20th century, two Swedish economists — Eli Heckscher and Bertil Ohlin — presented a theory/model/theorem according to which the comparative advantages arose from differences in factor endowments between countries. Countries have a comparative advantages in producing goods that use up production factors that are most abundant in the different countries. Countries would a fortiori mostly export goods that used the abundant factors of production and import goods that mostly used factors of productions that were scarce.
The Heckscher-Ohlin theorem –as do the elaborations on in it by e.g. Vanek, Stolper and Samuelson — builds on a series of restrictive and unrealistic assumptions. The most critically important — beside the standard market clearing equilibrium assumptions — are
(1) Countries use identical production technologies.
(2) Production takes place with a constant returns to scale technology.
(3) Within countries the factor substitutability is more or less infinite.
(4) Factor-prices are equalised (the Stolper-Samuelson extension of the theorem).
These assumptions are, as almost all empirical testing of the theorem has shown, totally unrealistic. That is, they are empirically false.
That said, one could indeed wonder why on earth anyone should be interested in applying this theorem to real world situations. As so many other mainstream mathematical models taught to economics students today, this theorem has very little to do with the real world.
From a methodological point of view one can, of course, also wonder, how we are supposed to evaluate tests of a theorem building on known to be false assumptions. What is the point of such tests? What can those tests possibly teach us? From falsehoods anything logically follows.
Modern (expected) utility theory is a good example of this. Leaving the specification of preferences without almost any restrictions whatsoever, every imaginable evidence is safely made compatible with the all-embracing ‘theory’ — and a theory without informational content never risks being empirically tested and found falsified. Used in mainstream economics ‘thought experimental’ activities, it may of course be very ‘handy’, but totally void of any empirical value.
Utility theory has like so many other economic theories morphed into an empty theory of everything. And a theory of everything explains nothing — just as Gary Becker’s ‘economics of everything’ it only makes nonsense out of economic science.
Some people have trouble with the fact that from allowing false assumptions mainstream economists can generate whatever conclusions they want in their models.
But that’s really nothing very deep or controversial. What I’m referring to is the well-known ‘principle of explosion,’ according to which if both a statement and its negation are considered true, any statement whatsoever can be inferred.
Whilst tautologies, purely existential statements and other nonfalsiﬁable statements assert, as it were, too little about the class of possible basic statements, self-contradictory statements assert too much. From a self-contradictory statement, any statement whatsoever can be validly deduced. Consequently, the class of its potential falsiﬁers is identical with that of all possible basic statements: it is falsiﬁed by any statement whatsoever.
On the question of tautology, I think it is only fair to say that the way axioms and theorems are formulated in mainstream (neoclassical) economics, they are often made tautological and informationally totally empty.
Using false assumptions, mainstream modelers can derive whatever conclusions they want. Wanting to show that ‘all economists consider austerity to be the right policy,’ just e.g. assume ‘all economists are from Chicago’ and ‘all economists from Chicago consider austerity to be the right policy.’ The conclusions follows by deduction — but is of course factually totally wrong. Models and theories building on that kind of reasoning is nothing but a pointless waste of time.
In recent years the public has lost faith the in the economics profession.
One reason for the lack of faith is the failure to predict the Great Recession, but the public’s dismissal of macroeconomists is based upon more than the failure to foresee the dangers the housing bubble posed for the economy. It is also due to false promises about the benefits to the working class from globalization, tax cuts for the wealthy, and trade agreements – promises that were often used to support ideological and political goals or to serve special interests.
In retrospect the evidence for the housing bubble was easy to see and a few people tried to sound the alarm but they were widely dismissed. Even when the warnings were taken seriously the belief was that the consequences from a housing bubble collapse would be relatively minor and confined to the housing sector. Very few people believed there would be a deep and long-lasting recession …
The arguments used to justify austerity policies put forth both by reputable economists and promoted by those with an ideological agenda for smaller government – the idea that reducing government deficits would create a confidence effect and stimulate the economy – turned out to be wrong. Repeated warnings about inflation due to quantitative easing from economists with standing in the profession, warnings that proved false again and again, provided ammunition to those with a vendetta against the Fed.
If we go back a bit further in time, it’s easy to find more examples. Globalization and international trade were supposed to make us all better off. There would be adjustment costs along the way that would hopefully be offset by government policies to help those who paid the cost of the transition, but in the long-run more trade would lift all boats. But that hasn’t happened. Wages for the majority of people have stagnated, there have been large job displacements that government policy has not done much to address, and the gains have gone to those at the top of the income distribution.
Tax cuts for the wealthy were supposed to stimulate growth and make everyone better off. There was dispute about this within the profession, but there were also many economists who provided intellectual support for the claim that tax cuts will create growth and widespread prosperity. The evidence from the Bush and Reagan tax cuts does not support this claim, but it is still made by some economists and this gives those who are serving wealthy interests or who want to force government to shrink by starving it of revenue the cover they need for their arguments …
We do need more humility about what we do and do not know, more willingness to change our minds when the evidence disagrees with our favorite theoretical model, and the willingness to acknowledge disagreement within the profession. But most of all we need to take a strong stand against those inside and outside the profession who misuse economic theory and empirical results for political and ideological purposes.
The Conservative belief that there is some law of nature which prevents men from being employed, that it is “rash” to employ men, and that it is financially ‘sound’ to maintain a tenth of the population in idleness for an indefinite period, is crazily improbable – the sort of thing which no man could believe who had not had his head fuddled with nonsense for years and years … Our main task, therefore, will be to confirm the reader’s instinct that what seems sensible is sensible, and what seems nonsense is nonsense. We shall try to show him that the conclusion, that if new forms of employment are offered more men will be employed, is as obvious as it sounds and contains no hidden snags; that to set unemployed men to work on useful tasks does what it appears to do, namely, increases the national wealth; and that the notion, that we shall, for intricate reasons, ruin ourselves financially if we use this means to increase our well-being, is what it looks like – a bogy.
John Maynard Keynes (1929)
Brexit is about much more than frustration about the E.U. and immigration. It is about a shortage of decent and secure jobs; an impossibly precarious labour market; inexplicable inequalities in incomes and wealth; closed access to affordable education, and a terrible deficiency of affordable housing; and it is about British Chancellor of the Exchequer Osborne’s single-minded austerity economics and the rule-free and tax-free space created for big banks and corporations.
The referendum result reflects a deep-seated anger and anxiety amongst large sections of the population who are disenfranchised and feel ignored, and who can no longer bear the economic burden of living in the Thatcherite free-market wasteland (alternatively known as Cameron’s “Big Society”) that Britain has become – sadly reinforced by the New Labour governments that began with Tony Blair …
It would be a tragic mistake to read this resentment against the E.U. as only anti-migrant, racist or bigoted, because the racism and bigotry have grown in conditions of economic austerity, artificial job scarcity and crisis, rising unemployment, rising job insecurity, and exploding inequalities as social protection for workers, pensioners and families have been scaled down …
The responsibility for the economic and political mess in Britain, the E.U. and beyond weighs heavily on the shoulders of economists who insist there is no alternative to a globalized market economy (TINA!), with freedom for the rich and wealthy and unfreedom for the rest, and who out-of-hand reject serious progressive programmes to reform the system and make it more democratic and humane …
There are no easy answers – but economics urgently needs to start reforming itself, and asking the right questions.
Societies where we allow the inequality of incomes and wealth to increase without bounds, sooner or later implode.
In a market economy it is money that counts.
In a democracy it is your vote that counts.
If you’ve got money, you vote in.
If you haven’t got money, you vote out.
If, as a result of Brexit, the economy crashes it will not vindicate the economists, it will simply illustrate once more their failure.
We, at Policy Research in Macroeconomics (PRIME) call for an urgent, independent, public inquiry into the economics profession, and its role in precipitating both the financial crisis of 2007-9, the subsequent very slow ‘recovery’; and in the British European referendum campaign …
Economists have once again proved themselves not only irrelevant, but a dangerous irrelevance.
For too long they have resisted call after call for reform. If they will not do it themselves then it is time for others to take control. The profession should be brought to account through a public inquiry into the this failure.
While it is risky to second guess public opinion, it may just be that the prospect of hardship to come might not have been very compelling for those already suffering the hardship of low wages, insecure low-skilled jobs, bad housing, high rents, an under-resourced and increasingly privatised NHS, and other forms of public sector ‘austerity’.
With this historic vote, the British people have not just rejected the EU. They have done something that should worry the British establishment, and their friends in the City of London, and internationally, far more. They have rejected economics – and in particular the dominant economic narrative …
The “experts” and the economic stories they tell, have been well and truly walloped by the result of this referendum. And rightly so, because while there is truth in the story that international co-operation and co-ordination is vital to economic activity and stability, there is no sound basis to the widely espoused economic ‘religion’ that markets – in money, trade and labour – must be unfettered, detached from democratic regulatory oversight, and must be trusted to ‘govern’ whole countries, regions and continents.
The British people have today rejected this mainstream, orthodox economics, a strain of fundamentalism that they may rightly judge has proved deleterious to their own economic interests.
And in case you — like e.g. Simon Wren-Lewis — think this kind of critique is only coming from ‘heterodox’ economists like Ann Pettifor and yours truly — well, then maybe you should read what a former Governor of the Bank of England has to say:
Since the crisis, many have been tempted to play the game of deciding who was to blame for such a disastrous outcome … A generation of the brightest and best were lured into banking, and especially into trading, by the promise of immense financial rewards and by the intellectual challenge of the work that created such rich returns. They were badly misled. The crisis was a failure of a system and the ideas that underpinned it, not of individual policy-makers or bankers, incompetent and greedy though some of them undoubtedly were. There was a general misunderstanding of how the world economy worked …
If we don’t blame the actors, then why not the playwright? Economists have been cast by many as the villain. An abstract and increasingly mathematical discipline, economics is seen as having failed to predict the crisis. This is rather like blaming science for the occasional occurrence of a natural disaster. Yet we would blame scientists if incorrect theories made disasters more likely or created a perception that they could never occur, and one of the arguments of this book is that economics has encouraged ways of thinking that made crises more probable …
Brexit — and its disdain of the establishment — will send well-earned warnings to politicians all over the world …
Brexit has structural similarities with Trump’s rise. It is the logical outcome of the Conservative Party’s political strategy of the past twenty years. Conservatives used the European Union (EU) as a whipping boy to help smuggle in their “Thatcher – Reagan” neoliberal economic policies. The Labor Party spoke out in defense of minorities, but it did not defend the EU and nor did it adequately confront neoliberalism.
In the US, Trump is the analogue “exit” candidate. His rise is the logical outcome of thirty years, during which Republicans used dog-whistle racism and the culture war to smuggle through their neoliberal economic agenda that has wrought the destruction of shared prosperity. Democrats resisted racism and the culture war, but were complicit in the promotion of neoliberalism.
The lesson for the Clinton campaign is it must move beyond rhetoric criticizing neoliberalism and adopt serious remedies that tackle its legacy of inequality, economic insecurity and loss of hope. Neoliberalism is the ultimate cause of the establishment’s rejection. Racism, immigration and nationalism may be the match for the anti-establishment fire: wage stagnation and off-shoring of jobs are the fuel.
There will be a lot of postmortems for the European Union (EU) after Brexit. Many will suggest that this was a victory against the neoliberal policies of the European Union …
The problem is that while it is true that the EU leaders have been part of the problem and have pursued the neoliberal policies within the framework of the union, sometimes with treaties like the Fiscal Compact, it is far from clear that Brexit and the possible demise of the union, if the fever spreads to France, Germany and other countries with their populations demanding their own referenda, will lead to the abandonment of neoliberal policies. Austerity will most likely continue …
Most of the austerity policies imposed on the peripheral countries are actually the result of the euro, and are to a great extent independent of the existence of a broader political union …
Personally, I cannot see that the disintegration of Europe would lead to a positive outcome. Sure the EU has a significant democratic deficit, and a bureaucracy that is seen as wasteful and inefficient … The same is true of American democracy.
At a minimum the European Union provided an environment in which people could move freely, in which petty nationalism gave way to acceptance of foreigners and immigrants, something particularly relevant with the refugee crisis in the neighboring region. Some may suggest that this was very little to show for. And the alternative, does it have something to show for? If the European Union really collapses, there will be very little for progressives to be happy about.
So what’s wrong with the economy? …
A 2002 study of United States fiscal policy by the economists Olivier Blanchard and Roberto Perotti found that ‘both increases in taxes and increases in government spending have a strong negative effect on private investment spending.’ They noted that this finding is ‘difficult to reconcile with Keynesian theory.’
Consistent with this, a more recent study of international data by the economists Alberto Alesina and Silvia Ardagna found that ‘fiscal stimuli based on tax cuts are more likely to increase growth than those based on spending increases.’
From Mankiw’s perspective ‘the Alesina work suggests a still plausible hypothesis.’
Austerity policies not only generate substantial welfare costs due to supply-side channels, they also hurt demand — and thus worsen employment and unemployment.The notion that fiscal consolidations can be expansionary (that is, raise output and employment), in part by raising private sector confidence and investment, has been championed by, among others, Harvard economist Alberto Alesina in the academic world and by former European Central Bank President Jean-Claude Trichet in the policy arena. However, in practice, episodes of fiscal consolidation have been followed, on average, by drops rather than by expansions in output. On average, a consolidation of 1 percent of GDP increases the long-term unemployment rate by 0.6 percentage point and raises by 1.5 percent within five years the Gini measure of income inequality.