Why the realism of assumptions do matter

8 April, 2017 at 18:02 | Posted in Economics | 1 Comment

97817847190121Few economists think about methodology, but the methodological foundation of neoclassical economics is Milton Friedman’s (1953) version of ‘positivism.’ Positivism asserts two important theses. First, neither the extent to which the assumption set of a theory incorporates all the core elements of the phenomenon under investigation, nor the institutional or behavioral or empirical realism of the assumptions adopted matter in evaluating their validity or usefulness. The “relation between the significance of a theory and the “realism” of its “assumptions” is almost the opposite of that suggested by [critics of positivism]. Truly important and significant hypotheses will be found to have “assumptions” that are wildly inaccurate descriptive representations of reality…” (Friedman 1953, p. 14). Second, it is impossible to determine whether one assumption is more realistic than another. A theory “cannot be tested by comparing its “assumptions” directly with “reality.” Indeed, there is no meaningful way in which this can be done” (p. 41). The only legitimate test of a theory, then, is whether its derived hypotheses can be used to make predictions that are consistent with relevant data: “The only relevant test of the validity of a hypothesis is comparison of its predictions with experience” (Friedman 1953, p. 9). Since prediction testing of necessity involves ceteris paribus assumptions, in practice the profession relies on econometric hypothesis-testing with past data.

Why would an academic profession sanction the use of theories based on crassly unrealistic assumptions? It is not an intuitively attractive idea. One suspects that the underlying reason is: economists are, in the main, committed to the defense of propositions that cannot be generated by models based on realistic assumptions. For example, a long string of unrealistic assumptions are necessary to generate the desired conclusion that unregulated financial markets perform optimally …

Milton Friedman was not only an economist; he was an energetic conservative political activist as well. His positivist methodology made it possible for conservative economists to use an absurd set of assumptions that no one would accept as a reasonable description of real- world capitalism to generate wide-spread acceptance of the proposition that unregulated capitalism is an ideal system. Realistic assumptions lead to theories that show both the strengths but also the myriad dangers and failures of unregulated capitalism contained in the historical record. But positivism made possible a ‘scientific’ defense of the proposition that capitalism has no dangers and failures. In other words, Friedman’s positivism insulates flawed theories of capitalism that cannot explain or predict the actual behavior of capitalism from effective criticism.

Economics may be an informative tool for research. But if its practitioners do not investigate and make an effort of providing a justification for the credibility of the assumptions on which they erect their building, it will not fulfill its task. There is a gap between its aspirations and its accomplishments, and without more supportive evidence to substantiate its claims, critics like James Crotty — and yours truly — will continue to consider its ultimate arguments as a mixture of rather unhelpful metaphors and metaphysics.

The marginal return on its ever higher technical sophistication in no way makes up for the lack of serious under-labouring of its deeper philosophical and methodological foundations.

A rigorous application of economic methods really presupposes that the phenomena of our real world economies are ruled by stable causal relations. Unfortunately, real world social systems are usually not governed by stable causal mechanisms or capacities. The kinds of ‘laws’ and relations that economics has established, are laws and relations about entities in models that presuppose causal mechanisms being invariant, atomistic and additive. But — when causal mechanisms operate in the real world they only do it in ever-changing and unstable combinations where the whole is more than a mechanical sum of parts. If economic regularities obtain they do it as a rule only because we engineered them for that purpose. Outside man-made ‘nomological machines’ they are rare, or even non-existant.


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  1. Paul Diesing, “Hypothesis Testing and Data Interpretation: The Case of Milton Friedman,” Research in the History of Economic Thought and Methodology, 1985, vol. 3, pp. 61-69 http://www.huppi.com/kangaroo/L-chimonetarism.htm

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