Pure game theory — an irrelevant tautology

31 October, 2017 at 18:13 | Posted in Economics | 13 Comments

Applied game theory is a theory of real-world facts, where we use game theoretical definitions, axioms, theorems and (try to) test if real-world phenomena ‘satisfy’ the axioms and the inferences made from them. When confronted with the real world we can (hopefully) judge if game theory really tells us if things are as postulated by theory.

like-all-of-mathematics-game-theory-is-a-tautology-whose-conclusions-are-true-because-they-are-quote-1But there is also an influential group of game theoreticians that think that game theory is nothing but pure theory, an axiomatic-mathematical scientific theory that presents a set of axioms that people have to ‘satisfy’ by definition to count as ‘rational.’ Instead of confronting the theory with real-world phenomena it becomes a simple matter of definition if real-world phenomena are to count as signs of ‘rationality.’

This makes for ‘rigorous’ and ‘precise’ conclusions — but never about the real world. Pure game theory does not give us any information at all about the real world. It gives us absolutely irrefutable knowledge — but only since the knowledge is purely definitional.

Mathematical theorems are tautologies. They cannot be false because they do not say anything substantive. They merely spell out the implications of how things have been​ defined. The basic propositions of game theory have precisely the same character.

Ken Binmore

Pure game theorists, like Ken Binmore, give us analytical truths — truths by definition. That is great — from a mathematical and formal logical point of view. In science, however, it is rather uninteresting and totally uninformative! Even if pure game theory gives us ‘logical’ truths, that is not what we are looking for as scientists. We are interested in finding truths that give us new information and knowledge of the world in which we live.

Scientific theories are theories that ‘refer’ to the real-world, where axioms and definitions do not take us very far. To be of interest for an economist or social scientist that wants to understand, explain, or predict real-world phenomena, the pure theory has to be ‘interpreted’ — it has to be ‘applied’ theory. A ‘pure’ game theory that does not go beyond proving theorems and conditional ‘if-then’ statements — and do not make assertions and put forward hypotheses about real-world individuals and institutions — is of little consequence for anyone wanting to use theories to better understand, explain or predict real-world phenomena.

Pure game theory has no empirical content whatsoever. And it certainly has no relevance whatsoever to a scientific endeavour of expanding real-world knowledge.

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Science and reason

29 October, 2017 at 09:44 | Posted in Theory of Science & Methodology | 2 Comments

scrivenTrue scientific method is open-minded, self-critical, flexible. Scientists are, in short, not as reasonable as they would like to ​think themselves. The great scientists are often true exceptions; they are nearly always attacked by their colleagues for their revolutionary ideas, not by using the standards of reason, but just by appealing​ to prejudices then current.​ Being reasonable takes great skill and great​ sensitivity to the difference between “well-supported” and “widely accepted.” It also takes great courage, because it seldom corresponds to being popular.

Admati on ‘the banker’s new clothes​’

29 October, 2017 at 08:29 | Posted in Economics | 1 Comment

 

Så länge skutan kan gå

28 October, 2017 at 10:36 | Posted in Varia | Comments Off on Så länge skutan kan gå

 

Mästerligt!!

Chicago economists — people who have their heads fuddled with nonsense

27 October, 2017 at 13:06 | Posted in Economics | 2 Comments

joblossMainstream macroeconomics has always had problems with the notion of involuntary unemployment. According to New Classical übereconomist Robert Lucas, an unemployed worker can always instantaneously find some job. No matter how miserable the work options are, “one can always choose to accept them,” according to Lucas:

KLAMER: My taxi driver here is driving a taxi, even though he is an accountant, because he can’t find a job …

LUCAS: I would describe him as a taxi driver [laughing], if what he is doing is driving a taxi.

KLAMER: But a frustrated taxi driver.

LUCAS: Well, we draw these things out of urns, and sometimes we get good draws, sometimes we get bad draws.

Arjo Klamer

In New Classical Economics unemployment is seen as a kind of leisure that workers optimally select. In the basic DSGE models used by these economists, the labour market is always cleared – responding to a changing interest rate, expected lifetime 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.

Yours truly has to admit of being totally unimpressed by this kind of New Classical macroeconomic quackery. I guess Keynes would have felt the same:

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 … 0616_ig-john-maynard-keynes_1024x576Our 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)

Text och musik

26 October, 2017 at 10:49 | Posted in Economics | 1 Comment

radioI en tid när ljudrummet dränks i den kommersiella radions tyckmyckentrutade ordbajseri och fullständigt intetsägande pubertalflamsande tjafs har många av oss mer eller mindre gett upp. Radion, som en gång i tiden var en källa till både vederkvickelse och reflexion har degenererat till en postmodern ytlighetsavgud.

Men det finns ljus i mörkret!

I programmet Text och musik med Eric Schüldt — som sänds på söndagsförmiddagarna i P2 mellan klockan 11 och 12 — kan man lyssna på seriös musik och en programledare som har något att säga och inte bara låter foderluckan glappa.

En lisa för själen.

I förra söndagens program spelades bland annat denna vackra georgiska sång:

A memorable evening with Joan Robinson

25 October, 2017 at 22:32 | Posted in Economics | 1 Comment

After dinner – by now I had had a couple of glasses – I decided I had to make something of this once-in-a-lifetime opportunity to engage with one of my heroes.  Joan … was in the armchair again, and I sat down on the floor facing her at her feet.  I began by asking her what it was like being a student at Cambridge back in the Twenties.  After recalling the lectures of the literary critic I. A. Richards, she moved on to Wittgenstein and Sraffa and their weekly one-on-one discussions over tea … Soon the whole room of economists was debating the meaning of Tractatus Logico-Philosophicus. And, bizarrely, something was about to happen that would change the course of my life.

Joan-Robinson-What-Are-The-Questions-And-Other-EssaysAs the debate continued it occurred to me that perhaps no one in the room had really read the Tractatus.  Joan Robinson stayed out of the debate and, although I was still sitting at her feet, I now had my back to her. Then suddenly from behind me her loud raspy voice broke into the conversation. Here are her exact words.

“The world is all that is the case.  The world is the totality of facts, not of things.  The world is determined by the facts, and by their being all the facts.  For the totality of facts determines what is the case, and also whatever is not the case.  Those are the first four propositions of the Tractatus.  I’ve never been able to understand them.”

It was a magic moment for me – the relaxed integrity of her intellect was so plain to see.  And such a contrast to the outcome of my conversation sixteen years before.  I wasn’t yet in a position where I could change my life’s course, but in time I was, and if it hadn’t been for that evening with Joan Robinson and the Tractatus I would never have become an economist.

Edward Fullbrook

Economists are missing the big picture

25 October, 2017 at 14:57 | Posted in Economics | 2 Comments

 

Trump — a reckless, untruthful, outrageous, incompetent & undignified buffoon

25 October, 2017 at 09:28 | Posted in Politics & Society | 2 Comments

 

INET conferencing​ beyond disappointment

24 October, 2017 at 19:33 | Posted in Economics | 7 Comments

I’m sitting in a coffee shop opposite Haymarket Station in Edinburgh. Just up the road, the Institute for New Economic Thinking (INET) is holding its conference. I’m supposed to be there, as I was yesterday and the day before. But I am not at all sure I want to go. The last two days have left a very bitter taste.

Boring PresentationThis conference, grandly entitled “Reawakening”, is supposed to be a showcase for the “new economic thinking” of INET’s name. I hoped to hear new voices and exciting ideas …

Not a bit of it. In the last two days we have had panel after panel of old white men discussing economic theories developed by old white men, many of them dead. Economic beliefs that I thought had been comprehensively debunked have reappeared, dressed up as “new thinking” …

I returned for a panel on debt traps, public and private – and I despaired again … Oh dear. It went from bad to worse.

Pontus Rendahl … claimed that “banks don’t create money” and explained that Barclays creates its own currency “pegged at par to the central bank currency”, which apparently only works if the central bank “is complicit”. The Bank of England debunked this nonsense back in 2014. Why is it still being presented now? …

This is not “new thinking”, it is the same old elite economists’ voodoo in different clothes.

Frances Coppola

It is indeed difficult not to agree. A lot of the stuff presented at INET conferences are just regurgitations of the same old mainstream dogma. And to even for a second think that a visionless neoclassical economist like Rendahl should have anything to do with new thinking in economics is of course totally gobsmacking!

The one philosophy​ of science book every economist​ should read

23 October, 2017 at 18:19 | Posted in Theory of Science & Methodology | 5 Comments

bhaskIt is not the fact that science occurs that gives the world a structure such that it can be known by men. Rather, it is the fact that the world has such a structure that makes science, whether or not it actually occurs, possible. That is to say, it is not the character of science that imposes a determinate pattern or order on the world; but the order of the world that, under certain determinate conditions, makes possible the cluster of activities we call ‘science’. It does not follow from the fact that the nature of the world can only be known from (a study of) science, that its nature is determined by (the structure of) science. Propositions in ontology, i.e. about being, can only be established by reference to science. But this does not mean that they are disguised, veiled or otherwise elliptical propositions about science … The ‘epistemic fallacy’ consists in assuming that, or arguing as if, they are.

Why the ‘analytical’ method does not work in economics

22 October, 2017 at 19:38 | Posted in Theory of Science & Methodology | 2 Comments

To be ‘analytical’ is something most people find recommendable. The word ‘analytical’ has a positive connotation. Scientists think deeper than most other people because they use ‘analytical’ methods. In dictionaries, ‘analysis’ is usually defined as having to do with “breaking something down.”

anBut that’s not the whole picture. As used in science, analysis usually means something more specific. It means to separate a problem into its constituent elements so to reduce complex — and often complicated — wholes into smaller (simpler) and more manageable parts. You take the whole and break it down (decompose) into its separate parts. Looking at the parts separately one at a time you are supposed to gain a better understanding of how these parts operate and work. Built on that more or less ‘atomistic’ knowledge you are then supposed to be able to predict and explain the behaviour of the complex and complicated whole.

In economics, that means you take the economic system and divide it into its separate parts, analyse these parts one at a time, and then after analysing the parts separately, you put the pieces together.

The ‘analytical’ approach is typically used in economic modelling, where you start with a simple model with few isolated and idealized variables. By ‘successive approximations,’ you then add more and more variables and finally get a ‘true’ model of the whole.

This may sound as a convincing and good scientific approach.

But there is a snag!

The procedure only really works when you have a machine-like whole/system/economy where the parts appear in fixed and stable configurations. And if there is anything we know about reality, it is that it is not a machine! The world we live in is not a ‘closed’ system. On the contrary. It is an essentially ‘open’ system. Things are uncertain, relational, interdependent, complex, and ever-changing.

Without assuming that the underlying structure of the economy that you try to analyze remains stable/invariant/constant, there is no chance the equations of the model remain constant. That’s the very rationale why economists use (often only implicitly) the assumption of ceteris paribus. But — nota bene — this can only be a hypothesis. You have to argue the case. If you cannot supply any sustainable justifications or warrants for the adequacy of making that assumption, then the whole analytical economic project becomes pointless non-informative nonsense. Not only have we to assume that we can shield off variables from each other analytically (external closure). We also have to assume that each and every variable themselves are amenable to be understood as stable and regularity producing machines (internal closure). Which, of course, we know is as a rule not possible. Some things, relations, and structures are not analytically graspable. Trying to analyse parenthood, marriage, employment, etc, piece by piece doesn’t make sense. To be a chieftain, a capital-owner, or a slave is not an individual property of an individual. It 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. A cheque presupposes a banking system and being a tribe-member presupposes a tribe.  Not taking account of this in their ‘analytical’ approach, economic ‘analysis’ becomes uninformative nonsense.

Using the ‘analytical’ method in social sciences means that economists succumb to the fallacy of composition — the belief that the whole is nothing but the sum of its parts.  In the society and in the economy this is arguably not the case. An adequate analysis of society and economy a fortiori cannot proceed by just adding up the acts and decisions of individuals. The whole is more than a sum of parts.

Mainstream economics is built on using the ‘analytical’ method. The models built with this method presuppose that the social reality is ‘closed.’ Since social reality is known to be fundamentally ‘open,’ it is difficult to see how models of that kind can explain anything about what happens in such a universe. Postulating closed conditions to make models operational and then impute these closed conditions to society’s real structure is an unwarranted procedure that does not take necessary ontological considerations seriously.

In face of the kind of methodological individualism and rational choice theory that dominate mainstream economics 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. Here, the ‘analytical’ method fails again.

The overarching flaw with the ‘analytical’ economic approach using 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 a Wittgensteinian ‘Tractatus-world’ characterized by atomistic states of affairs. 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.

Since at least the marginal revolution in economics in the 1870s it has been an essential feature of economics to ‘analytically’ treat individuals as essentially independent and separate entities of action and decision. But, really, in such a complex, organic and evolutionary system as an economy, that kind of independence is a deeply unrealistic assumption to make. To simply assume that there is a strict independence between the variables we try to analyze doesn’t help us the least if that hypothesis turns out to be unwarranted.

To be able to apply the ‘analytical’ approach, economists have to basically assume that the universe consists of ‘atoms’ that exercise their own separate and invariable effects in such a way that the whole consist of nothing but an addition of these separate atoms and their changes. These simplistic assumptions of isolation, atomicity, and additivity are, however, at odds with reality. In real-world settings, we know that the ever-changing contexts make it futile to search for knowledge by making such reductionist assumptions. Real-world individuals are not reducible to contentless atoms and so not susceptible to atomistic analysis. The world is not reducible to a set of atomistic ‘individuals’ and ‘states.’ How variable X works and influence real-world economies in situation A cannot simply be assumed to be understood or explained by looking at how X works in situation B. Knowledge of X probably does not tell us much if we do not take into consideration how it depends on Y and Z. It can never be legitimate just to assume that the world is ‘atomistic.’ Assuming real-world additivity cannot be the right thing to do if the things we have around us rather than being ‘atoms’ are ‘organic’ entities.

If we want to develop a new and better economics we have to give up on the single-minded insistence on using a deductivist straitjacket methodology and the ‘analytical’ method. To focus scientific endeavours on proving things in models is a gross misapprehension of the purpose of economic theory. Deductivist models and ‘analytical’ methods disconnected from reality are not relevant to predict, explain or understand real-world economies.

‘Laws of economics’ — a fictional cage

22 October, 2017 at 10:15 | Posted in Economics | Comments Off on ‘Laws of economics’ — a fictional cage

Increasingly, our debates about — and our solutions to — pressing issues such as immigration, budgets and debt are framed in the context of all-powerful economic laws that dictate what is and is not possible. There’s just one slight problem: There are no laws of economics.

cage

Referencing “the laws of economics” as a way to refute arguments or criticize ideas has the patina of clarity and certainty. The reality is that referencing such laws is simply another way to justify beliefs and inclinations …

Liberating ourselves from the fictional cage of these laws will not suddenly reveal hidden answers. But it will allow for more pragmatic examination of what is working and what is failing and why. Economic theories are guides, ones that have substantial utility. But once elevated to the realm of laws, they fall short and do us no good.

Zachary Karabell

Mainstream economics is usually considered to be very ‘rigorous’ and ‘precise.’ And yes, indeed, it’s certainly full of ‘rigorous’ and ‘precise’ statements like “the state of the economy will remain the same as long as it doesn’t change.” Although true, that is, however — as most other analytical statements — neither particularly interesting nor informative.

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

Deducing laws in theoretical models is of no avail. 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 models and lose sight of reality.

Do unrealistic economic models explain real-world phenomena?

21 October, 2017 at 11:48 | Posted in Economics | 2 Comments

When applying deductivist thinking to economics, neoclassical economists usually set up ‘as if’ models based on a set of tight axiomatic assumptions from which consistent and precise inferences are made. The beauty of this procedure is, of course, that if the axiomatic premises are true, the conclusions necessarily follow. idealization-in-cognitive-and-generative-linguistics-6-728The snag is that if the models are to be relevant, we also have to argue that their precision and rigour still holds when they are applied to real-world situations. They often don’t. When addressing real economies, the idealizations and abstractions necessary for the deductivist machinery to work simply don’t hold.

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

As Hans Albert has it:

Clearly, it is possible to interpret the ‘presuppositions’ of a theoretical system … not as hypotheses, but simply as limitations to the area of application of the system in question. Since a relationship to reality is usually ensured by the language used in economic statements, in this case the impression is generated that a content-laden statement about reality is being made, although the system is fully immunized and thus without content. In my view that is often a source of self-deception in pure economic thought …

200px-Hans_Albert_2005-2A further possibility for immunizing theories consists in simply leaving open the area of application of the constructed model so that it is impossible to refute it with counter examples. This of course is usually done without a complete knowledge of the fatal consequences of such methodological strategies for the usefulness of the theoretical conception in question, but with the view that this is a characteristic of especially highly developed economic procedures: the thinking in models, which, however, among those theoreticians who cultivate neoclassical thought, in essence amounts to a new form of Platonism.

Seen from a deductive-nomological perspective, typical economic models (M) usually consist of a theory (T) – a set of more or less general (typically universal) law-like hypotheses (H) – and a set of (typically spatio-temporal) auxiliary assumptions (A). The auxiliary assumptions give ‘boundary’ descriptions such that it is possible to deduce logically (meeting the standard of validity) a conclusion (explanandum) from the premises T & A. Using this kind of model economists are (portrayed as) trying to explain (predict) facts by subsuming them under T, given A.

An obvious problem with the formal-logical requirements of what counts as H is the often severely restricted reach of the ‘law.’ In the worst case, it may not be applicable to any real, empirical, relevant situation at all. And if A is not true, then M doesn’t really explain (although it may predict) at all. Deductive arguments should be sound – valid and with true premises – so that we are assured of having true conclusions. Constructing, e.g., models assuming ‘rational’ expectations, says nothing of situations where expectations are ‘non-rational.’

Economic theories and models have to be compared to the situations they are supposed to represent/explain/predict. There is no way of getting around questions of realism and real-world relevance. Building theories and models that are ‘true’ in their own very limited ‘idealized’ domain is of limited value if we can’t supply bridges to the real world. Economic ‘laws’ that only apply in specific ‘idealized’ circumstances —  in ‘nomological machines’ — are not the stuff that real science is built of. Results derived in mainstream economic models

Results deduced in a ‘closed world’ mainstream economic model is obtained only because the model (machine) was built for that purpose. Outside the machine — in the real world — we know that most of the assumptions, including the typical ceteris paribus condition, do not apply.

Most mainstream economic models are abstract, unrealistic and presenting mostly non-testable hypotheses. How then are they supposed to tell us anything about the world we live in?

When confronted with the massive empirical refutations of almost every theory and model they have set up, mainstream economists usually react by saying that these refutations only hit A (the Lakatosian ‘protective belt’), and that by ‘successive approximations’ it is possible to make the theories and models less abstract and more realistic, and – eventually — more readily testable and predictably accurate. Even if T & A1 doesn’t have much of empirical content, if by successive approximation we reach, say, T & A25, we are to believe that we can finally reach robust and true predictions and explanations.

There are grave problems with this modelling view. What Hans Albert most forcefully is arguing with his ‘Model Platonism’ critique of mainstream economics, is that there is a strong tendency for modellers to use the method of successive approximations as a kind of ‘immunization,’ taking for granted that there can never be any faults with the theory. Explanatory and predictive failures hinge solely on the auxiliary assumptions. That the kind of theories and models used by mainstream economics should all be held non-defeasibly corroborated, seems, however — to say the least — rather unwarranted.

Confronted with the massive empirical failures of their models and theories, mainstream economists often retreat into looking upon their models and theories as some kind of ‘conceptual exploration,’ and give up any hopes/pretences whatsoever of relating their theories and models to the real world. Instead of trying to bridge the gap between models and the world, one decides to look the other way.

To me, this kind of scientific defeatism is equivalent to surrendering our search for understanding the world we live in. It can’t be enough to prove or deduce things in a model world. If theories and models do not directly or indirectly tell us anything of the world we live in – then why should we waste any of our precious time on them?

Galbraith vs Buckley on Good Society

21 October, 2017 at 11:15 | Posted in Economics, Politics & Society | 1 Comment

 

En outsiders väg

20 October, 2017 at 21:22 | Posted in Varia | 1 Comment

 

Come On Eileen

20 October, 2017 at 20:42 | Posted in Varia | 1 Comment

 

Why economists can’t predict the future

20 October, 2017 at 17:50 | Posted in Economics | 2 Comments

 

Economic predictions and forecasts have little value. They usually amount to nothing more than intelligent guessing.

Making forecasts and predictions obviously isn’t a trivial or costless activity, so why then go on with it?

The problems that economists encounter when trying to predict the future really underlines how important it is for social sciences to incorporate Keynes’s far-reaching and incisive analysis of induction and evidential weight in his seminal A Treatise on Probability (1921).

treatprobAccording to Keynes we live in a world permeated by unmeasurable uncertainty – not quantifiable stochastic risk – which often forces us to make decisions based on anything but ‘rational expectations.’ Keynes rather thinks that we base our expectations on the confidence or ‘weight’ we put on different events and alternatives. To Keynes, ​expectations are a question of weighing probabilities by ‘degrees of belief,’ beliefs that often have preciously little to do with the kind of stochastic probabilistic calculations made by the rational agents as modelled by ‘modern’ social sciences. And often we “simply do not know.”

How strange that social scientists and mainstream economists, as a rule, do not even touch upon these aspects of scientific methodology that seems to be so fundamental and important for anyone trying to understand how we learn and orient ourselves in an uncertain world. An educated guess on why this is a fact would be that Keynes concepts are not possible to squeeze into a single calculable numerical ‘probability.’ In the quest for measurable quantities, one puts a blind eye to qualities and looks the other way.

So why do companies, governments, and central banks, continue with this more or less expensive, but obviously worthless, activity?

A part of the answer concerns ideology and apologetics. Forecasting is a non-negligible part of the labour market for (mainstream) economists, and so, of course, those in the business do not want to admit that they are occupied with worthless things (not to mention how hard it would be to sell the product with that kind of frank truthfulness). Governments, the finance sector and (central) banks also want to give the impression to customers and voters that they, so to say, have the situation under control (telling people that next years x will be 3.048 % makes wonders in that respect). Why else would anyone want to pay them or vote for them? These are sure not glamorous aspects of economics as a science, but as a scientist, it would be unforgivably dishonest to pretend that economics doesn’t also perform an ideological function in society.

Twenty years ago

19 October, 2017 at 10:07 | Posted in Economics | 4 Comments

5112X+PoJkLModern economics has become increasingly irrelevant to the understanding of the real world. In his seminal book Economics and Reality (1997) Tony Lawson traced this irrelevance to the failure of economists to match their deductive-axiomatic methods with their subject.

It is — sad to say — as relevant today as it was twenty years ago.

It is still a fact that within mainstream economics internal validity is what really counts and external validity is only rarely discussed. Why anyone should be interested in that kind of theories and models is beyond imagination. As long as mainstream economists do not come up with any export-licenses for their theories and models to the real world in which we live, they really should not be surprised if people say that this is not science, but autism!

Using mathematics and logic is interesting and fun. It sharpens the mind. In pure mathematics and logic, we do not have to worry about external validity. But economics is not pure mathematics or logic. It’s about society. The real world. Forgetting that, economics becomes irrelevant pseudo-science.

Economics, it might be argued, has gotten this backwards. We have imposed our pre-conceived methods on economic reality in such manner as to distort our understanding of it. We start from optimal choice and fashion an image of reality to fit it. We transmit this distorted picture of what the world is like to our students by insisting that they learn to perceive the subject matter trough the lenses of our method.

tonyThe central message of Lawson’s critique of modern economics is that an economy is an “open system” but economists insist on dealing with it as if it were “closed.” Controlled experiments in the natural sciences create closure and in so doing make possible the unambiguous association of “cause” and “effects”. Macroeconomists, in particular, never have the privilege of dealing with systems that are closed in this controlled experiment sense.

Our mathematical representations of both individual and system behaviour require the assumption of closure for the models to have determinate solutions. Lawson, consequently, is critical of mathematical economics and, more generally, of the role of deductivism in our field. Even those of us untutored in ontology may reflect that it is not necessarily a reasonable ambition to try to deduce the properties of very large complex systems from a small set of axioms. Our axioms are, after all, a good deal shakier than Euclid’s.

Axel Leijonhufvud

Economics and Reality was a great inspiration to me twenty years ago. It still is.

Price stickiness

19 October, 2017 at 08:53 | Posted in Economics | Comments Off on Price stickiness

‘New Keynesian’ macroeconomists have for years been arguing (e.g. here) about the importance of the New Classical Counter-Revolution in economics. ‘Helping’ to change the way macroeconomics is done today — with rational expectations, Euler equations, intertemporal optimization and microfoundations — their main critique of New Classical macroeconomics is that it didn’t incorporate price stickiness into the Real Business Cycles models developed by the New Classicals. So — the ‘New Keynesians’ adopted the methodology suggested by the New Classicals and just added price stickiness!

6a00d8341c652b53ef01630539828a970d-800wiBut does putting a sticky-price DSGE lipstick on the RBC pig really help?

It sure doesn’t!

I have elaborated on why not in On the use and misuse of theories and models in mainstream economics, and David Glasner gives some further reasons why a pig with lipstick is still a pig:

In the General Theory, Keynes argued that if you believed in the standard story told by microeconomics about how prices constantly adjust to equate demand and supply and maintain equilibrium, then maybe you should be consistent and follow the Mises/Robbins story and just wait for the price mechanism to perform its magic, rather than support counter-cyclical monetary and fiscal policies. So Keynes then argued that there is actually something wrong with the standard microeconomic story; price adjustments can’t ensure that overall economic equilibrium is restored, because the level of employment depends on aggregate demand, and if aggregate demand is insufficient, wage cutting won’t increase – and, more likely, would reduce — aggregate demand, so that no amount of wage-cutting would succeed in reducing unemployment …

The real problem is not that prices are sticky but that trading takes place at disequilibrium prices and there is no mechanism by which to discover what the equilibrium prices are. Modern macroeconomics solves this problem, in its characteristic fashion, by assuming it away by insisting that expectations are “rational.”

Economists have allowed themselves to make this absurd assumption because they are in the habit of thinking that the simple rule of raising price when there is an excess demand and reducing the price when there is an excess supply inevitably causes convergence to equilibrium. This habitual way of thinking has been inculcated in economists by the intense, and largely beneficial, training they have been subjected to in Marshallian partial-equilibrium analysis, which is built on the assumption that every market can be analyzed in isolation from every other market. But that analytic approach can only be justified under a very restrictive set of assumptions. In particular it is assumed that any single market under consideration is small relative to the whole economy, so that its repercussions on other markets can be ignored, and that every other market is in equilibrium, so that there are no changes from other markets that are impinging on the equilibrium in the market under consideration …

I regard the term “sticky prices” and other similar terms as very unhelpful and misleading; they are a kind of mental crutch that economists are too ready to rely on as a substitute for thinking about what are the actual causes of economic breakdowns, crises, recessions, and depressions. Most of all, they represent an uncritical transfer of partial-equilibrium microeconomic thinking to a problem that requires a system-wide macroeconomic approach. That approach should not ignore microeconomic reasoning, but it has to transcend both partial-equilibrium supply-demand analysis and the mathematics of intertemporal optimisation.

David Glasner

The stuff of genius

18 October, 2017 at 20:47 | Posted in Education & School | 3 Comments

Several years later I developed a broader theory of what separates the two general classes of learners—helpless versus mastery-oriented. I realized that these different types of students not only explain their failures differently, but they also hold different “theories” of intelligence. The helpless ones believe that intelligence is a fixed trait: you have only a certain amount, and that’s that. I call this a “fixed mind-set.” Mistakes crack their self-confidence because they attribute errors to a lack of ability, which they feel powerless to change. They avoid challenges because challenges make mistakes more likely and looking smart less so … Such children shun effort in the belief that having to work hard means they are dumb.

Your-Inner-GeniusThe mastery-oriented children, on the other hand, think intelligence is malleable and can be developed through education and hard work. They want to learn above all else. After all, if you believe that you can expand your intellectual skills, you want to do just that …

We validated these expectations in a study published in early 2007 … As we had predicted, the students with a growth mind-set felt that learning was a more important goal in school than getting good grades. In addition, they held hard work in high regard, believing that the more you labored at something, the better you would become at it. They understood that even geniuses have to work hard for their great accomplishments. Confronted by a setback such as a disappointing test grade, students with a growth mind-set said they would study harder or try a different strategy for mastering the material.

The students who held a fixed mind-set, however, were concerned about looking smart with less regard for learning. They had negative views of effort, believing that having to work hard at something was a sign of low ability …

EinstinePeople may well differ in intelligence, talent and ability. And yet research is converging on the conclusion that great accomplishment, and even what we call genius, is typically the result of years of passion and dedication and not something that flows naturally from a gift. Mozart, Edison, Curie, Darwin and Cézanne were not simply born with talent; they cultivated it through tremendous and sustained effort. Similarly, hard work and discipline contribute more to school achievement than IQ does.

Carol S. Dweck

Being diagnosed a ‘gifted child’ sure is a confidence boost. But it’s not always the blessing people so often assume. It can also blind you to the fact that even if you’re smart, there are other people who are also smart. People you can learn from and that makes brain neurons grow new connections. For some of us that insight — unfortunately — comes late in life.

John von Neumann

18 October, 2017 at 19:03 | Posted in Varia | Comments Off on John von Neumann

 

Joan Robinson and the inadequacies of revealed preference theory

17 October, 2017 at 19:13 | Posted in Economics | 6 Comments

We are told nowadays that since utility cannot be measured it is not an operational concept, and that ‘revealed preference’ should be put in its place. Observable market behaviour will show what an individual chooses …

joanIt is just not true that market behaviour can reveal preferences. It is not only that the experiment of offering an individual alternative bundles of goods, or changing his income just to see what he will buy, could never be carried out in practice. The objection is logical, not only practical …

We can observe the reaction of an individual to two different sets of prices only at two different times. How can we tell what part of the difference in his purchases is due to the difference in prices and what part to the change in his preferences that has taken place meanwhile? There is certainly no presumption that his character has not changed, for soap and whisky are not the only goods whose use affects tastes. Practically everything develops either an inertia of habit or a desire for change.

We have got one equation for two unknowns. Unless we can get some independent evidence about preferences the experiment is no good. But it was the experiment that we were supposed to rely on to observe the preferences.

As so often, Robinson hits the nail on the head.

The very raison d’être for developing revealed preference theory in the 1930’s and 1940’s was to be able to ascertain people’s preferences by observation of their actual behaviour on markets and not having to make unobservable psychological assumptions or rely on any utility concepts. This turned out to be impossible. Samuelson et consortes had to assume unchanging preferences, which, of course, was in blatant contradiction to the attempt of building a consumer and demand theory without non-observational concepts. Preferences are only revealed from market behaviour when specific theoretical constraining assumptions are made. Without making those assumptions there are no valid inferences​ to make from observing people’s choices on a market.

But still, ​a lot of mainstream economists consider the approach offered by revealed preference theory a great progress. As people like Robinson, Georgescu-Roegen, and Kornai have shown, this is, however, nothing but an illusion. Revealed preference theory does not live up to what it claims to offer. As part of the economist’s​ tool-kit, ​it is of extremely limited use.

If we want to be able to explain the behaviour and choices people make, we have to know​ something about people’s beliefs, preferences, uncertainties​, and understandings. Revealed preference​ theory does not provide us with any support whatsoever in accomplishing that.

Paul Romer on Richard Thaler

17 October, 2017 at 15:53 | Posted in Economics | Comments Off on Paul Romer on Richard Thaler

cheryl-chow-quote-im-not-a-showhorse-im-a-workhorseI understand the purely aesthetic appeal of a convincing scientific explanation … The problem is that people can derive aesthetic pleasure from many different types of “explanation.” After all, the problem with the traditional choice model based on conscious utility maximization is not that it is ugly. And, on grounds of mathematical beauty, no economic model can touch a theory of perfect competition grounded in convex duality. The real problem is that these models are show horses, not work horses.

As far as I can tell, the only way to decide when and how to add some messy detail to a scientific explanation is also the way to distinguish the work of scientists from our work of scientologists and their ilk. Scientists are the ones who remain committed to useful knowledge as the only final output that matters …

To be sure, we have to leave room for early work on knowledge that looks to be potentially useful. But ultimately, scientific knowledge has to do real work. This why Dick’s contributions are so important.

Paul Romer

Microeconomic aggregation problems

16 October, 2017 at 14:59 | Posted in Economics | 3 Comments

If a demand function for the economy as a whole is to be estimated, just drawing upon the economy’s overall income and the price system, is it legitimate to use the demand system derived for an individual? In other words, can we estimate demand functions independently of the distribution of income and preferences across consumers?

fineNot surprisingly, the answer is no in general, and the conditions for it to be yes are extremely stringent, indeed unrealistically so. Essentially, the economy as a whole needs to consume as it were a single individual with a given income. But if we take income from one consumer and give it to another, the pattern of demand will be different unless those two consumers have the same preferences. So we have to assume that each and every consumer has the same preferences. However, even this assumption is not enough​. Suppose it is true, and take income from a rich person and give it to a poor person. Their patterns of consumption around their initial levels of income are liable to be very different, luxuries as opposed to necessities. So, redistributing the income from rich to poor will not leave demand unchanged but shift it from luxuries to necessities. To have an aggregate demand function as if the economy were a single individual it is necessary both that every individual has the same preferences and that those preferences remain in the same proportions at every level of income (or, to put it another way, once you know one indifference curve for our representative individual, you know them all, not only for that consumer, but for all others as well — all consumers must have the same, so-called homothetic indifference curves). To be sure that the aggregation problem to be negotiated, it is necessary that the economy’s demand be reduced to a single indifference curve … Significantly, the insurmountable nature of the aggregation problem is well established within the orthodoxy, as a result of what is known as the​ Sonnenschein-Mantel-Debreu theorem …

Obviously, this is entirely unacceptable …

Indeed, this is, from a scientific point of view, “entirely unacceptable.”

But so what? Why should we care about mainstream economists making assumptions that are totally unwarranted and unjustifiable? Why should we care that people make outrageous assumptions based solely on mathematical tractability and convenience? Why should we care about Sonnenschein-Mantel-Debreu?

Because those assumptions in general — and the assumptions behind Sonnenschein-Mantel-Debreu in particular — ultimately explains why New Classical, Real Business Cycles, Dynamic Stochastic General Equilibrium (DSGE) and ‘New Keynesian’ microfounded macromodels are such bad substitutes for real macroeconomic analysis!

These models try to describe and analyze complex and heterogeneous real economies with a single rational-expectations-robot-imitation-representative-agent. That is, with something that has absolutely nothing to do with reality. And — worse still — something that is not even amenable to the kind of general equilibrium analysis that they are thought to give a foundation for, since Hugo Sonnenschein (1972) , Rolf Mantel (1976) and Gerard Debreu (1974) unequivocally showed that there did not exist any sustainable condition by which assumptions on individuals would guarantee either stability or uniqueness of the equlibrium solution.

Opting for cloned representative agents that are all identical is of course not a real solution to the aggregation problem that the Sonnenschein-Mantel-Debreu theorem points to. Representative agent models are — as I have argued at length here — rather an evasion whereby issues of distribution, coordination, heterogeneity — everything that really defines macroeconomics — are swept under the rug.

Of course, most macroeconomists know that to use a representative agent is a flagrantly illegitimate method of ignoring real aggregation issues. They keep on with their business, nevertheless, just because it significantly simplifies what they are doing. It reminds — not so little — of the drunkard who has lost his keys in some dark place and deliberately chooses to look for them under a neighbouring street light just because it is easier to see there …

Mainstream microeconomics is full of blatant inadequacies. Trying to ‘save’ it by assuming fantasy things like representative agents and homothetic indifference curves, is a sure sign of a deductive-axiomatic research programme gone terribly wrong.

How to get published in top economics journals

16 October, 2017 at 14:05 | Posted in Economics | 2 Comments

Halmos2If you think that your paper is vacuous,

Use the first-order functional calculus.

It then becomes logic,

And, as if by magic,

The obvious is hailed as miraculous.

Paul Halmos

 

Putting theories to the test

13 October, 2017 at 16:10 | Posted in Economics | 5 Comments

Mainstream neoclassical economists often maintain — usually referring to the methodological individualism of Milton Friedman — that it doesn’t matter if the assumptions of the theories and models they use are realistic or not. What matters is if the predictions are right or not. But, if so, then the only conclusion we can make is — throw away the garbage! Because, oh dear, oh dear, how wrong they have been!

The empirical and theoretical evidence is clear. Predictions and forecasts are inherently difficult to make in a socio-economic domain where genuine uncertainty and unknown unknowns often rule the roost. The real processes that underly the time series that economists use to make their predictions and forecasts do not conform with the assumptions made in the applied statistical and econometric models. Much less is a fortiori predictable than standardly — and uncritically — assumed. The forecasting models fail to a large extent because the kind of uncertainty that faces humans and societies actually makes the models strictly seen inapplicable. The future is inherently unknowable — and using statistics, econometrics, decision theory or game theory, does not in the least overcome this ontological fact. The economic future is not something that we normally can predict in advance. Better then to accept that as a rule “we simply do not know.”

papIt is of paramount importance that economists be frank with themselves and their audience. The limitations of current practice … must be recognized openly. If we are engaged in ex post facto explanation, we should be quite ready to say so, rather than pretend that our ‘theories’ can pass the same tests that theories of well-developed sciences can pass … Recognition of the character of current methodological practice will go a long way toward substituting fact for myth and thus open the way to new horizons of research.

Axioms — things to be suspicious of

13 October, 2017 at 09:51 | Posted in Economics | 1 Comment

miracle_cartoon To me, the crucial difference between modelling in physics and in economics lies in how the fields treat the relative role of concepts, equations and empirical data …

An economist once told me, to my bewilderment: “These concepts are so strong that they supersede any empirical observation” …

Physicists, on the other hand, have learned to be suspicious of axioms. If empirical observation is incompatible with a model, the model must be trashed or amended, even if it is conceptually beautiful or mathematically convenient.

Jean-Philippe Bouchaud

Thaler and behavioural economics — some critical perspectives

12 October, 2017 at 12:06 | Posted in Economics | 2 Comments

Although discounting empirical evidence cannot be the right way to solve economic issues, there are still, in my opinion, a couple of weighty reasons why we perhaps shouldn’t be too excited about the so-called ’empirical revolution’ in economics.

behBehavioural experiments and laboratory research face the same basic problem as theoretical models — they are built on often rather artificial conditions and have difficulties with the ‘trade-off’ between internal and external validity. The more artificial conditions, the more internal validity, but also less external validity. The more we rig experiments to avoid the ‘confounding factors’, the less the conditions are reminiscent of the real ‘target system.’ The nodal issue is how economists using different isolation strategies in different ‘nomological machines’ attempt to learn about causal relationships. One may have justified doubts on the generalizability of this research strategy since the probability is high that causal mechanisms are different in different contexts and that lack of homogeneity and invariance doesn’t give us warranted export licenses to the ‘real’ societies or economies.

If we see experiments or laboratory research as theory tests or models that ultimately aspire to say something about the real ‘target system,’ then the problem of external validity is central (and was for a long time also a key reason why behavioural economists had trouble getting their research results published).

A standard procedure in behavioural economics — think of e.g. dictator or ultimatum games — is to set up a situation where one induce people to act according to the standard microeconomic — homo oeconomicus — benchmark model. In most cases, the results show that people do not behave as one would have predicted from the benchmark model, in spite of the setup almost invariably being ‘loaded’ for that purpose. [And in those cases where the result is consistent with the benchmark model, one, of course, have to remember that this in no way proves the benchmark model to be right or ‘true,’ since there, as a rule, may be many outcomes that are consistent with that model.]

For most heterodox economists this is just one more reason for giving up on the standard model. But not so for mainstreamers and many behaviouralists. To them, the empirical results are not reasons for giving up on their preferred hardcore axioms. So they set out to ‘save’ or ‘repair’ their model and try to ‘integrate’ the empirical results into mainstream economics. Instead of accepting that the homo oeconomicus model has zero explanatory real-world value, one puts lipstick on the pig and hope to go on with business as usual. Why we should keep on using that model as a benchmark when everyone knows it is false is something we are never told. Instead of using behavioural economics and its results as building blocks for a progressive alternative research program, the ‘save and repair’ strategy immunizes a hopelessly false and irrelevant model.

By this, I do not mean to say that empirical methods per se are so problematic that they can never be used. On the contrary, I am basically — though not without reservations — in favour of the increased use of behavioural experiments and laboratory research within economics. Not least as an alternative to completely barren ‘bridge-less’ axiomatic-deductive theory models. My criticism is more about aspiration levels and what we believe that we can achieve with our mediational epistemological tools and methods in the social sciences.

The increasing use of natural and quasi-natural experiments in economics during the last couple of decades has led several prominent economists to triumphantly declare it as a major step on a recent path toward empirics, where instead of being a deductive philosophy, economics is now increasingly becoming an inductive science.

Limiting model assumptions in economic science always have to be closely examined since if we are going to be able to show that the mechanisms or causes that we isolate and handle in our models are stable in the sense that they do not change when we ‘export’ them to our ‘target systems,’ we have to be able to show that they do not only hold under ceteris paribus conditions and a fortiori only are of limited value to our understanding, explanations or predictions of real economic systems.

‘Ideally controlled experiments’ tell us with certainty what causes what effects — but only given the right ‘closures.’ Making appropriate extrapolations from (ideal, accidental, natural or quasi) experiments to different settings, populations or target systems, is not easy. ‘It works there’ is no evidence for ‘it will work here.’ Causes deduced in an experimental setting still have to show that they come with an export-warrant to the target system. The causal background assumptions made have to be justified, and without licenses to export, the value of ‘rigorous’ and ‘precise’ methods is despairingly small.

Taking assumptions like utility maximization or market equilibrium as a matter of course leads to the ‘standing presumption in economics that, if an empirical statement is deduced from standard assumptions then that statement is reliable’ …

maxresdefaultThe ongoing importance of these assumptions is especially evident in those areas of economic research, where empirical results are challenging standard views on economic behaviour like experimental economics or behavioural finance … From the perspective of Model-Platonism, these research-areas are still framed by the ‘superior insights’ associated with early 20th century concepts, essentially because almost all of their results are framed in terms of rational individuals, who engage in optimizing behaviour and, thereby, attain equilibrium. For instance, the attitude to explain cooperation or fair behaviour in experiments by assuming an ‘inequality aversion’ integrated into​ (a fraction of) the subjects’ preferences is strictly in accordance with the assumption of rational individuals, a feature which the authors are keen to report …

While the mere emergence of research areas like experimental economics is sometimes deemed a clear sign for the advent of a new era … a closer look at these fields allows us to illustrate the enduring relevance of the Model-Platonism-topos and, thereby, shows the pervasion of these fields with a traditional neoclassical style of thought.

Jakob Kapeller

So — although it is good that people like Kahneman and Thaler are rewarded ‘Nobel prizes’ and that much of their research has vastly undermined the lure of axiomatic-deductive mainstream economics, there is still a long way to go before economics has become a truly empirical science. The great challenge for the future economics is not to develop methodologies and theories for well-controlled laboratories, but to develop relevant methodologies and theories for the messy world in which we happen to live.

Keynes — the first behavioural economist

11 October, 2017 at 14:34 | Posted in Economics | 2 Comments

To-day, in many parts of the world, it is the serious embarrassment of the banks which is the cause of our gravest concern …

[The banks] stand between the real borrower and the real lender. They have given their guarantee to the real lender; and this guarantee is only good if the money value of the asset belonging to the real borrower is worth the money which has been advanced on it.

It is for this reason that a decline in money values so severe as that which we are now experiencing threatens the solidity of the whole financial structure. Banks and bankers are by nature blind. They have not seen what was coming. Some of them … employ so-called “economists” who tell us even to-day that our troubles are due to the fact that the prices of some commodities and some services have not yet fallen enough, regardless of what should be the obvious fact that their cure, if it could be realised, would be a menace to the solvency of their institution. A “sound” banker, alas! is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him.

But to-day they are beginning at last to take notice. In many countries bankers are becoming unpleasantly aware of the fact that, when their customers’ margins have run off, they are themselves “on margin” …

The present signs suggest that the bankers of the world are bent on suicide. At every stage they have been unwilling to adopt a sufficiently drastic remedy. And by now matters have been allowed to go so far that it has become extraordinarily difficult to find any way out.

It is necessarily part of the business of a banker to maintain appearances and to profess a conventional respectability which is more than human. Lifelong practices of this kind make them the most romantic and the least realistic of men. It is so much their stock-in-trade that their position should not be questioned, that they do not even question it themselves until it is too late. Like the honest citizens they are, they feel a proper indignation at the perils of the wicked world in which they live,—when the perils mature; but they do not foresee them. A Bankers’ Conspiracy! The idea is absurd! I only wish there were one! So, if they are saved, it will be, I expect, in their own despite.

John Maynard Keynes, Essays in Persuasion, 1931

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