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.

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2 Comments

  1. Thanks for this bit of writing, I think it certainly gets to the heart of the problem of modeling and that strictly we should consider our models as having a synthetic rather than an analytic nature. Within each element, or entity as I prefer to think of them, there can be a wealth of features which result in a less mechanical kind of process.

    These models are not simply mechanical as you describe, but must contain an essential process that you seem to have missed and that is one of decision decision-making. The entities have a number of inputs and outputs so there are decisions that need to be made each time an increment arrives and unbalances the relationship between what comes in and what goes out (see Boulding’s poem below).

    Some of the examples given in the above writing apply to individuals and families. This is not really the substance of what is being modeled here, which being macroeconomics takes only the aggregate activities of the many families, etc. With this as a necessary assumption, the basic structure of the system remains unchanged in form or topology, even though the variables within are able to grow or shrink.

    Since these models are closed and contain alternative paths, it is expected logically that as an increment of a variable (one at a time) is distributed around the system, it will return to its place of origin in a weaker form. (Incidentally it is this property that results in a trend to equilibrium, or its inherent stability.) Then the degree of its comparative lost strength is due to the decision-making process.

    We should also take into account that the same decision will not necessarily be made each time the increment of the increment etc., reaches the same place in the system, because the criteria for making this choice also depend on certain other aspects (or variable parameters) that also are changing.

    Thus, when we envisage the system as a whole, we see the mechanical aspects as its basic structure, but also there is also a more “personal” part due to the internal nature of the entities themselves, through which the variables pass. This is subject to changes of the decision-making kind, and in some cases these changes are undefined or at least determined in a more complex way than the more obvious mechanical aspects of passage through the basic structure. I have described this in detail in my book.

    THE SYSTEM by Kenneth Boulding, (1910 – 1993)

    A system is a big black box
    Of which we can’t unlock the locks
    And all we can find out about
    Is what goes in and what comes out.

    Perceiving input-output pairs,
    Related by parameters,
    Permits us, sometimes, to relate
    An input, output, and a state.

    If this relation’s good and stable
    Then to predict we may be able,
    But if this fails us heaven forbid!
    We’ll be compelled to force the lid!

    So lets be ready to break in!

    • “Since these models are closed and contain alternative paths, it is expected logically that as an increment of a variable (one at a time) is distributed around the system, it will return to its place of origin in a weaker form. (Incidentally it is this property that results in a trend to equilibrium, or its inherent stability.) Then the degree of its comparative lost strength is due to the decision-making process.”

      The financial world increases dollars through interest and hedges. You can synthesize a closed market through self-dealing and trader collusion in chatrooms, and increase the strength of dollar units as they flow around the system. Financial decision-making increases the degree of strength of US Dollars.


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