LARS P. SYLL

The limited value of economic theory

Submission to observed or experimental data is the golden rule which dominates any scientific discipline. Any theory whatever, if it is not verified by empirical evidence, has no scientific value and should be rejected.

Maurice Allais

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 a model and lose sight of reality.

In mainstream economics, empirical evidence still only plays a minor role and models largely function as a substitute for empirical evidence.

To have valid evidence is not enough. What economics needs is sound evidence. The premises of a valid argument do not have to be true, but a sound argument, on the other hand, is not only valid but builds on premises that are true. Aiming only for validity, without soundness, is setting the economics aspiration level too low for developing a realist and relevant science.

Why economics is an impossible science

In a word, Economics is an Impossible Science because by its own definition the determining conditions of the economy are not economic: they are “exogenous.” Supposedly a science of things, it is by definition without substance, being rather a mode of behavior: the application of scarce means to alternative ends so as to achieve the greatest possible satisfaction—neither means, ends, nor satisfaction substantially specified. Exogenous, however, is the culture, all those meanings, values, institutions, and structures, from gender roles, race relations, food preferences, and ethnicities, to technical inventions, legal regulations, political parties, etc., etc. The effect is a never-ending series of new theoretical breakthroughs, each an Economics du jour worthy of a Nobel prize, consisting of the discovery that some relevant little bit of the culture has something to do with it. Only to be soon superseded and forgotten since the continuous development and transformation of the culture, hence of the economy, leaves the Science in its wake. An impossible Science, by its own premises.

Marshall Sahlins

The increasing mathematization of economics has made mainstream economists more or less obsessed with formal, deductive-axiomatic models. Confronted with the critique that they do not solve real problems, they often react as Saint-Exupéry’s Great Geographer, who, in response to the questions posed by The Little Prince, says that he is too occupied with his scientific work to be able to say anything about reality. Confronting economic theory’s lack of relevance and ability to tackle real problems, one retreats into the wonderful world of economic models. One goes into the “shack of tools” — as my old mentor Erik Dahmén used to say — and stays there. While the economic problems in the world around us steadily increase, one is rather happily playing along with the latest toys in the mathematical toolbox.

Modern mainstream economics is sure very rigorous — but if it’s rigorously wrong, who cares?

Instead of making formal logical argumentation based on deductive-axiomatic models the message, we are better served by economists who more than anything else try to contribute to solving real problems. The motto of John Maynard Keynes is as valid as ever:

It is better to be vaguely right than precisely wrong

Economics — the new astrology

John Weeks (1941-2020)

 

 
A great economist has passed away.
R.I.P.

Piketty and the need for validating assumptions

Say we have a diehard neoclassical model (assuming the production function is homogeneous of degree one and unlimited substitutability) such as the standard Cobb-Douglas production function (with A a given productivity parameter, and k  the ratio of capital stock to labor, K/L) y = Ak^α , with a constant investment λ out of output y and a constant depreciation rate δ of the “capital per worker” k, where the rate of accumulation of k, Δk = λy– δk, equals Δk = λAk^α– δk. In steady-state (*) we have λAk*^α = δk*, giving λ/δ = k*/y* and k* = (λA/δ)^1/(1-α). Putting this value of k* into the production function, gives us the steady-state output per worker level y* = Ak*^α= A^1/(1-α)(λ/δ))^α/(1-α). Assuming we have an exogenous Harrod-neutral technological progress that increases y with a growth rate g (assuming a zero labor growth rate and with y and k a fortiori now being refined as y/A and k/A respectively, giving the production function as y = k^α) we get dk/dt = λy – (g + δ)k, which in the Cobb-Douglas case gives dk/dt = λk^α– (g + δ)k, with steady-state value k* = (λ/(g + δ))^1/(1-α) and capital-output ratio k*/y* = k*/k*^α = λ/(g + δ). If using Piketty’s preferred model with output and capital given net of depreciation, we have to change the final expression into k*/y* = k*/k*^α = λ/(g + λδ). Now what Piketty does in Capital in the twenty-first century is to predict that g will fall and that this will increase the capital-output ratio. Let’s say we have δ = 0.03, λ = 0.1 and g = 0.03 initially. This gives a capital-output ratio of around 3. If g falls to 0.01 it rises to around 7.7. We reach analogous results if we use a basic CES production function with an elasticity of substitution σ > 1. With σ = 1.5, the capital share rises from 0.2 to 0.36 if the wealth-income ratio goes from 2.5 to 5, which according to Piketty is what actually has happened in rich countries during the last forty years.

Being able to show that you can get these results using one or another of the available standard neoclassical growth models and Piketty’s two crucial assumptions — β = K/Y and σ > 1 — is of course, from a realist point of view, of rather limited value. As usual — the really interesting thing is how in accord with reality are the assumptions you make and the numerical values you put into the model specification.

Professor Piketty chose a theoretical framework that simultaneously allowed him to produce catchy numerical predictions, in tune with his empirical findings, while soaring like an eagle above the ‘messy’ debates of political economists shunned by their own profession’s mainstream and condemned diligently to inquire, in pristine isolation, into capitalism’s radical indeterminacy. The fact that, to do this, he had to adopt axioms that are both grossly unrealistic and logically incoherent must have seemed to him a small price to pay.

Yanis Varoufakis

My friend the forest

 

This one is for you, Jan Milch. A friend non plus ultra.