Economics beyond Krugman, Mankiw, and Rodrik

17 Dec, 2022 at 21:25 | Posted in Economics | 10 Comments

1390045613Economics students today are complaining more and more about the way economics is taught. The lack of fundamental diversity — not just path-dependent elaborations of the mainstream canon — and narrowing of the curriculum, dissatisfy econ students all over the world. The frustrating lack of real-world relevance has led many of them to demand the discipline to start developing a more open and pluralistic theoretical and methodological attitude.

Dani Rodrik — among economics journalists and commentators often described as a heterodox economist — has little understanding of these views, finding it hard to ‘understand these complaints in the light of the patent multiplicity of models within economics.’  Rodrik shares the view of his colleagues Paul Krugman and Greg Mankiw — both of whom he approvingly cites in his book Economics Rules — that there is nothing basically wrong with ‘standard theory’ and ‘economics textbooks.’ As long as policymakers and economists stick to ‘standard economic analysis’ everything is fine. Economics is just a method that makes us ‘think straight’ and ‘reach correct answers.’

Writes Rodrik in Economics Rules:

Pluralism with respect to conclusions is one thing; pluralism with respect to methods is something else … An aspiring economist has to formulate clear models … These models can incorporate a wide range of assumptions … but not all assumptions are equally acceptable. In economics, this means that the greater the departure from benchmark assumptions, the greater the burden of justifying and motivating why those departures are needed …

Some methods are better than others … For some these constraints represent a kind of methodological straitjacket that crowds out new thinking. But it is easy to exaggerate the rigidity of the rules within which the profession operates.

Young economics students that want to see a real change in economics and the way it’s taught, have to look beyond Rodrik, Mankiw, Krugman & Co. Those future economists who really want something other than the same old mainstream neoclassical catechism; those who really don’t want to be force-fed with mainstream neoclassical deductive-axiomatic analytical formalism, have to look elsewhere.

Just like Krugman, Rodrik likes to present himself as a kind of pluralist anti-establishment economics iconoclast, but when it really counts, he shows what he is — a mainstream economist fanatically defending the relevance of standard economic modelling strategies. In other words — no heterodoxy where it really would count.

Almost all the change and diversity that people like Krugman and Rodrik applauds only take place within the analytic-formalistic modelling strategy that makes up the core of mainstream economics. All the flowers that do not live up to the precepts of the mainstream methodological canon are pruned. You’re free to take your analytical formalist models and apply it to whatever you want – as long as you do it using a modelling methodology acceptable to the mainstream. If you do not follow this particular mathematical-deductive analytical formalism you’re not even considered doing economics. “If it isn’t modelled, it isn’t economics.” This isn’t pluralism. It’s a methodological reductionist straightjacket.

In Rodrik’s world “newer generations of models do not render the older generations wrong or less relevant,” but “simply expand the range of the discipline’s insights.” I don’t want to sound derisory or patronizing, but although it’s easy to say what Rodrik says, we cannot both have our cake and eat it. Analytical formalism doesn’t save us from either specifying the intended areas of application of the models or having to accept them as rival models facing the risk of being put to the test and found falsified.

The insistence on using analytical formalism and mathematical methods comes at a high cost — it often makes the analysis irrelevant from an empirical-realist point of view.

No matter how many thousands of models mainstream economists come up with, as long as they are just axiomatic variations of the same old mathematical-deductive ilk, they are not heterodox in any substantial way, and they will not take us one single inch closer to giving us relevant and usable means to further our understanding and explanation of real economies.


  1. Empirical-realism is an oxymoron; neither addresses the issue of verification or falsification.

  2. I wrote a similar piece — in a debate with Krugman here.

  3. I wonder can a mainstream, DSGE model that includes a properly-scaled financial sector persuade Kingsley Lewis that supply and demand for virtual paper contracts is more of a factor than real supply and demand in “furthering our understanding and explanation of real economies”?
    《Gross capital flows play a central role in today’s policy debates. Yet current theory largely relies on net flow models of saving and current accounts. This limits the scope of policy advice.》

    • @rsm
      1. The answer to your question is NO. The paper which you reference is gobbledygook.

      2. You are correct in pointing out that FX trading far exceeds world GDP.
      “Turnover in global foreign exchange (FX) markets in April 2022 [was] 30 times greater than daily global GDP.” – The global foreign exchange market in a volatile time: Dec. 2022 BIS Quarterly Review

      3. No-one fully understands all this cross-border financial activity. However it appears that that much of the volume is due to complicated derivatives as traders and speculators try to shed risks in volatile markets and gain small interest and tax advantages.

      4. On my understanding most of the time this financial frenzy has little effect on international trade in goods and services. Occasionally there are effects on exchange rates and thence the costs of exporters and importers, but such effects are short-term and only temporarily obscure the fundamentals of international trade.

    • Kingsley,
      Can you please clarify the “gobbedygook” in the following passages from the linked paper’s Introduction?
      《On the empirical front, better data have allowed for an increasingly detailed study of cross-border (and domestic) gross flows and gross positions.[1] However, on the theoretical front the vast majority of the literature continues to rely on net capital flow models that were first developed much earlier.[2]》
      《There are several reasons why such models are not sufficiently detailed to represent gross capital flows and stocks. First, they lack a separate monetary-financial dimension whereby final settlement for any purchase of physical resources must use a financial (non-physical) medium of exchange, whose creation, circulation and destruction is separate from the creation, circulation and consumption of physical resources. In modern economies this medium of exchange function is almost exclusively performed by banks’ gross liabilities, which we will refer to as deposits or deposit money. Second, this medium of exchange is also required for trades in gross financial assets, which are far larger than physical resource trades in modern economies. Third, an economy’s banking system has the capacity not merely to facilitate the transfer of but also to create (and destroy) this medium of exchange, mostly through the granting of new loans but also through the purchase of existing assets. There are therefore generally very large differences between the sizes, and the changes in size over time, of physical resource stocks and of financial sector balance sheets. Fourth, any cross-border purchases require settlement, which in most cases takes place through the interbank accounts of domestic and foreign banks, and which necessarily affects banking sector and household sector balance sheets. A model without a banking sector that provides the medium of exchange and final settlement can therefore not fully represent either the size or the mechanics of gross capital flows and stocks.4 Finally, as shown by Borio and Disyatat (2011), empirically cross-border bank loans and bank deposits account for a very large share of major economies’ overall cross-border gross positions, and should therefore be part of a complete model.》
      Why would so many self-consciously rationally-self-interested traders trade so much larger dollar volumes of non-physical goods, unless there was more money to be made there than in real trade? Is it pure faith that allows you to discount the effects of the money they make for themselves and their investors, which empirically dwarfs the money actual physical import-exporters report earning?

      • @rsm
        Perhaps I should have said that the article consists of a lot of bla-bla-bla (sections 1, 2 and 5) and gobbedygook (sections 3 and 4). The latter is their highly theoretical mathematical DSGE model of two countries.
        The paper does not present any new empirical results – it just combines “stylised facts” developed by others.
        Despite the model’s limitations,the authors’ “Simulation Results” are not entirely implausible. Figures 5-10 appear to to show that “large and persistent” financial shock might change the real exchange rate by a mere a few percent and that such effect largely disappears within a year.
        This is hardly a big deal warranting alarm.
        The unimportance of gross financial flows is partly explained by one of the author’s conclusions:
        “the observed high correlation of gross capital inflows and outflows is overwhelmingly an automatic consequence of double entry bookkeeping”.

    • Kingsley,
      《Correlated flows therefore do not represent, as in many interpretations, the result of synchronized economic decision-making by domestic and foreign investors.》
      Can you see notional derivative values as a sign of how much money traders need to get the interest inflows they demand? Are limits purely psychological?
      《 the creation of a sufficient quantity of US dollars is completely independent of US current account deficits.》
      Thus, did the Fed make liberal use of unlimited currency swap lines to backstop exchange rates in 2008 and 2020? And does the formal model include that central bank reaction function, thus predicting how to mitigate real exchange rate effects in future panics?

  4. Like Prof. Syll, everybody would prefer economics to be “relevant from an empirical-realist point of view” which could “further our understanding and explanation of real economies”.
    Unfortunately, Prof. Syll fails to give any examples to illustrate how these noble aspirations can be achieved.

    “Longum iter est per præcepta, breve et efficax per exempla”
    – Teaching by precept is a long road, but brief and beneficial is the way by example.
    Seneca – Moral letters to Lucilius, Letter VI §5, “On sharing knowledge”

    Candidus in nauta turpis color; æquoris unda debet et a radiis sideris esse niger.
    – A fair complexion is a disgrace in a sailor; he ought to be tanned from the spray of the sea and the rays of the sun.
    Ovid – Ars Amoratia I

    Fit fabricando faber.
    – A smith becomes a smith by working at the forge.

    • One example might be the Henry George Theorem proved by Stiglitz et al. 50 years ago, which shows that taxation is effectively the forced subsidization of landowners by taxpayers. In its modeling of capital markets, modern mainstream neoclassical economics treats this forced subsidy as if it were occurring in a free market, by the voluntary consent of all parties, rather than as what it is: legalized stealing.

      • @ Roy Langston
        After refreshing my memory of the literature I was surprised to find that I very much agree with you that Henry George’s ideas do indeed “further our understanding and explanation of real economies”.
        (However, Stiglitz’s analysis is based on highly simplified and unrealistic assumptions and there are many reasons to doubt that the effects of high rates of tax on ground rents would have substantial beneficial effects except possibly over several decades.)
        Arguably it is simple supply and demand models and Keynesian models of aggregate demand which are the most important ways in which economics “furthers our understanding and explanation of real economies”.

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