Just remember, everything economists present is a model, not God’s truth! Sometimes they even admit it
— Jonathan Schlefer
If economists are so smart, why are there so many of them?
— Dave Cohen
It is rare to find a truly excellent discussion of the inadequacies of the economics profession, so I am pleased to pass along this gem today. Binyamin Applebaum of the New York Times interviewed Harvard professor Jonathan Schlefer in In Economics, You Are What You Model.
So much heat, so little light.
Jonathan Schlefer’s new book, The Assumptions Economists Make, is a welcome attempt to sort through some of this confusion. Mr. Schlefer, a research associate at Harvard Business School, is a political scientist by training, with an undergraduate degree in math and a long-standing engagement with economics. He is, in other words, well equipped to serve as a translator.
“This book is about what economists do in their secret lives as economists, when they aren’t dashing off op-eds to tell everybody else what to believe, pulling the wool over undergraduates’ eyes in textbooks, or otherwise engaging in public relations,” he writes.
“What economists otherwise do is make simplified assumptions about our world, build imaginary economies based on those assumptions – otherwise known as models – and use them to draw practical lessons.”
I hope you are already suitably impressed, and it gets better. I've inserted a few comments, and will end with a brief discussion of what all this means.
Below is a (condensed) transcript of our recent e-mail exchange:
Applebaum — To what extent do you see a “march of progress” in the efforts of successive generations of economists to build useful models of the real economy?
Schlefer — There is a kind of progress in economics. Critics point out flaws in models; supporters revise the models to respond; and the models do become sharper. For example, John Maynard Keynes’s “General Theory” was a brilliant book, but his model was somewhat muddy, if you even grant that he had a model per se. If his model had been clearer, there wouldn’t have arisen so many disputing schools of “Keynesians” (with various prefixes and suffixes to distinguish themselves).
But whichever side you’re on in these disputes, the models favored by different sides have become sharper and the bases of disputes clearer.
Thus the "kind of progress" Schlefer refers to actually represents no progress at all. Models have become sharper, and thus the bases of seemingly endless theoretical disputes have become clearer. And that's all.
Applebaum — You are particularly critical of neo-classical economics, which has its roots in the late 19th century. As you note, that was a period of great optimism that the world was an orderly place and that scientific inquiry would shortly discover those rules. In economics, this expectation culminated in the “discovery” that markets move naturally toward stable equilibriums. Scientists long ago concluded that natural systems actually tend toward entropy. Why has faith in an orderly universe endured so much longer among economists?
Schlefer — I think economists’ faith in an orderly universe is Platonist: There is an absolute orderly world, they hope, if only we could logically uncover it. These market imperfections surrounding us are mere deviations from the harmony of market equilibrium. Platonism is appealing. We would like certainty.
But the Platonic ideal is either inaccessible — an almost religious faith that you cannot apply to practical policy — or it’s corrupt if you try to apply it. Thomas Sargent [an economist at New York University, and Nobel Prize laureate] wrote a fascinating essay called Evolution and Intelligent Design. Sargent means the term intelligent design to capture some hope for a perfect order, which he finds in tension with disorderly evolution.
The Platonic vision can persist in economics because economic models are mathematical (in that sense Platonic), and you can never decisively prove them wrong. You can say President Obama’s stimulus worked because the economy would have done worse without it. Or you can say it failed because the economy would have done better without it.
But you can’t decisively prove how the economy would have behaved without the stimulus. There are rational ways of weighing these disputes, but they rarely persuade people to change their minds. Physics models can be tested in experiments, which can be replicated anytime, anywhere, but economic models cannot. So you can maintain Platonic visions.
Applebaum — While policy makers spend a lot of time listening to economists, they seem rarely to accept the full measure of their advice. They appear to be exercising some of the very caution that you prescribe. So would you describe some examples of policy makers’ taking the wrong decision because they took an economic model too seriously?
Applebaum asks a naive question here. Politics guides economic policy, not the other way around. Schlefer corrects him, but then becomes confused.
Schlefer — I think politicians pick models to suit policies that they want, because they believe in them, because they think they will reap political gains or both.
Pay close attention to the examples Schlefer outlines here.
However, I still think models can affect policy. There is a model — a bad one, I argue — that says free markets determine income distribution, and if you try to interfere, you only cause harm. In a 1980s edition of his seminal textbook Economics, the Democratic economist Paul Samuelson declared that unions and minimum-wage laws cause unemployment, while “a labor market characterized by perfectly flexible wages cannot underproduce or have involuntary unemployment.” When not only free-market economists like Milton Friedman but also somewhat more interventionist economists like Samuelson took this line, they gave intellectual legitimacy to the attack on unions and minimum wages and thus supported the politics that worsened income inequality.
Applebaum — The dominant family of economic models – so-called DSGE models — have a terrible predictive record. The 2008 crisis was devastating to their credibility. But a recent paper by Rochelle Edge, a Federal Reserve economist, argues that other standard methods aren’t any better. So what’s the alternative?
Schlefer — There were actually pretty good models, including a widely cited one by Douglas Diamond of the University of Chicago and Philip Dybvig of Yale, that captured, at least in a crude way, the financial contagion that triggered crisis in 2008.
The Fed and other central banks didn’t use this model (although Ben Bernanke certainly knew it), perhaps because it is a crude picture. You can’t plug numbers into it the way you can plug them into DSGE models. But it was right in a crude way, while they were wrong in a sophisticated way. Models provide clear pictures of economies, but the hard part of economics is trying to figure out which picture applies to which economy and when.
I suggest criteria in the last chapter of my book. One key criterion is the realism of crucial assumptions: assumptions that crucially affect the picture of the economy you are trying to understand.
Here’s an example: Central banks’ principal models before the financial crisis, the so-called DSGE models, made a crucial assumption, hard as it is to believe, that economies are always in instantaneous equilibrium. The assumption is nuts to my mind, but it didn’t matter too much as long as the model was used to understand and control inflation in an economy moving along on a fairly even keel. The moment you could no longer rely on the economy to keep moving along on a fairly even keel, that crucial assumption made the model’s picture of an economy catastrophically bad.
Applebaum — You are sharply critical of the scientific pretensions of the economics field. You note, for example, that economists are fond of dressing up observations as “laws.” And you note that this kind of make-believe can have dangerous consequences. You write,
“Economists have misappropriated the very word ‘equilibrium’ to describe a situation that is not an equilibrium, either in plain English or in engineering…. Continuing to speak of ‘equilibrium’ allowed them to fool themselves – and others – into thinking they had shown that perfect-market economies were stable.”
But I am curious to know whether you see benefits to mimicking a scientific approach, particularly as you work in a field that calls itself political science.
Schlefer — Political science is not a science like physics. Whether it deserves to be called a science at all is a question I’ll evade here. But it is a systematic way of understanding events and maybe gaining some insight into the possible future. To argue a point in political science, you start by laying out competing theories about a situation, each in its most persuasive form. Then you ask what results each theory would be expected to produce and how they compare with actual events. The theory that does the best job is the strongest.
I think economics might proceed along these lines, admitting competing models to explain situations and seriously asking which seems to do the better job.
I've quoted most of the interview. If you want to read the rest, follow the link above.
Discussion
Economics is not a science in any sense. Instead, it is a constantly changing set of elaborate fantasies (mathematical models) which describe idealized, imaginary economies which do not and can not exist in the real world. Schlefer discusses this straightforward observation when he refers to a faith in "Platonic" ideals among economists. These fantasies are not falsifiable—you can never decisively prove them wrong. If the models can not be tested experimentally, they are meaningless, and thus you can maintain Platonic visions. Real world counterfactuals (experiments) are impossible.
You can say President Obama’s stimulus worked because the economy would have done worse without it. Or you can say it failed because the economy would have done better without it.
But you can’t decisively prove how the economy would have behaved without the stimulus.
In other words, you can say anything. Economic "science" is inevitably reduced to mere politics. And thus we understand at a deeper level why political considerations always guide economic policy, not the other way around. Schlefer himself was confused when he said the following:
However, I still think models can affect policy. There is a model — a bad one, I argue — that says free markets determine income distribution, and if you try to interfere, you only cause harm. In a 1980s edition of his seminal textbook Economics, the Democratic economist Paul Samuelson declared that unions and minimum-wage laws cause unemployment, while “a labor market characterized by perfectly flexible wages cannot underproduce or have involuntary unemployment.” When not only free-market economists like Milton Friedman but also somewhat more interventionist economists like Samuelson took this line, they gave intellectual legitimacy to the attack on unions and minimum wages and thus supported the politics that worsened income inequality.
Well, which was it? Models affecting policy? Or models giving intellectual legitimacy to the Reagan Revolution? Of course it was the latter because economic models describe imaginary economies—politicians pick models to suit the policies that they want. This is not a chicken and egg problem. Democratic economist Paul Samuelson knew which way the wind was blowing after the economic dislocations of the 1970s. And this sort of vicious politics (disguised as economic theory) continues in 2012 America. It's been one, long straight road downhill since the early 1980s.
Thus it comes as no surprise that many economists fall into these two categories.
- politicized cheerleaders (for example, Mark Zandi)
- politicized, self-satisfied (and self-appointed) apostles of progress (for example, Paul Krugman)
It may appear astonishing that so many people are hopelessly in thrall to this irrational profession, which completely dominates their thinking whether they are aware of it or not. But this observation isn't terribly surprising if economics is merely politics in disguise. The irreducible conclusion is that humans are political animals and can not rise above partisan group behavior, as I discussed in my Sunday post One Million Pageviews On DOTE. Economic "science" is yet another expression of human politics, unlike physics or paleontology, which are real sciences where evidential data counts for something.
I hope you can see that it is but one short leap to the quasi-religious, faith-based conclusion that human economies will just grow and grow without limit in the future. As I have said in the past, based on the available historical and contemporary evidence, it appears that the human urge to grow without limit is biological in nature, an innate drive.
So much for economics — so much heat, so little light.
