It’s The Micro Too

One of the things that keeps nagging at me, when I ponder the state of economics, is the odd coexistence of classical micro alongside various sorts of macro. Don’t forget that the entire right wing crusade of the last few decades was to make the two consistent. The rallying cry became that we should build macro on micro foundations. The result was the silliness of the new classicals and others who actually imagined classical micro had validity.

I have been prodded into thinking about this more by the following quote from Paul Krugman, hardly a new classicist:

“The brand of economics I use in my daily work ‰ÛÒ the brand that I still consider by far the most reasonable approach out there ‰ÛÒ was largely established by Paul Samuelson back in 1948, when he published the first edition of his classic textbook. It‰Ûªs an approach that combines the grand tradition of microeconomics, with its emphasis on how the invisible hand leads to generally desirable outcomes, with Keynesian macroeconomics, which emphasizes the way the economy can develop magneto trouble, requiring policy intervention. In the Samuelsonian synthesis, one must count on the government to ensure more or less full employment; only once that can be taken as given do the usual virtues of free markets come to the fore.”

Therein lies my problem. It’s that “grand tradition of microeconomics” that bothers me. Most of it seems wrong. On the surface it all appears so reasonable, but when you dig into the details it is highly contrived and full of baseless assumptions about human behavior. It is so simplified and distant from anything around us that I wonder about its value as the foundation for anything. The convenient way in which supply and demand match the intuition of the classical economists is astounding. It’s as if the world was constructed by economists. The way in which people never alter their preferences; the way in which there is nothing unknown; the way in which gathering information is costless and just as easy as anything; the way in which those demand curves are sloped just right; the way in which we can sum up hundreds of millions of individuals and arrive at … well the sum of hundreds of millions of individuals. No emergence. No complexity. Just that invisible hand working its magic, in an environment that looks as if it were tailor made for invisible hands. The list goes on.

My own starting point, and the ongoing source of my bemusement, is the hopeless representation of the business firm within the context of micro. Economists have a very weak grip on what a firm is, let alone what one does. Indeed the literature on the theory of the firm would not resonate at all with anyone who has actually worked in business. It is an invention, or contrivance, that distorts the firm in order to fit it into a pre-existing narrative. Sometimes economists simply ignore firms, preferring to focus in other issues. Yet firms are such a huge feature of an economy, they fill a void in the market. They mediate informationally complex transactions. They manage processes through many steps. They attempt to neutralize uncertainty by creating plans which act as alternative paths or representations of reality through time and space. They are a central feature of a modern economy, and yet they are reduced to near nothing in the textbook. A vast percentage of all economic transactions take place within the boundaries of firms – large and small – yet those transactions are presumed to disappear in the textbook version of micro. In the absurd version of classical micro it is only when transactions reappear back into the market that they count as an economic. Else they are hidden inside a ‘black box’, the contents of which economists are uninterested in, or leave to lesser folk like the organizational theorists.

Perhaps that’s because firms are examples of central planning, and are thus deemed offensive by the free market zealots. The ideological objection to central planning is so strong, and so embedded, that classical economics would prefer to ignore vast swathes of an economy – that part occupied by business firms – rather than incorporate them into a more hybrid, but accurate, theoretical construct.

There are other examples of the oddities of what Krugman calls the grand tradition of microeconomics. The way in which utility has morphed into revealed preference is another low point. That transformation helped open the door to more tractable mathematical expression. Whether it bore any relation to actual behavior is another matter. It made life easier for economists, but at great cost to their ability to represent real economic activity.

At the end of the day, and coming as I do from a business starting point, it is this classical micro that I find puzzling. It is filled with leaps of faith, and with what Daniel Dennett would call ‘sky-hooks’ – statements anchored to assumptions nailed to thoughts that exist only in mid air, in other words statements without foundation. Almost all classical micro is constructed this way, and on an extraordinarily naive version of human behavior. It is riven through with breathtaking simplifications that eliminate any vestige of complexity and substitute robotic reactions for anything remotely human.

Yet upon this flattened and antiseptic base we are supposed to erect the edifice of policy supporting macroeconomics.

Krugman sees how this can be done.

I don’t.