economic theory

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Blind Leading the Blind

A few days ago David Ruccio posted an article titled “Crash and Learn” on the state of economics education. I want to elaborate a little further, although my usual skepticism on this subject does bridle a tad at the concept of economics education. Is that the same as “military intelligence”?

Anyway, in that article is this quote:

In Manchester, Diane Coyle also defends the basic methodology of economics. She says there is confusion among critics between microeconomics, the study of the behaviour of individuals and firms, and macroeconomics, the study of whole economies. Macroeconomics, she admits, “is broken”. But microeconomics is both robust and often verifiable with real-world data. What, she asks, can heterodox economists contribute to typical concerns of microeconomics, such as discovering the right mix of policy incentives to discourage obesity?

Therein, as someone once said, lies the tale.

Macroeconomics is “broken”. I quite agree. It’s nice to see an august member of the trade admitting that snake oil is snake oil no matter how clever the mathematics looks. Not that I blame the math. You can’t make something silly into something smart simply by expressing it in the formal language of math. If the root is rotten so is the formal outcome.

But that part I like more is that she goes on to laud the robust nature of microeconomics.

Wrong.

Micro, if anything, is worse than macro. It is so utterly disconnected from reality that it is incapable of anything other than talking about itself. Which it does loudly and proudly.

Let’s begin with a broad observation: one of the problems with the mess that is macro is that for decades we have been told to build on micro foundations. Not only does this deny the existence of any phenomenon that might emerge from higher level interactions between lower level phenomena, it assumes that micro has anything useful to say. Yet it is at the level of micro that much of the absurdity of modern economics has festered. Rational behavior in all its ridiculous glory is a tenet of micro. So is all the nonsense about perfection of information. To pick up a microeconomics text is to enter an alternative universe where real people have been replaced by packets of data especially created by economists so that their incentive models, constrained optimization methods, and other paraphernalia all work smoothly.

These packets of data, we call them ‘agents’, have no choice even in the artificial domain of rational choice. Why? Because the rationality impose upon them is uniform. It conforms to special rules. Those rules dictate the response an agent gives in any situation. Those responses are thus entirely determined, not by the agent, but by the combination of rules and circumstances. So much for freedom of choice. No one, in this setting, makes a whimsical choice. Indeed they never change their mind. Ever. Instead they plod on under the tyranny of a rule-laden simplicity obeying the orders of their economist experimental overlords.

This is not human behavior, the essence of which is the variety of response and the diversity of interpretation of identical circumstances. It is exactly that diversity that promotes robust and sustainable growth. It provides alternatives. It opens spaces for argument and thus learning. Most importantly, it is the groundwork for survival in the face of the endemic uncertainty that permeates life. The basis of all problem solving is the possibility of alternatives.

Microeconomics in its mainstream versions falls far far short of talking about this kind of real world problem solving; the kind that takes place in unconstrained open systems; the kind that is influenced by higher level pressures like social power structures bearing down on the agent; the kind that real people have to make when faced with limited or asymmetrical information; and certainly not the kind that deals with complex and manifold solutions.

No, microeconomics is deeply deficient and is thus the root error in economics. It is a badly misshapen replica of a small aspect of the totality of human behavior. But it is what economists play with. Dabbling, as some do, with institutional or incentive structures can only partly mask the error. The same goes for tricks like the introduction of transaction costs. It is relatively easy to use the techniques of economics as it is now taught to advise on the construction of contracts, incentives and so on. All you have to do is to limit the responses of your agents, give them a limited palette of possibilities, and to presume that they all behave the way they do in the utopia of the textbooks. All you need to do, in other words, is shackle them far from reality.

One more thing: the typical concerns of microeconomics have wandered so far afield from the core of economic behavior and into distant fields such as obesity precisely because of the failure to create a microeconomics that could deal with, explain, or predict that care behavior. All micro has become is a sophisticated technique. It is a technology or a method. It has no explanatory power in real world economies so it has been exported to deal with problems elsewhere.

Perhaps it has value out there. I do not know. But is is certainly not the robust portion of economics.

As for the aspect of microeconomics that purports to be the study of business firms. The less said the better. The entire purpose of business is to create and then exploit asymmetries of information. This is accomplished by the conversion of learning into routine and replicable activity so that cost can be driven out and profit enhanced. It has nothing to do with maximization or any of the other oddities that prowl about in the economics textbooks. But it does have a lot to do with the existence and history of social structures and networks, power relationships, culture, technology, geography, and the institutions that govern our lives.

No. Micro is just as big a bust as macro.

 

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The Market and Nobels

As I awake from my self-imposed slumber and re-survey the state of economics:

Nothing has changed.

This is predictable, and, I submit, is the most predictable phenomenon within the ambit of the discipline. Economics is in disrepute, and its current elite are determined to keep it there.

The latest ersatz Nobel prize went to a couple of guys who theorize a lot about contracts. This is the kind of work that now dominates much of economics. Tinkering with mathematics, incentives, and other aspects of minutiae whilst steadfastly turning away from the rapidly approaching storms that threaten the lives of real people outside the tenured redoubts professors hide within.

I have come to think that economics itself is one of the greatest impediments to returning us all to a prosperous and sustainable path. It is one of those moribund institutions that festers away living in a long-ago past, secure in what little it knows, and terrified of what it might not know.

I don’t think people realize just how historical contingent economic is. It was invented in the aftermath of the onset of industrialization, it was an afterthought as a growing chorus of politically motivated observers sought to identify a body of thought to be deployed to defend modernization and to attack the old order.

That old order was the entire system of life built around the stability of an agricultural economy in which land was paramount, aristocrats carved out precious freedoms from the older-still order of monarchs and autocrats, and, by and large, regular people lived as many generations of their ancestors had. The entire social and political structure can be encapsulated in the word: tradition.

It was a tradition where the concept of an “economy” was foreign. Social, political and cultural lives were set. They depended upon acceptance of fate and acceptance of what had gone before being somehow proper. Religion played a heavy hand in keeping order. In return religion was allowed to have a privileged place in the world it helped keep in check.

That all changed, as we know, as our ancestors threw off the shackles of ignorance. They began to assert rights to freedoms previously unheard of. Some of them turned those new rights into commerce. And from this new commerce came an urge to rebel even more against the dead hand of autocracy and aristocracy.

This was the intellectual space that economics was created to fill. It was not from an urge to explore economies as they occurred in the real world, but, rather, it was an attempt to organize an intellectual opposition to the state.

Hence the relentless, and now submerged into subliminal zombie like repetition, exegesis from something we call free markets.

All mainstream economics begins with the proposition that there exist markets endowed with utopian qualities. These magical places are populated with people who behave in only one way: they exercise rational choice. Indeed, so rational are they that they exhibit no choice in any real world sense of the word choice. When presented with an array from which to choose these people will make only one choice. They are, thus, perfectly predictable. They can be accorded incentives to induce predictable behavior. They will never err. They will never fail prey to human weaknesses. Nor will they alter. They are, in sum, the perfect grist for the mathematical modeling mill. Which is why they were invented.

With this nirvana thus established, economists systematically explore various forms of relaxation of their utopian rules. This, they argue, allows them to home in on sundry “inefficiencies”. For it can only be that a fall from the sublime grace of utopia is to decline into a less than sublime underworld. That underworld inevitably includes the state.

So, from its very inception, economics was designed to “prove” that state intervention into markets was inherently to disrupt the utopian order.

This religious like argument from unreality into reality gave economics great power. It was, for instance, particularly useful post-1848 in forming a bastion against the Marxist critique of early industrialization. After all, if the so-called immutable laws of economics gave no pity to the workers being crushed by early capitalism how much more useful could this pseudo-science be? To capitalists anyway.

And also please recall: the early years of economics coincided with the establishment of liberal but not yet democratic politics. The siren call of commercial freedom beckoned the likes of JS Mill, Ricardo, Bentham et al, but democracy was still an anathema to them. Democracy, that is, in its current form. It was only later, in the early 1900’s, that democracy was fully formed as a method of counter-balancing the degradations of red-blooded capitalism.

So it ought be unsurprising to us that economics retains to this day its undercurrent of anti-democratic thought. Its roots are still in utopia, and that utopia can only be debased by a government. Even if that government represents the will of the people.

The original concepts of freedom emerging from the straight jacket of the old order have given us two separate lineages: one that is represented in economics as freedom of market exchange, i.e. capitalism; and another that is the freedom of association and equality that is democracy. The two are in conflict. They clash. They are different interpretations of the same root. But only one is accounted for inside economic theory.

Why?

Because economics was invented before democracy. It is very difficult, therefore, to bend mainstream economics into a ‘socially democratic economics’. For such an economics does not start in utopia. It starts in the real world. And the intersection between reality and the real world is only a faint echo nowadays.

As I said: economics is one of those institutions all these bright young mainstream economists ought to be looking at and devising ways to re-construct so as to support rather than hinder sustainable growth. But I doubt they will: they would be declared heretics. There’s no Nobel for a heretic.

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Basics

For a variety of reasons I pulled Olivier Blanchard’s macroeconomics textbook off my shelf yesterday — I have the fifth edition which dates back to 2007. Or at least that’s how he begins his opening paragraph, he says he’s writing in mid-2007. So it would be easy to plunge into the book and start to look for evidence that Blanchard’s version of economics led us all to expect or predict the crisis that unfolded only a year later.

But that’s no what caught my eye. No I was interested in another aspect of the book: it has no introduction to what an economy is.

I find that strange. Very strange.

This is supposed to be a textbook about macroeconomics. The subject matter of macroeconomics is the economy, or, rather, aspects of the economy, but there’s no attempt to describe the economy. Instead it plunges in as if we all know what an economy is and that it is uncontroversial. It begins thus:

“When macroeconomists study an economy, they first look at three variables:

  • Output — The level of production of the economy as a whole — and its rate of growth

  • The unemployment rate — The proportion of workers in the economy who are not employed and are looking for jobs

  • The inflation rate –the rate at which the average price of the goods in the economy is increasing over time”

So when macroeconomists study an economy they dive right in and study some variables. Do those variables describe what an economy is? They are clearly important, but why these three?

I realize these first few paragraphs are just to introduce a student to the journey, so I went further to look what happened in the more detailed sections. A few pages on we get to read a description of those three key variables. Here’s the start of the ‘output’ description:

“Economists studying economic activity in the nineteenth century of during the Great Depression had no measure of aggregate activity (aggregate is the word macroeconomists use for total) on which to rely. They had to put together bits and pieces of information, such as the shipments of iron ore, or sales at some department stores, to try to infer what was happening to the economy as a whole.”

Blanchard then goes on to describe the accounting system that measures GDP.

But GDP is not the economy. It is a measure of some aspects of an economy. GDP provides grist for the analytical mill, but is far from being a description of what an economy is. It is roughly akin to a corporate income statement — it tries to measure what went on in a particular period, but it omits tons of interesting stuff and misses entirely anything akin to a balance sheet.

I won’t belabor the point further: economics, when it is taught, ought to begin with a discussion of what an economy is. This is especially important for students who are not going to delve much further and who will, thus, miss the detailed elaborations that Blanchard et al presumably give later on.

Economies are people doing stuff: stuff we all do. They are not time-series, accounting conventions, lines on charts, or equations in models. They are people going about ordinary life. How that activity then gets expressed — some of it — in the collective we call a market is something to talk about. Why is some activity in that collective and not in another collective such as a family? And so on.

The problem with diving straight into macro variables such as output, unemployment rates, and inflation is that it elides any contention in our arriving at the importance of those variables. It elides the conversation about what to count and what not to count. It avoids the entire discussion about the richness and diversity of real economies, about their complexity, about their inherent uncertainty, and thus about our need for humility in our study of them. Plunging in is an expression of the hubris of economists who want the world to imagine that we have a deeper understanding than we do.

It is an avoidance of reality. Students would do well to confront that reality early on. It makes what follows both more interesting, contextual, and human.

Blanchard, of course is not alone. His book is excellent — if you are in his camp of economists. It’s just that it begins in the middle and not the beginning. It describes only part of the journey. It’s rather like having a map where the cartographer omitted to tell you what it’s a map of. Instead the cartographer simply lets you know there will be roads, rivers, and mountains each of which will be discussed at length. They are what cartographers like to put on maps. That’s true. But it always helpful to know what place the map is of.

Isn’t it?

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Open Ended [A Note to Myself]

One of the major reasons, perhaps the major reason, economics is oftentimes irrelevant to our understanding of economies is that it fails to notice a rather salient fact: economies have no end. They have no beginning either. Or, rather, the choice of an ending or a beginning are merely arbitrary selections by an analyst needing to close up the system for analytical purposes. But this act of closure destroys the validity of any results from the subsequent analysis.

Why?

Precisely because economies have no end. They have no end as in purpose. They have no end as in time. They just are. They emerge from the myriad interactions of however many people exist at any point in time, they are channeled along a path highly dependent upon whatever happened recently, they are in constant turmoil and evolution, and they are driven by the availability of information and energy sufficient to do work and create local order. That’s it.

They don’t inevitably move towards equilibrium because it is impossible ever to reach such a point. Let me put that differently: even were the economy miraculously to arrive at some sort of equilibrium no one would know because the task of calculating whether or not it was is impossibly complex. So an equilibrium is unrecognizable. Besides, given the inexorable change, any possible equilibrium is so ephemeral as to be irrelevant. Instead of moving an economy towards equilibrium the twin pressures of supply and demand simply contrive to move it into tomorrow. Whatever that is. The economy is a process or a perpetual unfolding without end. It is in a constant state of becoming, but never actually of being.

Which, of course, makes it devilishly difficult to compress into the kind of shapes amenable to late 19th century analysis which are those that dominated the beginnings of modern economics. A real economy constantly slips between our fingers and defies our descriptions.

As I said: an economy just is what it is.

And this is annoying because we all live in economies. We really want them to work for us. We love the riches they produce: and let’s be honest modern economies are very good at producing riches. We all revel in the multitude of goodies that economic evolution has supplied us with. Yet sometimes we want them to be different. We want adjustments. We wonder whether they are ‘fair’ or ‘equal’ and we criticize attributes such as the concentrations of wealth.

Those kinds of questions, issues, and requirements cannot be settled within economies. They are better solved or argued about in a broader arena. That’s what we have politics for. Which upsets economists who think they have understood economies. For they judge any interference in an economy to be a diminution of the economy in question. Wealth is being foregone, so they say.  We ought, instead, let the economy be.

The evolutionist in me has sympathy for such a position: but not for the reason economists give. They argue that interference inevitably produces inefficiency and moves the economy from its optimizing path. The new equilibrium, they tell us, will be one that produces less overall wealth, so someone, somewhere is losing something they might have had.

I disagree. Since no one can articulate what a maximum or an optimum might be, no one can argue that we might miss it. We have no idea. Economists certainly don’t. They’re still wandering around in a fog looking for an equilibrium that doesn’t exist. How can we possibly make something immeasurable measurably less so?

Fog, I think, is a useful metaphor.

We have worked out what a fog is, what conditions give rise to it, where it is likely to be, and so on. But that doesn’t mean we can describe an actual fog. Especially when we are in it. Instead we rely on our experience to deal with the consequences of fog. We mitigate fogginess.

So it is with economies. We know what they are made up of: myriads of transactions; we can identify them and distinguish characteristics of them: agricultural, industrial, or post-industrial. We even know a few of their more detailed features: distributions of income, growth rates, and many other interesting things we measure. And, importantly, we know how to deal with them. Not by having great understanding of the system and its details, but by mitigating the nasty bits when we come across them. Yes, we mitigate economies. We try to bash them into socially acceptable shapes.

We ought, by now, to realize that this effort on our part is futile as a method of directing the economy: it directs itself. All we can do is to mitigate its effects and make them more socially and politically palatable.

Those economists who argue that we ought to keep our meddling hands off the great wealth producing machine of free markets – allowing that all markets are somehow less than free in the textbook sense – make as little sense as those who think they can barge in and run economies efficiently from some central office. Both sides are wrong. Economies can be nudged. Their sordid parts, capitalism springs to mind, can be cleaned up. In this case by democracy. But economies cannot be planned. They exist and they evolve. They have no beginning. They have no end. They have no purpose. They just are.

In that setting notions of equilibrium, maximization, efficiency, and rational choice are totally irrelevant. They are inventions designed to study something other than reality. Fun though that may be, it isn’t the study of actual economies.

That is if you think economies evolve.

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The Paradox of People

Yesterday I stirred up a certain curiosity as to why I had lumped Peter Drucker into the same bag as both von Mises and Hayek.

Well, simply put, the three of them, along with Karl Popper and Joesph Schumpeter, had an enormous, even oversized, impact on modern economics. Yes economics. Let’s not fall into the same trap as economists do when they, with a sweep of their hands, dismiss business theory as not an aspect of economics. Of course it is. After all if business is not an aspect of the economy, what is?

In any case, the general point is that there is a distinct Austrian flavor to modern economic/business theory that can be traced back to the work of that group. More importantly, the influence of that group, particularly Hayek, was to emphasize the terrors and the tyranny of socialism to a degree that precludes social democracy as well. In the hands of their various followers that emphasis became exaggerated eventually emerging as doctrinaire anti-government theory.

We thus end up with a profound ideological stance as we enter economic thought: anything the government does almost invariably dilutes or pollutes the so-called perfection of the market. So deeply is this stance accepted that most economists fail to realize its political import: that the democratic expression of the people’s will through their elected representatives is viewed negatively automatically in economic thinking. What economists are saying is that the people are entirely rational in their economic dealings, thus producing the perfection of markets, but are irrational in their political dealings thus mucking up that same perfection. The contradiction is exquisite. The paradox unresolved.

This paradox of people sits as testimony to the gulf between what would be a holistic social science and the much more limited study of allocation and/or choice that economics has opened up for itself. Since it is my belief that economies are first and foremost social phenomenon and are thus enmeshed in the political, institutional, cultural, and historical milieu of general social activity, the limitations of economics and its ability to discuss real economies is rather glaring. In fact it can’t contribute much at all other than its over-developed enquiry into choice under a highly restrictive set of assumptions which seem entirely designed to eliminate any connection to the larger milieu just referenced.

The emergence of the of the paradox of people can be traced, substantially, back to the personal biases and histories of the group of Austrians I mentioned yesterday. Let me give you a lengthy quote from Tony Judt on the topic:

“… We live in the long shadow of a debate with which most people are unfamiliar. If we ask who exercised the greatest influence over contemporary Anglophone economic thought, five foreign-born thinkers spring to mind: Ludwig von Mises, Friedrich Hayek, Joseph Schumpeter, Karl Popper, and Peter Drucker. The first two were the outstanding “grandfathers” of the Chicago School of free-market macroeconomics. Schumpeter is best known for his enthusiastic description of the “creative destructive” powers of capitalism, Popper for his defense of the “open society” and his theory of totalitarianism. As for Drucker, his writings on management exercised enormous influence over the theory and practice of business in the prosperous decades of the postwar boom. … All were forced into exile … and all — Hayek in particular — were to cast their writings and teachings in the shadow of the central question of their lifetime: Why had liberal society collapsed and given away — at least in the Austrian case — to Fascism? Their answer: the unsuccessful attempts of the (Marxist) left to introduce into post-1918 Austria state-directed planning, municipally owned services, and collectivized economic activity and not only proven delusionary, but had led directly to a counterattack.” — “What is Living and What is Dead in Social Democracy?” Tony Judt, a public lecture at NYU, October 2009

A long shadow indeed.

Judt is correct. Much of modern economics thought, indeed much of the underpinnings of neoliberalism generally, is directly attributable to the lifetime experiences of a small group of emigre Austrian thinkers who managed to exert an outsized influence. Why? because their fears fit well within those of the postwar West: the dark cloud of Marxist authoritarianism hanging over the West during the early Cold War years made the Austrian experience appear a lot more relevant than it is.

And, as I have already said, one consequence is that modern economics has no theory of government that is democratic. It assumes tyranny from the outset. It dresses this as tampering with “freedom”. With freedom exclusively expressed as the kind of libertarianism advocated by the likes of Milton Friedman.

I make no apology for agreeing with Judt on this issue. Hayek and the others built considerable theories based on their personal, albeit profound, experiences of tyranny. They made the error of transferring the ills of far-left Marxist politics onto all forms of social action. They became blind to the subtleties of democracy, and especially blind to the crucial role democracy plays in balancing or mitigating against capitalism. Instead, in various ways, they preferred to believe that impersonal individual action could somehow accrete into perfect collective action as expressed through a market. Moreover such expression was always preferable to any other expression including, for example, that through the ballot box.

But why was the government always a source of tyranny for these thinkers?

Because once instantiated it becomes a self interested agent with goals of its own that are not wholly those of the voters. Government by the people for the people thus becomes government by an agent of the people for the people, introducing along the way all the issues of agency that economists love to wrestle with. Since economics has no theory of politics within it, other than the Hayekian version, it has great difficulty squaring the economic and political motivations of the people. Indeed it doesn’t really try.

What we end up with is a modern economics that not only harkens back to its roots as an effort to wrest the economic sphere away from post-medieval monarchic interference, but also is now infused with a deeply anti-democratic vision built on the more recent conflicts inside the decaying Hapsburg Empire and its immediate successor state.

For anyone advocating democracy that’s a pretty potent one-two punch. Until economics incorporates a modern post-marxist theory of politics it will always appear to be resolutely opposed to the popular will. This is despite its purported advocacy of radical individualism accumulated into the collective known as the market.

The paradox of people lives on. With an Austrian twist no less.

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