micro

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 To pick up a microeconomics text is to enter an alternative universe where real people have been replaced by packets of data especially created by economists so that their incentive models, constrained optimization methods, and other paraphernalia all work smoothly.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.