Wednesday, November 27, 2013

Defending the econ status quo

In post GFC naval-gazing discussions about the nature of the economics discipline important questions have arisen about the discipline’s general inability to put forth a coherent set of models explaining commercial behaviour in production and trade, particularly boom and bust cycles.

The revolution the discipline needs to have seems to be starting in the classroom rather than academic outlets such as journals. I have strong interest in the teaching of economics, having been involved with the development of Australian Learning Standards for university level economics. One thing I can say is that undergraduate economic students are spoon fed an unrealistic, often useless, outdated, and very narrow set of concepts and tools, rather than being introduced to the wider nature of economics as a moral science.

But is this teaching approach merely reflective of the discipline? Sadly, I believe it is. The neoclassical status quo is heavily entrenched.

I do see some light at the end of the tunnel. Economics now does have leaders in the revolution. While Krugman’s methods fall very neatly into the mainstream, he seems to be slowly writing more like a modern monetary theorist. Nick Rowe is as mainstream as they get, defending neoclassic models while still making the effort to understand Steve Keen’s path-breaking work in debt driven cycles.

At the student level change is being strongly advocated by the University of Manchester’s new Post Crash Economics Society. Unfortunately, this open letter by Peter Backus in response to their efforts reflects the challenge that lies ahead. Although it is one of the better defences of the economics discipline, in many ways it also reveals the flaws and ignorance of the profession I have so often noted.

Backus makes seven points in his defence of economics, which I paraphrase as headings for each following section. 

Many criticisms of economics are simply that economics is not the study of politics, history or philosophy 

This is a bugbear of mine; that somehow economics operates in a moral and political vacuum. As soon as you want to interpret some action, behaviour, rule or policy in terms of ‘welfare’ you are automatically making a moral judgement about what is in the interests of the people. While it might be on occasion correct that a very simply utility function can represent a common notion of welfare, this need not be the case in general. As such, all economic analysis of welfare is conditional upon a moral judgement about the desires, wishes, dreams and imaginations of all others.

This is important stuff. It gets to the heart of almost all the fundamental issues in economics - benefits of trade, incentives, information and so on. It is the departure point for many alternative schools of thought that do not profess to reduce all activity to a moral assumption about the nature of individuals in the economy. 

Economics can’t also be detached from history and politics. All regulation occurs via political processes and anyone worth their salt as an advisor to policy makers needs to acknowledge the intricacies and often conflicting incentives in the political sphere. As I learnt in my days in government, history matters. A policy might appear best on paper to some economic analyst, but it must be a coherent step forward for all the stakeholders involved and must not conflict with other current, or often historical, policy directions.

While many economists agree that increasing taxes on the wealthy has almost no effect on aggregate output, this is rarely acknowledged at undergraduate level. Learning even a little economic history would reveal that high tax rates on the extremely wealth were very common through much of the 20th century and by most estimates had no measurable impacts on output and growth. 

There is no monolithic neoclassical mainstream (and if there is it is not an ideology). Chris Auld, self proclaimed defender of this no-existent mainstream, also makes this point.

Yes there is. Seriously, as someone who has recently completed PhD level courses at one of Australia’s top economics schools, the neoclassical framework of utility maximising representative agent models appears to define the discipline. Whereas it simply defines one approach in a broad family of methodological approaches to economic analysis.

One commenter sums up the reality of the modern economics curriculum.

This is barely the case nowadays: it is normal in economics today that the average master’s degree student is not even able to tell in a few words what Post-Keynesian or marxist or institutionalist economics are about and what are their peculiar analytical tools compared to those of neoclassical economics. Do you know a lot of disciplines where the students are maintained in the complete ignorance of entire parts of their own discipline?

In my area of research I see sociologists embracing the tools of graph theory to analyse social interaction, while the econ crowd pay lip service and attempt to subsume social networks into their own framework, in the process negating the relevance of the concept (if a network is a powerful structure a network link must be more than a perfectly tradable commodity).

It is generally not the job of an economist to predict the future

I love this defence, only because it is a classic misrepresentation of the critique. The critique is not that economics didn’t predict this exact crisis, its timing, political response or international scope. The critique is that no mainstream economists where even analysing economic processes with models that even allowed for such an event to occur! Had the discipline been approaching economics using more dynamic modelling tools, and potentially through networked models that allow for cascading changes, there would have been a standing warning that the economy system is subject to large unexpected swings (yes, booms and busts) by the very nature of its structure.

Many of the underlying causes of the financial crash were political and regulatory and structural, not the fault of sloppy Economic thinking 

Backus makes the point here that government failed to properly regulated financial markets. Fair enough. But where were the voices in the economics profession calling for greater regulation? Even talking about central bank intervention in the currency is a taboo topic with most mainstream economists I’ve met. I doubt there is a single non-trivial financial regulation that the economics profession would agree would improve the operation of financial markets.

It is usually the case that the mainstream profess a belief that markets are virtuous and always correct, and therefore deviations from perfection are typically the result of meddling governments or some other market failure.

As an example of this more common ideological thinking, Justin Wolfers recently tweeted about the dodgy practices of car salesman as an example of how regulation could improve ‘free market’ outcomes. Mainstream poster-boy Tyler Cowen replied that in fact car sales are regulated, and hence it is likely the regulation at fault. 

Having worked under the Queensland version of car sales regulation (the Property Agents and Motor Dealers Act) I can tell you that the whole purpose of the regulation is improve outcomes for consumers who were constantly being ripped off in an unregulated market! Why the hell does Cowen think such regulations even exist? Because everything was fine and dandy and consumers felt they were being treated fairly in a market we know functions under massive information failures?

You often see affirmations of the belief in markets in other writings, with phrases such as “I believe in the power of markets to aggregate information”. Which is of course nonsense, since if there exist conditions for markets to aggregate information, then there exist conditions for some other non-price mechanism to do the same. 

A LOT of what you guys learn as undergraduates is based on Keynes

Not true. I’ll let others expand on this, but for anyone who has read Keynes’ work there is almost nothing identifiable in any undergraduate textbook that represents his ideas.

I am happy to discuss and debate Marx and variants of Marxism with you (but be warned, I’ve been to Cuba and North Korea is bad)

The comments at the original article do more than address this. Especially this “Marx’s writings are about capitalism, NOT about command economies.”

Economists are always trying to do better! We are always revising theories, debating alternatives 

Actually, as a young researcher I find that in fact the econ crowd to be very much a closed shop. Any analytical method that falls outside the utility maximising representative agent optimal control model solved with to some quirky modification is essentially rejected with comments such as “in what way is that a model?” Yet if it conforms to their methods it doesn’t matter how nasty the assumptions, or how irrelevant the model, it is revered and worshipped as some kind of all seeing totem.

Some might say the rise of experimental and behavioural economics is evidence of the openness of the profession to new ideas. Unfortunately the behavioural revolution has been hijacked by the mainstream who now treat such irreconcilable evidence as mere modification to an individual’s utility function.

One final point. 

Backus links to a paper about taxing the wealthy, saying “you need a lot of maths under your belt to understand it”. I have said before, maths is often used in economics to disguise the conceptual links between variables and the real life objects and actions the represent. Here’s just one example of teaching economics where you learn nothing at all about the link between mathematical representations and reality. In Backus’s linked paper the whole idea is explained in two paragraphs starting on the bottom of page 4, while the maths that follows is mere intellectual obfuscation. Indeed  I find the whole 'maths thing' in economics strange. All the maths does is demonstrate that a set of concepts can be internally consistent with each other, and occasionally is helpful to communicate and compare ideas. The maths can't be used to discover anything new that was not implicitly already assumed. Every proof stems directly from an assumption made. 

The challenge of reforming economics, to break down the narrow and unrealistic analytical frameworks, to update teaching to reflect improvements in theory and the rapid expansion of empirical research, is daunting. While I do have some hope, and am relieved to see some true believers softening their positions and broadening their perspective, one can’t underestimate the determination with which vested interests in maintaining the status quo will defend their territory. Good luck to the Manchester students.

1 comment:

  1. My evolving project of Transfinancial Economics may be of interest.