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October 31, 2006
Fisking Philip Ball
A few days ago Mark Thoma posted an article by Philip Ball, "consultant editor of Nature", taking economists to task for, well, being economists. Although Mark handled the rebuttal quite nicely, and there was lots and lots of fine commentary on Mark's site (a good chunk of which is summarized by Dave Iverson), I found the article so wrong-headed that I just can't help myself from commenting. So, a-commenting I go:
Baroque fantasies of a most peculiar science, by Philip Ball, Commentary, Financial Times (free): It is easy to mock economic theory. Any fool can see that the world of neoclassical economics, which dominates the academic field today, is a gross caricature in which every trader or company acts in the same self-interested way – rational, cool, omniscient. The theory has not foreseen a single stock market crash and has evidently failed to make the world any fairer or more pleasant.
It is true that neoclassical economists tend to be the methodological children of Milton Friedman, heirs to a positivist tradition that directly connects explanation and predictability. But predictability in this sense is conditional: If X occurs then, all else equal, Y will follow. As a matter of logic, large forecast errors may only prove that the arrival of X is especially uncertain, and that economists are not clairvoyant (a trait that I think is shared with physicists and other human beings).
To be fair, if Y equals a stock market crash, I cannot really tell you what X equals. I am unaware of any serious economist who claims they can. Even those economists who express knowledge of a "bubble" in some asset market or another shy from taking definitive stands on when and how the bubble will burst. I do know this, however: Economists have devoted a lot of energy to thinking about the lessons delivered by the Great Depression. At least part of the conventional wisdom formed from that thinking is that it is a very bad idea to restrain liquidity when liquidity is most desired. For an example of that wisdom in practice, I refer to you to the actions of the Federal Reserve in the aftermath of the 1987 market crash in the United States. I'll stick my neck out and claim that the world was more pleasant as a result of putting that lesson into action.
The usual defence is that you have to start somewhere. But mainstream economists no longer consider their core theory to be a “start”. The tenets are so firmly embedded that ... it is ... rigid dogma. To challenge these ideas is to invite blank stares of incomprehension – you might as well be telling a physicist that gravity does not exist.
That is disturbing because these things matter. Neoclassical idiocies persuaded many economists that market forces would create a robust post-Soviet economy in Russia (corrupt gangster economies do not exist in neoclassical theory)...
Economists accept -- insist, actually -- that institutions matter, and nobody would argue that market forces alone can create a "robust" economy absent well-defined property rights, functioning legal systems, and the like. If you doubt that, check out the latest John Bates Clark award.
Neoclassical economics asserts two things. First, in a free market, competition establishes a price equilibrium that is perfectly efficient: demand equals supply and no resources are squandered. Second, in equilibrium no one can be made better off without making someone else worse off.
Wrong. Mr. Ball is thinking of the concept of Pareto efficiency, which does indeed describe a situation in which "no one can be made better off without making someone else worse off." But there is no presumption among economists that free markets and competition will deliver such an outcome. Any time an economist speaks of asymmetric information (conditions in which one person knows something another does not), externalities (things like pollution that is not paid for by the polluters), inflexible prices or wages, or taxes on any sort of economic activity, he or she is starting from the presumption that the free-market outcome is not efficient. In fact, any time an economist speaks it is quite likely they are contemplating a world in which free-market outcomes are not efficient. To not recognize this is demonstrate a startling ignorance of what economics is actually about.
The conclusions are a snug fit with rightwing convictions. So it is tempting to infer that the dominance of neoclassical theory has political origins.
... the foundations of neoclassical theory were laid when scientists were exploring the notion of thermodynamic equilibrium. Economics borrowed wrong ideas from physics, and is now reluctant to give them up.
This error does not make neoclassical economic theory simple. Far from it. It is one of the most mathematically complicated subjects among the “sciences”, as difficult as quantum physics. That is part of the problem: it is such an elaborate contrivance that there is too much at stake to abandon it.
Well, OK, economics has become pretty mathematical, which does sometimes make it hard for non-economists to join the conversation. Shoot -- there are some papers that I can't figure out. But that does not equal an "error." (And I still think quantum physics is a lot harder -- and every bit as abstract.)
It is almost impossible to talk about economics today without endorsing its myths. Take the business cycle: there is no business cycle in any meaningful sense. In every other scientific discipline, a cycle is something that repeats periodically. Yet there is no absolute evidence for periodicity in economic fluctuations. Prices sometimes rise and sometimes fall. That is not a cycle; it is noise. Yet talk of cycles has led economists to hallucinate all kinds of fictitious oscillations in economic markets.
It's true -- economists do not define business cycles as things that repeat periodically in a deterministic way, like sine and cosine waves. Business cycles are instead defined somewhat loosely in terms of the co-movements of various aggregate variables (like GDP, employment, prices, etc., etc, etc.) If we want to get a bit more statistically formal, we might define a business cycle in terms of co-movements of aggregate variables within particular windows of time (say two to eight years, meaning that we are ignoring very short-run and very long-run fluctuations in the economy). And if want to define particular episodes of contraction (or recession) and expansion, we ask a committee to decide.
However we do it, the point is to identify a set of particular facts that can then be subjected to analysis, both theoretical and empirical. Don't like calling it a cycle? Fine. Call it Aggregate Fluctuations. Call it Co-Movement In Business Statistics. Call it a Kumquat. Just don't pretend a picky semantic point is serious criticism.
Meanwhile, the Nobel-winning neoclassical theory of the so-called business cycle “explains” it by blaming events outside the market. This salvages the precious idea of equilibrium, and thus of market efficiency. Analysts talk of market “corrections”, as though there is some ideal state that it is trying to attain. But in reality the market is intrinsically prone to leap and lurch.
I presume that Ball is referring to Real Business Cycle Theory. Let me try a very simple description of real business cycle theory: The business cycle -- those co-movements in macroeconomic variables that occur over certain frequencies (i.e windows of time) in the data -- result from random shocks that hit the economy combining with the intrinsic structure of the economy in such a way that those shocks are translated into ups and downs in GDP, employment, prices, etc., etc., etc.
What is Ball's criticism of this view of the world?
One can go through economic theory systematically demolishing all the cherished principles that students learn... [I]t is abundantly clear that herding – irrational, copycat buying and selling – provokes market fluctuations.
There are ways of dealing with the variety and irrationality of real agents in economic theory. But not in mainstream economics journals, because the models defy neoclassical assumptions.
Oh, I see. Maybe he missed this paper. And this paper. Or is unaware that conversations like this one, among economists who would otherwise describe their basic orientation as "neoclassical", are a part of any good macoeconomist's basic training.
There is no other “science” in such a peculiar state. A demonstrably false conceptual core is sustained by inertia alone. This core, “the Citadel”, remains impregnable while its adherents fashion an increasingly baroque fantasy. As Alan Kirman, a progressive economist, said: “No amount of attention to the walls will prevent the Citadel from being empty.”
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