Eight elementary errors – discussion from Real World Economics

There has been a lively discussion of Eight Elementary Errors of Economics at Real World Economics Review Blog.  Here are a couple of exchanges that raise good points. (If these commenters respond further I will post them here, in fairness to them.)  There has also been discussion of history, science, love and other topics.  You might like to have a look.

MichaelWStory, June 9, 2012 at 8:26 am | #28

There are a lot of problems with most of these assumptions:

• The measure of success is growth of the Gross Domestic Product.

Economists developed this measure, but it is a very rough tool and its limitations are acknowledged by the field. If politicians over rely on it, that does not say anything about econ as a field of study. Does the fact that life expectancy makes no measure of quality of life invalidate medicine?

• Clear evidence of poor performance is ignored. Growth, unemployment and inflation measures in the neoliberal era, since 1980, have never been as good as those in the 1950s and 1960s, when governments involved themselves substantially in the economy.

In the fifties and sixties the economy was better in the West only- by being so far ahead of other countries it was easy to out-compete. Most countries will not remember this period as a golden era. Now as development raises capabilities and living standards across the world Western workers are less in demand.

• Money and debt are excluded from economic models. I’m not making this up.

You are making this up. There are plenty of economic models which deal with debt and the money supply. What is true is that printing money is not counted as evidence of productivity or development- otherwise ZImbabwe would come top of development indices.

• Modern free-market theory, called the neoclassical theory, predicts the economy will always be close to equilibrium. If that were true it should tick along steadily and sudden changes should only occur in response to large external events like natural disasters or wars. Yet many times over the past two centuries financial markets have suddenly collapsed without any external cause. Some of the more recent examples occurred in 1987, 1997, 2001 and 2007. In 1987 stock prices dropped by 30-40% in a day, though thirty percent of the world’s factories had not been bombed overnight.

Stock prices are the cumulative predictions of all participants in the market. If there is widespread disinformation or ignorance which changes quickly then participants’ predictions will also change quickly. It could have nothing to do with the physical infrastructure, as this is only one aspect of the expectation of performance.

• The neoclassical theory is based on assumptions that are patently absurd or clearly shown by other disciplines to be untrue. Among the patently absurd, it is assumed our collective guesses about the future are accurate, yet people in 1890 could not have conceived how aeroplanes, two world wars, nuclear weapons, computers and digital communication would radically transform the world.

Evidence? Who assumes our collective guesses about the future are accurate?

• Economists assume there are no economies of scale beyond a point of diminishing returns, ignoring the lesson of Henry Ford’s assembly lines. Economies of scale allow the biggest firm to undercut other firms and grow faster, until it dominates a market. The existence of many such dominating firms, such as Microsoft, McDonald’s and Facebook, is also ignored.

This is the most nonsensical point. If you think that economists have ignored Henry Ford, you are misinformed. What you are saying is that the big companies you name did not reach the point of diminishing returns. If you can understand that at some level of car production between zero cars per year and infinity cars per year, it would become more difficult to produce each additional car (for example, when every acre of land is already covered in car plants) then you too, assume that there are no economies of scale beyond a point of diminishing returns, just like those foolish economists.

• It is assumed that people are innately individualistic and competitive, but psychologists have clearly documented our tendency to favour cooperation by punishing cheaters, even at a personal cost. Almost every mammalian species lives in groups, and social groups have an innate, and healthy, tension between individualism and cooperation. Most people understand they are better off if they balance their own wishes with those of their family and community.

Now in balance this is probably more valid- levels of cooperation differ widely between societies and are strongly correlated with economic success and political stability (compare Norway with Greece). There are economists studying these effects but there is a lot of political pressure to not look into this area as it has major implications for immigration and development policies.

• It is assumed we are coldly “rational” calculators, yet we are obviously strongly motivated by love, envy, fashion and insecurity, and marketers ruthlessly exploit these foibles. Psychologists have also clearly documented our tendency to other “non-rational” behaviours such as being risk averse. Neither the fashion industry nor the marketing industry would exist if economists were right.

In what sense would anybody regard ignoring somebody that you love as ‘rational’? The motivations from your goals are different to the means by which you go about achieving them. Most people are pretty rational about how to spend their money to maximise the benefits, whatever their motivation is. I would also query that risk aversion isn’t rational- it is simply a preference which people express with their spending.

June 10, 2012 at 8:28 am | #30
 MichaelW

I agree with many of your specific comments, but you seem to miss the implication, which is that they undermine the whole free-market story.
1. GDP – yet there is not a chorus of economists telling politicians to stop using GDP. Also economists are thick in Treasury and Finance departments and they still don’t use a better measure.
2. My point was that government “intervention” did not degrade the economy as the neoliberal ideology claims. I regularly get excuses in response to this point, but are any documented and quantified? Has anybody systematically compared the past three decades with the post-war decades? Rather there seems to be collective amnesia, why else would it be claimed that unemployment can’t fall below a level taken these days to be 4 or 5 percent – NAIRU, is that what it’s called?
3. I’m referring to many economists’ dismissal of private debt, their evident blindness to the mounting debt that presaged the GFC, and the role of paying debt down in depressing the US economy now. So my comment seems to apply to the main “forecasting” models. If there are some academic models with money and debt then good, why aren’t they being used to better “predict” the economy? I’m following Steve Keen here. Keen criticises the recent paper by Eggertson and Krugman (and so do I), which claims a great advance by having *two* representative agents, one owing and one owed. (The whole representative agent approach is invalid anyway if there are third-party interactions – see below.)
4. Equilibrium. Anyone with common sense would agree with what you say about stock markets. But the neoliberal ideology currently ruling the planet promotes “free” markets, on the basis that free markets give optimal performance, and the optimal performance is obtained at an abstract theoretical state of equilibrium. If indeed stock market participants do not have full and accurate information then you cannot prove the market will come to equilibrium, therefore you cannot claim the performance will be optimal, or any better than other ways of running markets (such as imposing a transaction tax to remove the profit from rampant speculation, which is parasitic and destructive and pulls markets well off optimal).
5. People who use rational expectations theory assume our collective guesses about the future are accurate. That is the way economists managed to allow for the flow of time and still claim an equilibrium. I believe Arrow and Debreu got a well-known prize for the result. If the future is unknowable, guess what – no equilibrium.
6. To get the neoclassical equilibrium result you have to assume no economies of scale beyond an ill-specified “point of diminishing returns”. This point has to be at a small enough scale that there are still many firms in the industry, otherwise “competition” is impeded and oligopoly or monopoly result. Oligopoly is common, and economies of scale up to large scale are pervasive. Therefore no equilibrium, no “free-market is best” ideology.
7. The neoclassical theory assumes no third-party interactions. But if I cooperate with you then you lose the prediction of equilibrium.
8. If I follow the latest fashion then I’m being influenced by a third party. If I buy something because of a psychologically persuasive ad on TV then ditto. No equilibrium. I put “rational” in quotes because I don’t define it to have economists’ meaning either. On risk aversion, psychologists have shown our preferences are asymmetrical – we are more reluctant to risk losing ten dollars we already have than we are to take a risk to win ten dollars we don’t have. It is not the kind of risk aversion economists call “rational”.

Evidently many economists don’t believe all the assumptions I have mentioned, including you. What you evidently haven’t realised is that without them there is no basis for claiming free markets are best. Yet that claim has been dominating the planet for three decades now (and influential before that of course) and doing great harm in the process – because you get many “invisible foot” results along with some “invisible hand” results. Things like environmental destruction. My own conclusion is not socialism, but that markets have to be managed so they give a desirable result. We do a lot of “managing” of markets already, but incoherently and often for the benefit of minority interests.

And where is the chorus of “mainstream” economists crying that neoliberalism has no basis and we should stop doing what they say?

 

June 10, 2012 at 8:53 am | #40

 

General comment –
(does not apply to everyone who has commented here)

On the few occasions when I have actually managed to engage some mainstream economists in this sort of debate, one of the common responses is “Of course economists know that, so what are you going on about”.

Well, I’m going on about it because any of my points knocks the underpinning from the current ideology dominating the globe, and causing great destruction and misery.

Apparently many neoclassical economists need to learn/remember the foundations of their own discipline.

So if you agree these assumptions and points are nonsense, then shout it from the rooftops AND demand more sensible and humane management of our societies.

Another frequent response is that I criticise but where is the alternative? I didn’t start down the path of writing about economics until I found a better framework that is likely to be able to accommodate these problems. It leads to a very different view of economies and how to manage them.

So, read my book if you seriously want to see a carefully thought through alternative.

??? (Anonymous commenter)

June 12, 2012 at 7:54 pm | #41

Geoff, I actually agree with you quite strongly–I think there needs to be much more public scholarship done by mainstream economists, and that we haven’t done enough to criticize the cranks in the media who misrepresent economic thought for political/personal gain.

The problem I have with your article here is that it’s one thing to blame serious economists for public inaction (which is somewhat legitimate), but it’s another to criticize the economic theory of introductory textbooks and public shills, which is what you’ve done in this article. This is compounded by the fact that you say that you know that this isn’t what mainstream economists actually believe in this comment, so the fact that you’re conflating right-wing ideology and actual economic thought (without explicitly separating the two) is a willful misrepresentation. My frustration (and perhaps that of others you’ve talked to) is that you’re not criticizing real economic scholarship, just a toy version of it, and those without background have no idea, so they take whatever you write at face value.

With respect to the lack of public scholarship, my guess is that it’s partially due to economists feeling frustrated over the remnants of how good a job Reagan did of publicly associating economics with his administration’s ideology (so that everyone thinks that we’re soulless Randians), and partially because academics are just very bad at public speaking/writing on average.

June 13, 2012 at 4:53 am | #42

 

??? –
Thank you for your comments, but I take issue with them, so far as I think I follow them.

You seem to imply that “the economic theory of introductory textbooks and public shills” is fair game, but that the economics of “serious economists” is not. My fundamental point is that if you give up the neoclassical assumptions (as you must) then you lose equilibrium and optimality. This is just as true for the introductory text version as for the latest sophisticated variation. Therefore all the claims of free markets being best are lost.

A hundred times a day it is claimed/assumed/implied that markets must be left to do what they do (with only the occasional “imperfection” needing attention). It has become one of the great myths of our society, thanks not just to the neoliberal ideologues but to the neoclassical economists before them.

Now economists thickly populate government, business, finance etc. Yet this prevailing myth is not challenged. Rather, they all seem to believe it.

You blame media cranks, shills, ideologues et al for propagating the myth, but what about all those economists who should know better? It’s not just that they don’t challenge it, they seem to believe it too.

My assessment, for what it’s worth, is that the field of economics has undergone self-selection for those who are inclined to support big business, “free enterprise”, “rugged individualism” and all the rest. Not all, but many.

So I won’t wear your charge of “wilful misrepresentation”. I am calling it the way I see it. Rand, Hayek and the rest have taken it further, but they did not invent the central free-market story.

Finally, I find it remarkable that a field would claim its introductory texts are not to be taken seriously: “you’re not criticizing real economic scholarship, just a toy version of it”. Evidently you can only criticise the latest “advances”. Sounds like a priesthood to me. And you won’t find physics introductory texts putting forth theories that won’t withstand criticism.

Finally finally, the disclaimer – I do not advocate socialism. I conclude that markets need to be managed, which is a very different thing. I know you didn’t say this, but this kind of discussion so easily falsely polarises into “capitalism” vs socialism.

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One thought on “Eight elementary errors – discussion from Real World Economics

  1. Pingback: change equals opportunity « power of language blog: partnering with reality by JR Fibonacci

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