Reforming Economics: Pluralism is Not Enough

[This longish essay was just published at Real World Economics Review Blog.  It is addressed to the “heterodox” community, those diverse economists of various schools that are not the dominant neoclassical school, though otherwise it is not particularly technical.]

Much of the current discussion of reforming economics focusses on the need for pluralism, particularly in teaching curricula, and very recently again on RWER.  Pluralist teaching is seen as challenging, because heterodox economic ideas are diverse, have little coherence, and are to a significant extent mutually incompatible.

This theme crops up frequently in discussions on RWER.  Now Cameron Murray, in the first issue of Inside, published by the Institute for Dynamic Economic Analysis, proposes to identify over-arching themes that can bring out the relationships among the various approaches.  This is commendable but it will not, on its own, result in a reformed economics.

I think the perceived difficulty of teaching heterodox economics comes from expecting too much from the exercise.  It will result in better-educated economists, and that is a very good thing.  Breaking the academic dominance of neoclassical economics would also be a very good thing.  However coherence in economics will not result from trimming and hammering existing fragmented ideas into a new box.

Coherence in economic theory will only come from deeper insights into how economies work.  Newton did not propose a more general framework that could accommodate the ideas of Ptolemy, Copernicus and Kepler, with excisions of a few difficult bits.  Rather, he found a deeper relationship that implied Kepler’s version of Copernicus’ system, and left Ptolemy’s system, by comparison, clumsy, limited and inaccurate.  It also explained falling apples and flying cannon balls.

Of the three main aspects of economic reform – teaching, theory and policy – the way forward is, perhaps paradoxically, most evident for policy.  Theory is the most challenging.  The approach to teaching can be clarified when it is considered in relation to theory and policy.  Here I will address policy and teaching reform in the context of a more fundamental approach to theory.

Much current economic policy is so misguided it is not hard to identify policies that would be less harmful, and hopefully even beneficial.  This comes into sharper focus if we identify some of the sources of mainstream nonsense.  Beyond that first step, a more coherent and fundamental view of the operation of economies can, I will argue here, be inferred from well-known observations in conjunction with modern ideas of self-organising systems.

I would identify three central follies of mainstream economics:  the neoclassical general equilibrium, the neglect of the roles of debt, money and banks, and the misuse of GDP to measure welfare.  There are other follies, to be sure, but if we got these idiocies out of policy thinking the world would already be a much better place.  More sensible policy approaches are already evident in broad outline, and future work can refine them.

Critiques of the neoclassical theory are plentiful, but not all of them are as fundamental as they might be, so I will summarise here my own assessment, from my book Sack the Economists.  The assumptions required to obtain a theoretical general equilibrium are absurdly unrealistic:  we must all be able to predict the future, there must be no increasing returns to scale beyond an ill-defined point of diminishing returns, we must all have complete and timely knowledge, we must not be influenced by third parties (thus excluding fashion, manipulative marketing and herd behaviour in financial markets), and so on.  The predictions of the theory are also blatantly contradicted by observations of real economies.

Both theory and observation tell us real economies are unstable.  Theory first: if you relax any of these assumptions, your system is likely to become unstable.  This is most obvious for increasing returns to scale, which can allow the biggest firm to grow at the expense of all the others.  Delayed or incomplete information implies delayed or weak feedback, which can result in overshooting instabilities.  Herd behaviour exaggerates trends, also yielding overshoot, as is most obvious in financial markets.  The whole point of marketing and fashion is to cause one product to “go viral”, at the expense of all others, another kind of instability.  So a more realistic theory of economies will involve internal instabilities (otherwise why would neoclassicists restrict themselves with such glaringly unrealistic assumptions).

Now observation:  instabilities are easy to identify in real economies.  A market crash is an obvious example.  The growth of one firm to dominance in a market segment is an instability so common that many market segments are dominated globally by a handful of firms, through the operation of increasing returns and other mechanisms, both economic and political, legitimate and not.  Henry Ford and Microsoft are the cliche examples.  The distribution of wealth tends to become highly concentrated, a form of instability.  Herd behaviour in financial markets, due to following trends and rumours rather than “fundamentals”, is commonly remarked, and it drives rapid fluctuations.

If your system is full of internal instabilities, there can be no general equilibrium.    Without equilibrium, the neoclassical claim of optimality is lost.  The fundamental consequence is that there is no basis whatsoever to conclude free markets are best.  An unfettered market might yield results that are desirable and efficient, or they might be undesirable, or inefficient, or both.  The central claim of the neoliberal ideology that dominates the world is lost.

A system that is full of internal instabilities will be a self-organising system, and it may be far from equilibrium all the time.  Its behaviour may be simple (like the neoclassical system), not-so-simple, complex or chaotic.  Evidently, given their erratic behaviour, our modern economies are in the regime of complexity or chaos.  From the theoretical perspective, a complex self-organising system is a radically different beast from the gently oscillating, near equilibrium neoclassical system.  Equilibrium is not a useful first approximation, to understand it you must start from a quite different place.  You have to ask quite different questions about it, such as whether you can recognise general trends or “character” in its behaviour, and identify the main drivers of those trends.  You also have to be humble, because a strongly interconnected system will not respond simply to interventions.

All of this means you cannot make any general claims about a “free” market, you have to look and see what it is doing.  If it is doing bad things, like trashing the planet, then you need to look at the incentives that drive it to such behaviour.  It is not hard to identify incentives to profit by dumping pollution or over-exploiting natural resources.  Many such perverse incentives are actually due to interventions in the market (on behalf of rich sponsors).  If we just got rid of subsidies to the fossil fuel industry, the world would be better off.

If removing perverse incentives (intentional or not) does not improve markets’ behaviour sufficiently, then actively introducing benign incentives may be advisable.  A cap-and-trade scheme for reducing greenhouse gas emissions is an example.

Thus, despite the perhaps-daunting conclusion that economies are complex systems, improved policy approaches are readily evident.  We already intervene a lot in economies, we just do it incoherently, guiltily, or for perverse ends.  If we intervened more coherently and with a clearer vision, we might find our world improves with amazing speed.  At the very least, we would be better off if we stopped accelerating toward a precipice.

The role of academic economics in this conception will be to refine and better quantify the ideas just outlined.  Old questions will recede and new questions come to the fore.  Thus, it is important to clarify which are the most important feedbacks in the system, and which behaviours they most influence, and that will be a large and continuing task.  Questions like “Why do firms exist?” are secondary, until more basic things are sorted out.  Questions like “What is my optimal investment strategy for the next fifty years?” become irrelevant.

There are already some strongly developing correctives to the second major folly of mainstream economics, the neglect of debt, money and banks, both commercial and central.  Commercial banks and other private financial institutions generate money and debt endogenously to the system.  A number of prominent people identified the role of excessive debt in the Global Financial Crisis (or Great Recession) starting in 2007.  Steve Keen has perhaps the best-developed theory of how debt renders a whole economy dynamically unstable.  I have given a very simple but instructive model of how a weakly restrained debt build up can lead to overshoot and crash.

The other major institutions involved with money and debt are the central banks.  The group promoting Modern Money Theory has shown that the operations of central banks are almost the opposite of the intuitions of most economists and politicians.  J. D. Alt’s explanations in Diagrams and Dollars are the easiest to follow.  They argue, for example, that the role of taxes is not primarily to balance a budget, but to “pull” the circulation of official money, which the central banks produce.  A government with money-creating power can never go broke, and never default on its debts.  Nor need “printing money” yield ruinous inflation unless the economy is already at full capacity, which is certainly not true in the post-GFC world.  They fully expose the folly of austerity policies, which exacerbate recession and depression.

The third major mainstream folly is the misuse of the GDP to measure the overall welfare of a society.  This misuse grossly distorts our priorities.  Things that involve money are promoted, while the many good things that do not involve money are neglected or disparaged.  Anything that involves money counts as a positive, even cleaning up pollution, recovering from a natural disaster, or suffering the consequences of ill health or a car crash.  There is a well-developed, unholy and unspoken alliance between unscrupulous businesses and politicians to promote anything that involves money, no matter how destructive, because it simultaneously increases the firms’ profits and the GDP.  The drive to endlessly increase the GDP is destroying the planet.

There are well-developed alternatives to the GDP that could be quickly deployed.  They involve balance sheets:  positives, negatives and a net benefit.  Some yield one number, like the Genuine Progress Indicator, others three numbers, like triple bottom line, and yet others may not be reduced to simple numbers, like reports on the state of society or the natural environment, and whether or not they are improving.

Thus broad policy alternatives to mainstream doctrines are readily identifiable, to manage markets, to manage banks, money and debt, and to measure or characterise the effects of policies.  Other aspects of the economy can also be addressed without a lot of theory, such as promoting more responsible forms of collective ownership than corporations, and promoting business models that strengthen beneficial market feedbacks.

How economics is to be taught is still somewhat challenging, but the framework just outlined clarifies an approach.  The new ideas can be taught, and in fact taught more readily, because they are not as highly elaborated as the neoclassical theory.  One reason neoclassicism now dominates curricula is that it requires the mastery of difficult mathematics applied to a great many aspects of the imaginary neoclassical world.  These can all be dispensed with, and the new ideas taught more readily and quickly.

(As a scientist, a non-economist, I observe among some heterodox economists a tendency to think that any replacement of neoclassical economics will necessarily have to be highly developed mathematically.  In fact much economic management relies on experience and qualitative assessments, because neoclassical models have little to say about much of the economy, like banks, and because the inadequacy of the neoclassical theory is recognised in practice, if not commonly admitted or articulated.  Also, when economies are understood as complex systems, there is a limit, a kind of uncertainty principle, to how much quantification is useful.  This is because such systems are not predictable in intimate detail, but only in general trends and character, like climate, or animals.  Thus the lack of a theory as highly elaborated as the neoclassical theory is not a problem.)

The difficulty Murray addresses is that non-neoclassical economics comprises many distinct schools that are diverse and not uncommonly incompatible with each other.  No doubt there is much of value that can be carried over into a new, more integrated economics, and over time much else might be discarded.  I am no expert in all of that, except to note that many habits of thought from old schools and paradigms will need to be let go, and that is not easy.

In the context developed here, the existing schools of thought can be sensibly taught the way the history of economics is taught.  Murray’s proposal to identify over-arching domains that can bring some coherence to this teaching is certainly constructive, but it does not change the nature of the exercise, which is still more like history.  As I have already argued, pluralism, on its own, will not generate a new and coherent economics.

Coherence will only be brought to economics when a sufficiently fundamental insight is identified.  I have argued above that recognising economies as complex self-organising systems is such an insight.  How well this hypothesis serves to make sense of economies can be explored and debated.  It may be supported, or it may be superseded, but for now it brings more coherence to understanding economies and is therefore a useful framework both for teaching economics and for further research.

Though some may recoil from mention of the “s” word, this is just how science proceeds to improve our understanding of the world.  Newton gave us an insight into the motions of falling apples and orbiting planets.  Subsequently Einstein gave us a more accurate and more general insight into how gravity works.  Nevertheless Newton’s version was, and remains, very useful.

To those who are not comfortable with the idea that economics can be a science I would offer several observations.  First, modern science is moving beyond the reductionist clockwork universe of Descartes.  The power of systems theory is that it can be holistic:  it can embrace living things without killing them, and we can understand more about them without pretending they are predictable, determinist automatons.  (Indeed that pretence is a central deficiency of neoclassicism.)  There is room for free will.

Second, there are such things as historical sciences.  In my own field of Earth science, we cannot run experiments with alternative Earths.  We must make do with evidence from the remote past or the remote interior, but it is still possible to pose hypotheses and test them for consistency with observations.  The Earth is rather messy and the details of its development are affected by myriad details, but it is still possible to gain a broad understanding of its development.  Human societies are even messier and more erratic, but historians and social scientists are still able to draw out coherent broad narratives.

Third, mathematics can be useful, but it is not science.  Mathematics is a tool that is sometimes useful in science.  Sometimes it is appropriate to use elaborate mathematics, or to work at high precision, but in other contexts a rough estimate using simple algebra may yield important insight.  Many neoclassical economists seem to believe that sophisticated mathematics makes their work scientific, but neoclassical economics is pseudo-science:  it is a system of belief, with no useful relevance to the observable world, dressed up in mathematics to look like science.  Just because neoclassical economics abuses mathematics does not mean mathematics has no place in economics.

Fourth, only in some fields, like experimental physics, is the point of science to make accurate predictions of the future.  In the historical and living sciences the point is to gain broad understanding of how something works, without expecting to predict what will happen next.  Market crashes, in their nature, will not yield to accurate predictions of when they will occur.  However if we can better identify the conditions under which they are likely and adjust things so they are less likely, then economics can be extremely useful and beneficial.

Fifth, if the point of economics is to give us useful guidance on how real economies work, and if some ideas are abandoned because they don’t fit what we can see, then to my understanding it is science, in the most general sense.  If you don’t agree with my semantics, but you agree we are trying to elicit useful guidance about the observable world, then let’s not get hung up on the semantics, let’s just get on with it.

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16 thoughts on “Reforming Economics: Pluralism is Not Enough

  1. Lyonwiss

    Your response to my comment on your post in Real World Economic Review (RWER) blog was (December 8, 2014 at 1:59 am):

    Lyonwiss – you have over-interpreted my words and substituted your own definition. See my response above to Egmont – I am not talking about “vague” theories, I also agree with Feynmann.

    I have said very clearly, neoclassical economics is not science, it is pseudo-science. You say “economics” is not a science, a much broader claim. Just because you can’t see where to gain specific purchase on an aspect of economies (hence your word “vague”?) doesn’t mean there are not parts of economies that cannot be understood specifically, and that understanding tested in the scientific sense.

    I agree neoclassical economics is pre-Ptolemaic. Are you saying there can never be any scientific understanding of any parts of an economy? If you don’t like my claim economies can be approached scientifically, fine, I beg to differ and I’ll get on with it.

    My answers to some of your questions posed above were sent in the following comment, which, like many other comments, was censored by the RWER moderator, probably because my views are contrary to their political agenda. I’m enclosing that comment here:

    Geoff, I’m not just talking about science or economics, I’m actually doing scientific economics here:

    http://www.asepp.com

    I do say “economics is not science”, in the sense that most economics, as in the major schools of economics: neoclassical, Keynesian, Marxist, Austrian, etc. are not science, because they have not been tested against the facts of observation.

    You asked: “Are you saying there can never be any scientific understanding of any parts of an economy?” Obviously not. Knowledge obtained from the scientific method is science. Economists only pretend to follow the scientific method (with mathematical models). Most economic knowledge is philosophy or “made-up stories” (Barbara Bergmann).

    I have applied the scientific method to Keynesian economics, because it is really the mainstream economics (not neoclassical) which is responsible for monetary policy, quantitative easing, etc. – the theory behind central banks’ drive to collapse the global economy. (They are succeeding in Japan.) A scientific refutation of the main Keynesian proposition is here:

    http://www.asepp.com/keynesian-economic-collapse/

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    1. Geoff Davies Post author

      Thanks Lyonwiss.
      I wonder if your comments not being posted is due to a technicality, or a spam filter. Even here, your comment was held for adjudication. Sometimes too may links can be a trigger, but you only had two, so I don’t know. I really doubt there’s any political censoring at RWER though, I’ve never had any hint of that. Probably they’re just busy. It takes a while for me to get a response these days if I send them an article. You might see if there are guidelines on commenting.

      On you response, we seem to be on the same wavelength now. I agree existing economics “schools” are mostly not scientific. We both agree one can study economies scientifically. Good. I’ll have a look at your keynesian stuff as I get a chance.

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      1. Lyonwiss

        Geoff,

        No, I don’t think it’s just a technicality. It is just pluralist hypocrisy – heterodoxy is just as sensitive to criticism as orthodoxy, which explains why economics is unscientific. For example and ironically, on another recent post titled “The rise and fall of debate in economics”, my response to BC’s comment was also censored. My response to BC’s comment was as follows.

        You said correctly, “The world is consistently manifesting evidence of a slow-motion depression, whereas the vast majority of economists are paid to ignore it or are allowed to behave as though it is not happening, because they have no incentive to know, nor will anyone pay them to find out and say so.”

        Has anyone noticed that since the global financial crisis, there has not been a single idea coming out INET, RWER, or WEA which makes one iota of difference in the behaviour of bankers or policy makers?

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      2. Geoff Davies Post author

        Lyonwiss,
        I agree RWER doesn’t offer significant solutions. I get weary of the steady parade of secondary issues with mainstream, which are a waste of time once you see the underlying fundamental problems. I only posted there again because I wrote the piece for IDEA (which has yet to respond).

        Have you asked RWER blog if there’s any problem with your comments? I still doubt the censorship theory, after all I’m pretty critical too. But if that’s what you think I can’t prove otherwise.

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      3. Lyonwiss

        Geoff
        After my complaint about RWER on your blog above, I have noticed today that my censored comment has been uncensored recently and backdated (i.e. to the original date) into the history of comments.

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      4. Lyonwiss

        I’m suggesting that its is not just the spam filter because I have submitted several comments in the past and they have never seen the light of day – which I have put down to censorship. This is the only time that is different and I suspect that it may be due to the conversation we have here.

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      5. Geoff Davies Post author

        My Sack the Economists website gets hundreds of spams per week. I don’t scan them, I just trash them. If there was a legit comment in there, it gets trashed. I expect the same would be true at RWER. I still suggest stuff up beats conspiracy, but believe what you will.

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      6. Lyonwiss

        Believe what you will Geoff. To this RWER post:

        http://rwer.wordpress.com/2014/12/22/the-failure-of-economics-is-due-to-the-use-of-axiomatic-method/

        I made the following lengthy comment on 21 December (without links or objectionable words) which was never published.

        Egmont,

        Axiom 1: Velocity of light is constant.
        Axiom 2: Maxwell’s equations are formally invariant for moving objects.

        Axiom 1 + Axiom 2 => Special theory of relativity

        Both axioms firmly empirically based, directly or indirectly tested every day.

        Axiom 1: It is the most famous failed experiment in history, which was set up to measure the anisotropy in the velocity of light in 1881-1887 by Michelson and Morley. Many other experiments have been conducted since, with the last experiment in 2009 improving the constancy of the velocity of light to 17 decimal places.

        Axiom 2: Maxwell’s equations are the mathematical summary of centuries of experiments in electromagnetism. The equations are applied flawlessly everyday in electrical appliances, power generation, telecommunication etc.

        Maxwell’s equations are invariant only under Lorentz transformation, which requires Axiom 1. Lorentz transformation is the essence of the special theory of relativity, which led to new discoveries including time dilation, length contraction, Doppler effect and energy and matter equivalence E=MC2.

        In this example, axioms have to be universally valid and accurate, then mathematics can be used to make important new discoveries, which is the benefit of formalization when valid.

        But economics is not physics. There are no universally valid axioms in economics. The formalization and proof of Arrow-Debreu general equilibrium are no more than a mathematical exercise, because many of the axioms are false or unrealistic. Economists drew the wrong conclusion from this exercise, believing that it proved the existence of general equilibrium. In fact it proved exactly the opposite – general equilibrium is highly unlikely.

        The nearest thing to an empirically derived axiom in economics is the Phillips Curve which has assumed a singular status among empirical economic discoveries and became a major preoccupation of economic research. Yet there has never had any empirical confirmation of its claims, with most observations refuting its statistical significance.

        Formalization can be great as in theoretical physics. But without any valid axioms, sophisticated mathematical models in finance and economics are all form and no substance. They are used mostly to fool the ignorant. Logical deductions from fallacies are mostly fallacies, but with occasional accidental truths and without any way of telling which is which.

        My own preference is to use formalism and mathematics whenever it is helpful to condense a logical argument. But most mathematical models in economics and finance, including DSGE models, credit risk models, capital market models, etc. are unscientific, being full of unsubstantiated assumptions, doing nothing, predicting nothing, except to con stupid managers and to endanger the economic and financial system.

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  2. Dufa Wira

    Thanks Mr Davies, I read your work with interest.
    My main concern with the current state of economics is the widespread refusal to consider the role of externalities (ie. the commonwealth). Until externalities are properly measured and accounted for, ‘economics’ can only assess a small part of the wealth of human societies (ie. chattel wealth) and cannot claim to provide wise guidance for good government.

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    1. Geoff Davies Post author

      I agree Dufa, externalities are not properly accounted for, or paid for. Far from it. So the full costs of production are not rolled into the price, so markets cannot function properly – the price signals are distorted.

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  3. allcoppedout

    Thought I’d just drop by and say thanks for your effort. The heteros are in danger of credulous uptake from other disciplines, including dead ducks like virtue ethics and neuro-quackery – there’s a 50 year critique of unwarranted abstraction from science to the social sciences generally and all of us are at risk of being swooned by the ‘objective voice’ that is so easy to feign. My eventual view is economics has nothing I recognise as data. Keep it up mate.

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  4. allcoppedout

    My specialism, so many years ago I have forgotten most of it, was in stoichiometry (chemistry). Science is much less a coherent body of knowledge that we generally think. Few of us actually engage in any area of its practice. I think Geoff may be starting out from an ‘over-egged pudding’ on coherence, much as I want to agree.

    Economists of any hue engaging in teaching have sunk a lot of costs in what they have learned and all become resistant to the postmodern moment in which we treat assumed basics in incredulity. We stand as ‘experts’ and I wonder what Geoff or I would do faced with a bunch of creationists challenging our science. I say this because we may be viewed in a similar fashion by economists – very much as outsiders who have not done the discipline’s spade work, sounding shrill and unsophisticated. I know how to use a saw, but would be a liability in a group of professional carpenters.

    What really gets taught in economics classes Geoff – have you ever been in any? My first appearance in one was as a university teacher, wondering what the **** to do and cursing my head of department. The syllabus was based on some chapters from a book by Samuelson and the exam questions and assignment based on sums derived from this. I had Death by Powerpoint slides from the publisher. I taught the class how to do the sums with spreadsheets and systems analysis.on the intricacies of bidding for European funding. Twenty years later, PP slides untouched. I had learned economics was a religion and nearly all my students that they could pass exams using my techniques. One hopes they got the drift on such as private debt not cancelling out in the real world of the poor sod carrying it and capital was about as neutral as fuming nitric acid.

    Only a short story. The teaching process is part of the problematic long before we think on content. When I taught behind the Iron Curtain, either side of its collapse, many asked whether what the World Bank was sponsoring just another shade of Soviet bullshit. I think I was supposed to answer ‘no’ – but was never a good learner. I agree on ‘sack the economists and disband their faculties’ – hang might be more appropriate – but this is also Townsend’s advice on personnel departments (Up The Organisation – 1972). This leaves a welcome void, but teachers could quickly fill that with new dogma. That ain’t science. One holy book doesn’t replace another in our ideals, ‘coherent’ or otherwise.

    What could I offer you from stoichiometry, 20 years business teaching, management and detective experience, in earth science? Or vice versa? And so what can we offer the economists? I barely had a scientific colleague who would not hand them all long prison sentences and hang them later. We are in danger of being missionaries finding a tribe with weird cultural values, confusing the economists’ poison oracles as a strange way of killing chickens, rather than a form of dispute resolution. Science is a challenge to their way of thinking, their form of life. We walk as sheep in sheeps’ clothing in this ideological world of wolves. There will be no scientific economics, though an open, honest, technological accounting system might collapse the ‘need’.

    Take care – hope there is another book coming.

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  5. Bob Bollen

    Geoff. I’m also not an economist, so value your writing. Thank you.

    You say “I have argued above that recognising economies as complex self-organising systems is such an insight.” I’d like to agree to that too; but who’s working on this? what have they found? where can we read about this?

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