Author: jdc

Who is economic man?

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A provocative opening to this article attacking something called “economic man”:

“Myth: Homo economicus is a valid assumption of human behavior.
Fact: Homo economicus is a fiction useful to right-wing economists.”

“Economic man” would be too easy, of course; “Homo economicus” sounds more intellectual and somehow also more ridiculous. Anyway, if I pretend not to see the right-wing bit – what’s a right-wing economist? – I think the fact is a fact and the myth is a fact too, and not just because defining a “valid assumption” is not quite as obvious as it seems.

The essay is actually pretty interesting, though obviously normatively motivated. It goes on to say:

“Specifically, social scientists believe that human behavior is often complex, imperfect, limited, self-contradictory and unpredictable. Homo economicus, however, is a greatly simplified model which assumes that individuals possess the following traits:

* Perfect self-interest
* Perfect rationality
* Perfect information”

I love that “human behavior is…. unpredictable”; the logical conclusion of that argument would be to abandon all social science, would it not? Let’s take the long view and ignore that bit. Aside from that, as I’ve argued before, the perfect information trait has been scrutinized intently for a few decades, so it’s probably an obsolete criticism. The rationality bit is, again, untestable, since what we mean by rationality is that some pattern that’s to some degree predictable – whatever it might be – affects behavior.

The self-interest trait is the one that comes in for a lot of criticism, in the essay and generally. The most important myth to dispel right away is that “self-interest” means “cares only about things that materially affect me”; it means “cares only about things that I care about”, which is delightfully tautological and more innocuous. We have a special definition of “selfish”. I think what the critic really means is more in the spirit of the following, from Wikipedia (sorry):

“Economic man is also amoral, ignoring all social values unless adhering to them gives him utility. Some believe such assumptions about humans are not only empirically inaccurate but unethical.”

There are two problems with that: one is the use of “unethical”, which I’ll save for another day, and the second is methodological. It’s possible to write down a rational, self-interested “economic man” who will do anything. Literally anything can be “rationalized”; it’s meaningless to say that it’s “empirically inaccurate” to assume that “social values” give a person utility, because it’s impossible to empirically answer that question one way or another. Economists seeking accuracy would, methodologically, model a person who acted in accordance with social values as if that person got utility from conforming to social values. Our rational, self-interested man has magically developed a social conscience!

Later in the original article, the author says (in direct contradiction to their earlier claim that behavior is unpredictable, by the way):

“Biologists recognize four levels of survival: the gene, the individual, the group, and the specie. All of them interact to produce the complex and often paradoxical behavior we witness in humans. The error of Homo economicus is that it focuses only on one level: the individual. It cannot explain why couples bear children (to promote genetic survival), or why soldiers often sacrifice their lives in war (to promote group survival), or why people practice charity (to promote human survival).”

Again, I can only plead that we recognize that whatever economists do or are perceived to do, their method of modeling people can explain anything, and I mean that as both a criticism and a compliment. Our method is neutral, our method is empty. Attack the normative interpretation of our conclusions. Attack the assumptions we make. Don’t attack the method: you’re shooting at thin air.

Let’s do a thought experiment: imagine we had a super-supercomputer that could accommodate all the complexity we wanted, and imagine that our computer has also figured out how to perfectly model every single human being, and imagine that we believe it. Forget the fatalist implications and just ask: would an economist – who seeks to model choice and the allocation of scarce resources, to describe the world, to make predictions, and, ultimately, to inform – reject the computer? Would he reject the model? If he would, he is not a scientist: if the economist would reject it, then I’ll let all the critics of economics attack him, because surely the only way to justify rejection of that gift would be because the model would generate predictions that the economist didn’t like.

Economists should never make their “economic man” to suit their ideological goals. That’s not science. We must make our “economic man” realistic but clear, acknowledge what he does and does not do, what he does and does not embody. He can be anything we want: we are therefore powerful, and must then be honest, if nothing else.

Perhaps we should stop using this phrase

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I mentioned the old “dismal science” slight on economics the other day. It’s not exactly new news, but I like the story of the origins of the term a lot, because knowing it would surely cause people to think twice before using the phrase.

Here‘s a good article that tells the story of Thomas Carlyle’s first uses of the phrase.

“Carlyle attacked Mill, not for supporting Malthus’s predictions about the dire consequences of population growth, but for supporting the emancipation of slaves. It was this fact—that economics assumed that people were basically all the same, and thus all entitled to liberty—that led Carlyle to label economics “the dismal science.””

Now, economics is probably pretty low on the list of reasons to oppose slavery, but it seems that Carlyle was taking issue with John Stuart Mill (among others) for arguing that since people are basically the same, there’s no such thing as a “natural” hierarchy of people. Carlyle’s position, sadly, speaks for itself:

“Carlyle disagreed with the conclusion that slavery was wrong because he disagreed with the assumption that under the skin, people are all the same. He argued that blacks were subhumans (“two-legged cattle”), who needed the tutelage of whites wielding the “beneficent whip” if they were to contribute to the good of society.”

Aside from its connotations – which are about as politically incorrect as it’s possible to be these days, and would certainly not be allowed to be printed in any of the places where we see the phrase “dismal science” – the target Carlyle was directing his argument towards is not much like the method of economic science at all. In fact, he seems to really be taking issue not with the practice of scientific, positive economics but with the assumptions the economists made about people. From another article on the same subject:

“In short, Carlyle was of the view that compulsion, rather than market forces should regulate the supply of labour on plantations in the West Indies because the laws of supply and demand are not appropriately applied to the relationship between White and Black as they are contrary to “their mutual duties” (white = master and black = servant) as ordained by “the Maker of them both”. In Carlyle’s opinion: “declaring that Negro and White are unrelated, loose from one another, on a footing of perfect equality, and subject to no law but that of supply and demand according to the Dismal Science”, “is clearly no solution” to the problem.”

Oddly enough, and though it’s probably ridiculous to compare them, Carlyle is attacking exactly the same assumption that is still criticized today: the assumption on the motivation of people in economic models. Certainly the reasoning of the critic of today is significantly less outrageous than Carlyle’s, but they’re shooting at the same target.

Carlyle certainly seems to demand a different kind of response than today’s defense of the modeling of people – “it’s just an abstraction, we know we’re not being realistic”. Luckily, as some of Mill’s angry and eloquent responses indicate, Carlyle’s normative beliefs were vigorously challenged right from the start. His assumption was, I hope we can agree, unrealistic. If he had performed a positive economic analysis based on his assumption, it would have been badly wrong and inaccurate.

No normative belief or opinion can ever be “wrong”, but an assumption can certainly be wrong. Which assumption would lead to better economic science: Carlyle’s assumption of natural servitude or Mill’s assumption of natural equality? If Carlyle had argued that slavery was a good thing, plenty of people would have disagreed with his opinion. When he argued that people are inequal and thus servitude is a better use of people than freedom, he didn’t just have an objectionable opinion, he had bad science.

Modern economics has fought hard to work the number of abstractions made on the motivation of people down to just one: rationality. We don’t restrict what people care about, we just require there to be some method to the madness. Economics should be value-free, boring, scientific, clinical, and, yes, dismal, but I’d think twice before I called it the “dismal science”.

Looking at brains

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A related question to what people want is what makes people happy. The answers aren’t necessarily the same, but in thinking about one, especially as a modeler, it helps to think about the other.

I saw Andrew Caplin talk a couple of months ago about this paper, in the growing neuroeconomics field. My layperson’s understanding of neuroeconomics is that it looks at the brain to try and figure out what’s going on while we make choices. It seems to be concerned at least as much with “what makes people happy” (or at least what makes their brain light up on the machines) as it is with what people actually choose, a point that separates it somewhat from other economic fields that take preferences as given and observe only choices. The argument, presumably, is that knowing more about what motivates people might shed more light on their choices.

Caplin described a paper titled, excellently, “Responses of monkey dopamine neurons to reward and conditioned stimuli during successive steps of learning a delayed response task” (link) which described a Pavlovian experiment on monkeys. First the monkeys were given food, which set off a dopamine response in their brains, supposedly a sign of pleasure. Then the researchers started to ring a bell before giving the food, and the dopamine response shifted from the food to the bell. Finally, they rang the bell and withheld the food, and the dopamine measure showed pleasure at the bell and disappointment at the time when the food was expected.

The upshot is that this physical measure of pleasure in the brain seems to show that news was just as important as the tangible outcome: the monkeys don’t just care about the food. People, too, clearly care about more than just money, goods or tangible outcomes: perhaps I am happy to see a good weather forecast for tomorrow even though I didn’t actually get anything.

It’s related to the great loss and rediscovery of preferences in economics. At some point (to grossly oversimplify the history) the profession settled on making abstract simplifications of people’s motivations. Then a while went by and someone said “people don’t conform to your economic theory, they must be irrational!”, when of course the more obvious explanation is that people’s motivations are more complex than the simplification. If people care only about money, then according to some theory I should see this. If I see that instead, I have not disproved the theory independently from the assumption on preferences.

The potentially exciting thing about neuroeconomics is that, even allowing for inexactness, it might tell us more about the actual hedonic motivators of people. Ambitious, yes, but not unimaginable. Of course, to an economist who wasn’t under the mistaken impression that simplified preferences are supposed to be realistic, it might just amount to saying “your simplification is a simplification”, which is slightly less exciting news. Or not news at all.

In fact, one interpretation of the monkey result might be that new information – or expectations – matters to people’s decisions. Macroeconomists – Nobel memorial winners, Phelps and Friedman – incorporated expectations into their models forty years ago. If anything, what we’re seeing is individual-level (or at least individual monkey-level) evidence that, yes, expectations are important. That might be another way of saying that evidence from experimental/behavioral/neuroeconomics like this is fun, but it doesn’t materially change what economists are up to: if more complexity makes our modeling more accurate, we often end up doing it.

What do you want to happen?

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Step one in normative economics is, I think, finding out what you want. Without a goal, positive economics is as useless as a coffee break (unless, of course, your goal was a cup of coffee). Is it odd, then, that economists don’t seem to spend any time figuring out what people want?

Although I’m certainly no authority, it seems to me that psychologists and sociologists spend a lot more time on this question. For example, I recently came across a psychology article with the wonderful title “Not Having What You Want versus Having What You Do Not Want”(here’s a link, but the full text is subscriber-only). I cannot resist quoting the first paragraph:

“No childhood passes without disappointment about a birthday present, no adolescence seems to be complete without a disappointing love affair, and hardly anyone is a stranger to the unpleasant feeling that stems from buying an expensive consumer product that turns out to be less than expected. All in all, a life without disappointment seems rare.”

And they call economics the dismal science… I wish we could be so melancholy. The point, however, is that while behavioral economics might be trying to push the boundary of what the people in economic models care about by incorporating, for example, disappointment, I don’t know of any economics literature that’s trying to figure out what people actually care about.

Of course, it’s difficult. How could we go about it? Economists are very distrustful of surveys as unscientific. One of my favorite normative economics results is hidden in a paper called “Economics of the Endangered Species Act” (link): US household surveys asked people what they’d be willing to pay to save each of a set of endangered species. Scaled up, the answers implied that the US population would be willing to pay one percent of its total income to save two percent of endangered species. It’s a bit of a facetious point, but it’s a neat way of showing that talk is cheap in answering surveys. Simply observing what people do can’t really answer the question either, especially when we’re talking about a bigger scale than the individual level.

Do we assume that democracy will elect leaders who represent the goals and ambitions of the people? I think the whole thing poses a serious problem for any economist bold enough to make a policy recommendation: how has the normative branch of economics tried to figure out what people want?

If someone asked you what you wanted, specifically or generally, for you or for the country, or the world, what might make the list? Money, a job, friends, lovers, health, the environment? How closely will the list match the things inside your head? What if you had to give up one thing on your list to get another? Again, a common recourse in economics is to turn our back on this whole sorry mess and just take the things in which we have relatively high confidence: most people like money to some degree.

No economics paper seems to be complete without the mysterious “welfare analysis”, which is essentially a bolted-on normative exercise attached to a positive, descriptive theory. How valuable is such an exercise if we have simplified the motivation of people in the theory? Obviously the normative “welfare analysis” is equally dependent on the assumptions of our theory as the theory itself. It’s a false dawn that is equally as unsuited to answering the question of “what should be” as positive economics itself: again, if we could come up with the metric that captured the quality of any conceivable thing, the magical normative criteria, we should pack up and start a technocracy.

Yet there is no reason to force the positive and normative analyses into the same box. Expanding the foundations of normative analysis, in particular, to include the hypothetical answer to the question of what people want to happen, can happily be done without affecting the quality of positive theory, whether or not it rests on the same foundations. The economist who claims to evaluate the quality of an outcome fails to see that what he calls normative economics is only as realistic as positive economics: not at all. Real normative economics would spend more time trying to figure out what people really want.

Unreal

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As someone who laments misperceptions of what economists are and do, the barriers to communication with anti-capitalist groups make me very sad indeed. How did I get there? I was looking for something entirely different when I stopped to read an article by Roy Weintraub talking about neoclassical economics. To someone with my beliefs in what economics is, it’s a bit schizophrenic. This is nice:

“Neoclassical economics is what is called a metatheory. That is, it is a set of implicit rules or understandings for constructing satisfactory economic theories. It is a scientific research program that generates economic theories.”

This is pretty good news: the beast called “neoclassical economics” is merely a box inside which we concoct scientific theories: inside our box, this would lead to that. Weintraub continues to say that the assumptions of neoclassical economics

“include the following:

1. People have rational preferences among outcomes. 2. Individuals maximize utility and firms maximize profits. 3. People act independently on the basis of full and relevant information.”

Of these, 1 is redundant to me because I think rationality is not testable and is therefore irrelevant, especially since it’s probably implied by 2, and 3 is at best outdated (economists these days are very interested in the implications of imperfect or asymmetric information). If I was pressed to define neoclassical economics, I think perhaps the definition I would use is similar to 2. I’d say that neoclassical economics is the branch of economics that models entities (individuals, firms, governments, etc) as if they try to get the outcome they like best from the ones that are available.

I disagree more with the stance of the article when Weibtraub repeatedly invokes “the neoclassical vision”. The connotations of this phrase probably reinforce the misconception that economists think the box in which neoclassical economics works obeys the same rules as the real world. I doubt a physicist thinks that a vacuum is the same as the real world, just as I doubt that any economist thinks that the abstractions of economic modeling are the same as the real world.

It’s true that a positive economist who seeks to explore “what is” should not neglect to examine the differences between abstraction and reality, but again we must ask at what point the value of realism is eroded by its inability to draw any conclusions. I think the real choice we’re faced with is the application of the economic method that says “if this unrealistic simplification, then that” versus a shrug of the shoulders; if it were possible to achieve the ideal “if this, then that”, who would reject it? Should we stop trying because we can’t be perfect?

Perhaps partly because of such confusions, “neoclassical economics”, aside from having a silly name, seems to have become something of a lightning rod for the anti-capitalist set as much as it is for economists with different ideas. Google neoclassical economics and you get – on page one – a page from adbusters (an anti-consumerist publication – Wikipedia entry), and a less histrionic “critique of neoclassical economics” by Herb Thompson.

“Neoclassical economists normally treat economic instability as the effect of exogenous, stochastic factors even though nonlinear economics suggests that what may previously have been considered exogenous, or random, may more likely be endogenous to capitalist social formations.”

I confess I’m not sure what “nonlinear economics” means (the almighty Google was inconclusive): clearly I, too, have been indoctrinated to the neoclassical cabal. However, I actually think that the quotation touches on an interesting idea. Can we figure out if the primacy of money as a measurement of outcomes “caused” the rise of the capitalist method of organizing resources, or if the capitalist method “caused” the rise of the primacy of money?

A difficult one. For example, to take a typical example of an anti-capitalist complaint, do people buy sweatshop goods because they don’t know they’re sweatshop goods or because they care more about cheap goods than where they came from? I think the latter is more consistent with “money primacy leads to capitalism” and the former is more consistent with “capitalism leads to money primacy”, although I’m sure that could be debated.

It is possible to imagine that incorrect normatization of positive economics – by which I mean the mistaken assumption that some measurable positive economic variable is a measure of the quality of an outcome – actually causes problems within the economic system. People will do what they will, but if a policymaker chooses a policy based on the primacy of money as a measure of the quality of an outcome, there’s a real possibility that the system itself is influenced by its measurement.

The Thompson article also includes the following excellent paragraph:

“The ‘rational’ consumer of the mainstream economist is a working assumption that was meant to free economists from dependence on psychology…. The dilemma is that the assumption of rationality as intertemporally optimising is often confused with, and regularly presented as, real, purposive behaviour. In fact, the living consumer in historical time routinely makes decisions in undefined contexts. They muddle through, they adapt, they copy, they try what worked in the past, they gamble, they take uncalculated risks, they engage in costly altruistic activities, and regularly make unpredictable, even unexplainable, decisions.”

First of all, this is crucially wrong: “rationality” is not something that can ever be more than an assumption, unless you think you can test it. Further, assuming rationality does not exclude any of the motivations Thompson talks about. It would be trivial to write down a model of a rational person who “engaged in costly altruistic activities” – I simply have the person care about others and optimize rationally. The assumption that Thompson is really discussing here is the straw man of “rationality equals maximizes money”, which I have previously argued is absolutely not an assumption of any economic theory, neoclassical or otherwise.

Beyond that, this is really back to the same problem that the Weibtraub article was getting at: we’re doing the “if this unrealistic simplification, then that”. There’s a strong push in so-called “behavioral economics” to figure out if there’s a workable way to first make realistic generalizations on how people behave and second to incorporate them into the unrealistic simplification of neoclassical economics. While that goes on, the economist who seeks to defend his method must be clear on what his unrealistic simplification actually is and what it is used for.

As usual, no-one is fit to judge if the anti-capitalist model is “better” than the capitalist status quo, but I greatly hope that we would be able to talk about what each would mean. If somehow I were able to convince adbusters to sit down with me and I asked them what they wanted to do and what they wanted to achieve, what might they reply? I don’t know what they would say, but whatever their answer, I would like to figure out what it would take to achieve their goals, what the consequences of their chosen actions would be, what it would mean for people, not just them or me. I hope they would like to figure that out too. That’s positive economics.

Psychologists are evil

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This is just an outstanding quotation, from a New York Times article:

“Often introducing money into the exchange — putting it into the marketplace — is what people find repugnant. Mr. Bloom asserted that money is a relatively new invention in human existence and therefore “unnatural.”

Economists are asking the wrong question, Mr. Bloom said at the panel. They assume that “everything is subject to market pricing unless proven otherwise.”

“The problem is not that economists are unreasonable people, it’s that they’re evil people,” he said. “They work in a different moral universe. The burden of proof is on someone who wants to include” a transaction in the marketplace. (Mr. Roth, who acknowledges that “economists see very few tradeoffs as completely taboo,” did not take the criticism personally.)”

Sadly, it seems that Bloom was kidding. Isn’t it nice that “economists are evil” is a statement that can be mistaken for seriousness, but “psychologists are evil” is so clearly ridiculous?

How can economists plausibly evil, but psychologists cannot? I think the idea that economists “assume that “everything is subject to market pricing unless proven otherwise.”” is wrong. It’s a common criticism: economists reduce everything to dollars and cents, trying to measure the value of stuff that’s invaluable (the article is talking about how “repugnance” affects trade, using the example of selling organs).

As the social science of the allocation of scarce resources, how could economics operate without trying to figure out some concept of the value of something to someone? I think environmentalists have long despised economists for this reason. Say we’re talking about a scarce natural resource, a rain forest for example. Again, positive economic science cannot possibly hope to tell us what the “best” use of this resource is, but it can hope to tell us the consequences of each use. Unfortunately, it’s clearly easier to measure, say, the value of this resource to the logger and grazer who seek to use it today than it is to measure the value to humanity of preserving the forest.

Similarly, it’s easier to measure the willingness to pay for an organ by a terminally ill individual, and to measure the willingness of another individual to give up an organ, than it is to measure the potential consequences of allowing the sale of organs. The question at hand is: do we do what we can, even given this imbalance, or does the imbalance justify making no valuation, even the ones that are possible? Is attempting to value anything an assumption that “everything is subject to market pricing”?

Trying to understand more about the consequences of a particular allocation of resources is not the same as either propagandizing for that allocation or method of allocation, that is, markets. Even in jest, the charge that we “operate in a different moral universe” is a serious one. It actually makes me very sad, because I’m very familiar with the particular problem of introducing myself as an economist: it alienates a decent percentage of people you meet. (“I’m an economist, but I’m not evil, honest”.) Economists are evil, or at least morally bankrupt, to some people. I wish that wasn’t the case.

It’s understandable. Let’s take the ideal world where all positive economics is done scientifically and without normative judgment. Is it surprising that value-neutral economic science seems evil, while value-neutral physics, or chemistry, or psychology, seems like the noble pursuit of knowledge? The Methodology of Positive Economics by Friedman is, again, eloquent on this subject:

“The subject matter of economics is regarded by almost everyone as vitally important to himself and within the range of his own experience and competence; it is the source of continuous and extensive controversy and the occasion for frequent legislation. Self-proclaimed “experts” speak with many voices and can hardly all be regarded as disinterested; in any event, on questions that matter so much, “expert” opinion could hardly be accepted solely on faith even if the “experts” were nearly unanimous and clearly disinterested. The conclusions of positive economics seem to be, and are, immediately relevant to important normative problems, to questions of what ought to be done and how any given goal can be attained. Laymen and experts alike are inevitably tempted to shape positive conclusions to fit strongly held normative preconceptions and to reject positive conclusions if their normative implications – or what are said to be their normative implications – are unpalatable.”

It’s not just confusion between positive and normative economics, between the practice of the science and its interpretation, it’s the very attempt to be value-neutral, to be agnostic, that makes economics seem evil. This is all the more true if, as Friedman is arguing, that there’s temptation to attach value judgment to positive economics. If there’s any hope of us shedding the “evil” tag, this is a temptation that all economists must resist and fight.

Getting what you want: when should politics invoke economics?

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The health policy exchange during the Democratic debate on Thursday shows exactly where economics should fit into policy, and politics. I’m not in the business of policy analysis, so instead let’s ask how an economist could help Senator Clinton achieve the goal she stated in the debate:

“But if you don’t start by saying you’re going to achieve universal health care, you will be nibbled to death.”

As I said before, I think there are two places for positive economics in the formulation of policy. One is when we ask “what will happen if we do this?”, and the second is when we ask the question Hillary’s statement invites: “how can I achieve that?”. America is no technocracy, so there’s no way positive economics can tell us what to do; that question is for every person and every candidate to decide.

This doesn’t just apply to questions within the rules of the game. If we take the biggest possible economic question, “how should our resources be allocated?”, it’s still the case that positive economic science cannot tell us, for example, which of capitalist markets, socialist planning, or making decisions by rolling dice is “best”. It’s not even difficult – it’s impossible. The furthest positive economics can go is to say that if you want to achieve some particular objective then one of the systems might be the most successful, but that obviously relies on the purely subjective notion of what you want.

Even when our questions get more specific – for example, not “how should our resources be allocated?” but “what should we do about health care?” – exactly the same principle applies. So, with that in mind, Senator Clinton has taken the subjective position in support of “universal health care”. Let’s take a look at the second part of the quotation from the debate:

“But if you don’t start by saying you’re going to achieve universal health care, you will be nibbled to death.”

The argument there is that if you don’t define your normative goal well enough, even getting close to it becomes more difficult, which is probably true. Even more fundamentally, it’s impossible for a politician to be “wrong” when taking a normative position. Like I said, I won’t try a policy analysis asking whether Clinton’s policies will really achieve her goal, and I make no judgment on that question.

With that in mind: unfortunately, actual policy has to be made to try to achieve the normative goal. If there’s significant doubt that the policy will lead to the outcome stated in the goal, then the politician is misguided or, worse, lying. Political campaigns sometimes seem to promote either depressive pronouncements of how we’re all going down in flames, or their ideological counterpart, the Utopian “I can make it all better”, neither of which have much in common with the real goals of the candidate. Realism doesn’t often sell well, but noble aims without realism run dangerously close to fraud.

To put this in a real context, even if I don’t care about your immigration policy, I care about whether or not you are honest in presenting it. Again, positive economics can’t say whether you should close the borders; it can (perhaps) describe some of the likely consequences of doing so, and to convince me that your plan to close the borders is sensible you must convince me that, on balance, the many dimensions (moral, financial, political) of the problem favor your plan. If, in doing so, you fail to acknowledge or deny the consequences your argument is immediately bankrupt. That doesn’t only apply to whatever consequences economic science can help us figure out – it applies to everything.

Even though I believe that economics can be a tool for analyzing more than just financial consequences, it would be wrong to claim that economic science can tell us everything we need to do. If it could, we might as well just cede to a technocracy. What we can do is help set out the means to your chosen end (as in the example of achieving universal health care), or describe the consequences of your policy (as in the example of closing the borders). To argue that other things matter more than what economic science tells us is defensible; to lie about what economic science tells us is wrong.

Too complicated?

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One of the principles of writing economic theory is to create a simplified abstraction of reality. If the theory convincingly isolates an idea, it cannot be too simple; hopefully, the narrower the question, the simpler the theory can be written.

Economists therefore appeal to the “all else equal” assumption a lot. The oft-perceived superiority complex of economists is traceable to our willingness to use the “all else equal” clause to make our questions answerable, theoretically and empirically. If we want to write relevant economic models that investigate the link between A and B, we hold C equal; whether or not C would really be equal or relevant in reality, we can’t isolate the effect we’re interested in if we don’t figure out a way stop it from contaminating the abstraction.

It’s the same principle that underlies the ideal of “controlled experiments” in all science; empirically, if we want to figure out how A and B are related, I need to be careful to avoid finding an effect because a third factor C is involved. For example, there’s an important difference between “people who exercise more have a longer lifespan” and “people who exercise more also eat well, and people who eat well have a longer lifespan”. That’s well understood in statistics and empirics generally; there’s no reason why the same principle is not also needed when we use the theoretical standard of proof rather than the empirical standard of proof.

Why, then, is “economic theory” so amazingly bewildering? With very little exaggeration, we can claim that no great development in the science of economics has used very complicated techniques, even when math was involved, yet even to the technically competent a lot of economics research is very difficult to understand. Of course, if an economist could all find ground-breaking theory that can be represented in two lines, I’m sure she’d write it. Is the reason for the complexity an attempt to make average ideas look better?

Let’s be charitable and assume that’s not the case. I think that once we exclude the “obfuscation motive”, there are two possible reasons why economic theory is technically complex. One might be that the relationships being investigated are broader, that less is held equal, that we’re looking to more nuanced explanations. Another possible reason is, paradoxically, that theory gets more complex as the questions get narrower – the more we assume, the higher the complexity.

Why? Imagine I want to figure out the relationship between a person’s income and the number of hours that person does voluntary work. This is a question that asks about how people allocate a scarce resource, time. I might make an abstraction that says “if all people like both money and helping others, then people with higher incomes will spend more time helping others, while people with lower incomes will spend more time trying to earn extra money.” I might make an abstraction that says “people with more income work more so have less time to volunteer”. What assumptions lead to the first conclusion, and what to the second?

If I wanted to broaden my question, I might start including in my theory labor market conditions, the availability of volunteering opportunities, the peer pressure to volunteer, the social pressure to earn more money to buy a big car, and so on and so forth. That would certainly make my theory more complicated; whether or not it makes it a better theory than the one that kept all that stuff equal and abstracted from it is a matter of preference, but I’m sure it would be more difficult to understand.

The second way to make the theory more “complicated”, at least superficially, might be to keep all the same stuff equal, but to say “imagine the person cares this much about money and this much about volunteering; then someone with this income will volunteer this much”. The abstraction is getting more abstract; we are getting more and more specific about the conditions of our model, and we must use more specific techniques to, in particular, quantify the result.

What do we gain from this quantification, and what do we lose? Perhaps we can look at actual evidence on the link between income and volunteering, and compare it to the quantified prediction, but that only works if all else is equal in our evidence, too. A better justification is that we can get a theoretical idea of how big our effect is. However, as we get more specific we get more abstract; in this example, we’re getting more abstract about preferences, which are themselves unobservable. We’ve gone from “a person cares about money and volunteering” to attaching magnitudes to those cares.

The link between simplicity and usefulness is not just in the realism of the abstraction; it’s also in the procedure itself. Economic theory should be neither too broad or too narrow, but “just right”, whatever that means. Assume too little and we can’t figure out what’s really causing what; assume too much and you rest an entire argument on a special case. What’s the simplest model that explores the relationship I care about, and what’s the simplest model that shows what I want to show about that relationship?

Oh, and a practical suggestion: I’d love it if we all stopped writing ceteris paribus and used “all else equal”. What’s with the Latin?

Arguing in economics: the gray area

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Despite being interested in figuring out exactly what economics is, really, I have to confess that I don’t really care about the common question “is economics a science?”. Trying to answer it seems to tie people in knots, and I don’t think the question by itself is very important. However, I just found a nice article on the subject which set me thinking.

My economics education was very essay-centric, and, perhaps paradoxically, I think was a good means to understanding what it takes to be “scientific” in a social science. A good essay has to contain more than raw emotion, but similarly should not avoid interpretation. It’s equally difficult to argue using facts alone as it is to argue without them.

Is “good economics” the same? A theorem or result is, by nature, empty in itself – it’s just a logical chain from start to finish. With the right starting point, you can “prove” anything; with an unproveable starting point, you’re really in business. However, for the result to matter, it has to be put in context. What does it mean? Maybe it’s semantics, but the search for meaning – the interpretation – is the birth of a normative judgment, still value-free but certainly pushing that label as far as it can go, before the true normative judgments of what we want are made.

The separation of the “scientific method” of economics and the use of its results must be sacred. The former, done from a position of honesty, can never be “wrong”, since it’s just logic. Why, then, must we introduce interpretation at all? The best reason to do so is the problem of “underdetermination”, the idea, captured in the Friedman quotation I mentioned in a previous post, that if there exists another theory at least as consistent with the evidence, our theory is “underdetermined”: all, perhaps, related to the problem of the unproveable starting point.

The underdetermination issue is, I think, especially relevant to theories which rely on behavioral assumptions, given that we know that humans are (sometimes) capable of being pretty nuanced in their behavior. Whether or not any scientific theory can be airtight is up for debate; in economics, I am convinced that no theory can be airtight. That’s not to say we can’t be nice empiricists and check predictions against evidence like scientists do, but it is to say that the alternative, consistent theories must be addressed before we can cross the line from positive science to normative policy. I have to show that my theory can be right, but also argue that mine is the most right, especially if I want to take my theory from the sterile, all else equal, scientific vacuum into inference about the real world.

Just like a debater or an essay writer, any position I occupy can be attacked, and defense is the only response that will preserve that positive, scientific position. If we can prove anything, if any hypothesis is underdetermined, then whether or not economics can be called a science, the scientific method alone won’t be enough. Somewhere between that scientific method and the politicking of normative selection lies that subtle gray area which all of our correct, consistent theories must cross. There we must decide what we want to use them for, and how they should be received; the “useful” ones must be the only ones allowed to survive.

Can you test rationality?

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Is it possible to test if people are rational? I think the answer, practically, is a very short no: if a rational person tries to achieve his most preferred outcome of the ones that are available, we can’t distinguish the rationality or irrationality of his choice from his preferences. That is, if I don’t know what you like, I can’t tell if you did something because you liked it or because you’re “irrational”.

Yet rivers of ink have been spilled trying to “prove” or “disprove” models of rational choice. The most famous study of the type is the “Allais paradox”, discussed here. It says that when you pose different choices to people, their responses to pairs of choices are “inconsistent” with each other because the two choices really represented the same cash outcomes.

Whether you look at the question being asked by this type of work “are people rational?”, or “what do people care about?”, it’s pretty clear that any observation cannot answer either of these without knowledge of the other. In “The Methodology of Positive Economics” (pdf) Milton Friedman made the valid, general point that

“If there is one hypothesis that is consistent with the available evidence, there are always an infinite number that are.”

It just so happens that if we interpret some piece of evidence as being consistent with “people are irrational”, one of the “infinite number” towers above all others: “you guessed the preferences wrong”. There’s nothing wrong with trying to figure out how to better model the decisions of people, but claiming to have proved irrationality is nonsensical.