Seven reasons economics needs to start from scratch

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Business Cycle / Complexity Economics / Economics / Eric Beinhocker / Philosophy

There are a number of problems with mainstream macro-economics so fundamental that they require the slate to be wiped clean and the enterprise begun from scratch. Here is an incomplete (but growing) list of knockout issues with the conventional approach.

Economics can’t describe the Business Cycle Economics’ first assumptions prevent it from explaining its central phenomenon. The first question of the economy is the nature of the business cycle. Economics has no useful theory of the business cycle. In fact, since Walras (100 years) it has been impossible for economics to generate a theory of business cycle because it assumes that the economy is an equilibrium system. An equilibrium system can not self-generate cycles of any kind. link

Economics can’t describe the Global Financial Crisis The most widely used economic models in the run up to the GFC did not contain banks or a financial sector. That is to say that the models used by economists could not describe the most significant economic phenomenon of the last 50 years. Rather than discard their discredited theory economists have added a series of fiddle factors in an attempt to hide their failure. These models are still widely taught. link

Economists don’t understand the relationship between their models and the real world Economists believe that only universal economic models can be scientific. Attempts to create these models require assumptions that are known to be false. But followers of this approach believe so strongly in the premise that there can be no science of economics if there is no one universal model, they prefer to accept false assumptions as an approximation to the truth. The removal of the essential constraint of realism has turned economics away from the search for truth. link

Economics uses an invalid methodology Following Milton Friedman, economists have adopted the methodological assumption “the more significant the theory, the more unrealistic the assumptions”. This sometimes called the F-twist. In practice “unrealistic” means false.

Economics actively prefer theories with false premises over true ones. If a theory with false premises produces outputs that can be construed to match observed values the theory is thought to be confirmed. Macroeconomists simply “do not care about facts”. link

Economics makes assumptions that break the most basic scientific laws Economists have little understanding of the nature of science and use methods that a physicist would laugh at. In particular, economics uses the wrong mathematics because it misidentifies the nature of the economy as a system. For the system to be as described it’s defining characteristic would be entropy – the trend towards less order, complexity and structure over time. The truth is precisely the opposite. link

Economists are fixated on discredited 19th century science There are many examples of anachronism in economics. For instance there is a bizarre interest in strong reductionism. It is inexplicably thought to be scientific although the physical sciences abandoned the idea before contemporary scientists were born. Not one engineer, chemist or biologist believes their science to be applied particle physics. Strong reductionism denies what philosophy and science call emergence. Emergent properties are essential to all physical phenomena at the visible level, and all social phenomena, including those studied by economists. link

Economists can establish no clear links between their models and observation As models become more complex it gets ever more difficult to connect them to actual observations. This is known as the Identification Problem. Consider for instance an equilibrium model be comprised of two equations – one for the demand curve and one for the supply curve. Observations of pairs of quantities of supply and prices in the market can not, of themselves, validate that theory. It isn’t possible to determine whether it is the supply or demand curve that is moving. link

It is very difficult to make reliable inferences about causality from the observation of variables that are part of a simultaneous system. In practice its heads economics wins tails we lose. In 2003 Robert Lucas said “macroeconomics … has succeeded: Its central problem of depression prevention has been solved”. In 2008 he said that the success of macro-economics had nothing to do with depressions – economics predicted that such events cannot be predicted.

In summary – macro-economics makes use of models that

– use mathematical approaches long ago discredited
– ape centuries old science
– are based upon premises that are known to be false
– are compatible with just about any observed event in the real world

This leaves them largely, if not completely, devoid of value.

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2 Comments

  1. Jan Svenda says

    Hey,

    Continuing our discussion from the FT article. I would agree with every point (and probably add that studying history is imperative and is completely missing).

    I had a look the other day at what American Economic Review thought was its ‘Top 20 Articles’ (http://pubs.aeaweb.org/doi/pdfplus/10.1257/aer.101.1.1) from which I really liked only Hayek’s classic and maybe the presidential address from Friedman. My preferences are though besides the main point.

    The main point that I took away from this list is the following comment underneath the article of, funnily enough, Robert Lucas on output-inflation tradeoffs which ends with this sentence;

    ‘The underlying assumption has gone out of favor, but the modeling technique has been very influential.’

    I felt that this is the essence of contemporary economics. The author was wrong in the conclusion BUT the modeling technique, now, that’s something useful.

    I am not sure though what do with the current toxic state as it is so well embedded in the whole field. I am also not sure about the nature of economics as a subject.

    // Personally I am currently focused on central banking and the role of central bank in the economy because I believe that this is the biggest issue in the real world now, especially when the central bank operates in a financial sector that is or at least was deregulated but the central bank is not ‘decentralized’ (i.e. it allows a sandbox environment for bankers which then have skewed incentives). Also one has to look at the glaring conflicts of interests within the US central bank etc.

    This specific topic also comes back to your article and the point about the financial crisis which is completely misunderstood by the academia.

    Best,

    Jan

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