Tag Archives: economics

Thinking about welfare economics – or not

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I’ve been reading I.M.D.Little’s [amazon_link id=”0198281196″ target=”_blank” ]Critique of Welfare Economics[/amazon_link] (1950 originally – I have Andrew Sentance’s slight musty, rescued from his garage, 1973 paperback). He wrote: “There can be no significance in national-income comparisons unless a value judgement about changes in distribution is presupposed. But statisticians … do not, of course, wish to make any such presupposition.” He continues that they can tell us that the market value of consumption goods has increased, but cannot conclude that consumption has increased. “There is, after all, no such thing as consumption, the size of which can be measured.”

[amazon_image id=”0198281196″ link=”true” target=”_blank” size=”medium” ]A Critique of Welfare Economics[/amazon_image]

Winging its way to me now, courtesy of a recommendation by Martin Wolf, is [amazon_link id=”0521094461″ target=”_blank” ]Theoretical Welfare Economics[/amazon_link] by J de V Graaff (1957), which one contemporary review described as “an elegantly executed demolition of ordinary welfare theory.” I don’t need a lot of persuading about the demolition-worthiness of the theory but it does leave rather a huge question about (a) what we think we’re measuring with the national accounts and (b) what we think standard evaluations of public policy are telling us. The answer, of course, is that mostly we don’t think about it.

[amazon_image id=”0521094461″ link=”true” target=”_blank” size=”medium” ]Theoretical Welfare Economics[/amazon_image]

People and economists

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There’s a chapter online from a forthcoming book, Economic Psychology edited by Robert Ranyard, called How Laypeople Understand Economics, by David Leiser and Zeev Krill. Although not entirely surprising, the chapter is very interesting. Those of us who are economists long ago internalised the subject’s distinctive way of thinking and understanding of how variables are related. Most people find economics difficult, even mysterious, however. There are some excellent demystifications, from John Lanchester’s [amazon_link id=”039335170X” target=”_blank” ]How to Speak Money[/amazon_link] to Tim Harford’s [amazon_link id=”0349119856″ target=”_blank” ]Undercover Economist[/amazon_link], and all the rest of the popular economics literature. But as this chapter points out, laypeople – including many politicians – will use one of three strategies for trying to make sense of economic discussions: use heuristics; use metaphors; fall back on teleological or causal explanations.

One example of a common heuristic is ‘good begets good’ – if there is a change in one variable perceived to be good, it is assumed it will cause good changes in other variables. On metaphors, the authors comment: “Understanding of financial marketsrelies onseven metaphors: the market as a bazaar, as a machine, as gambling, as sports, as war, as a living being and as an ocean. Crucially, each metaphor highlights and hides from view certain aspects of the foreign exchange market. Some of themetaphors imply market predictability, others do not. For instance, the sports and themachine metaphors were found to be associated with fixed rules and predictability, whereas the bazaar and war metaphors with unpredictability.”

[amazon_image id=”039335170X” link=”true” target=”_blank” size=”medium” ]How to Speak Money: What the Money People Say-And What It Really Means[/amazon_image]  [amazon_image id=”0349119856″ link=”true” target=”_blank” size=”medium” ]The Undercover Economist[/amazon_image]

Economics, meet reality

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I was reading some of the essays in the volume on [amazon_link id=”0521709849″ target=”_blank” ]The Philosophy of Economics[/amazon_link] edited by Daniel Hausman, and was struck by the echo in a terrific comment by Herbert Simon of something Dani Rodrik says in [amazon_link id=”0393246418″ target=”_blank” ]Economics Rules[/amazon_link]. (The Simon paper was originally in the AER P&P volume for 1963, Vol 53 (1963): 229-231.)

Simon, like Rodrik, points out the logical fallacy of using an empirical observation to validate the assumptions of a theoretical model devised to explain – or at least for consistency with –  that empirical observation. The assumptions must also be empirically valid, or validated, Simon argues. “The remedy for the difficulty is straightforward, although it may involve more empirical work at the level of the individual actors than ost conventionally-trained economists find comfortable.”

Market theories, and macro theories, do need micro-foundations, but empirical ones, foundations based on how people or firms behave. Do businesses maximize profits? Of course not, or at least, economists do not test the assumption before they build models on it. In my years on the Competition Commission taught me, many businesses can be blithely unaware of which of their activities make the most profit. As I’ve complained about macro models before, they might indeed have theoretically rigorous micro foundations but are ad hoc with respect to reality.

[amazon_image id=”0521709849″ link=”true” target=”_blank” size=”medium” ]The Philosophy of Economics: An Anthology[/amazon_image]  [amazon_image id=”0393246418″ link=”true” target=”_blank” size=”medium” ]Economics Rules: The Rights and Wrongs of the Dismal Science[/amazon_image]  [amazon_image id=”0472050079″ link=”true” target=”_blank” size=”medium” ]The Cult of Statistical Significance: How the Standard Error Costs Us Jobs, Justice, and Lives (Economics, Cognition & Society)[/amazon_image]

Simon goes on to suggest that economics adopts the scientific practice of making sure assumptions simplify but approximate sufficiently closely to the real world. He, like [amazon_link id=”0472050079″ target=”_blank” ]Deirdre McCloskey and Steven Zilliak[/amazon_link], bemoans the tyranny of statistical significance rather than maningfully significant: in hypothesis testing, “We do not primarily want to know whether there are deviations of observation from theory which are ‘significan’ in this [statistical] sense. It is far more important to know whether they are significant in the sense that the approximation of theory to reality is beyond the limits of our tolerance.” Unfortunately, it is much easier to read a t-statistic from a software package than to think (and apparently also too hard to consider the statistical power of regression results) so the tyranny of statistical significance continues.

Being modest about economics

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“Economics is a wide enough subject already without having to include the whole of philosophy, psychology, sociology and human biology in addition. Let economists get on with their work, and let students of other social sciences get on with theirs.”

Colin Clark, [amazon_link id=”B0019XFB9M” target=”_blank” ]The Conditions of Economic Progres[/amazon_link]s, 1940

[amazon_image id=”B0006DB6N6″ link=”true” target=”_blank” size=”medium” ]The Conditions of Economic Progress[/amazon_image]

Sharks and economists

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I’m very much looking forward to hearing Joris Luyendijk talk about his book [amazon_link id=”1783350644″ target=”_blank” ]Swimming With Sharks[/amazon_link] at the Festival of Economics in Bristol next month. It’s an excellent piece of reportage on the City and the ways in which it traps its workers into certain forms of behaviour.

[amazon_image id=”1783350644″ link=”true” target=”_blank” size=”medium” ]Swimming With Sharks: My Journey into the World of the Bankers[/amazon_image]

However, Joris’s attack on economics in The Observer this weekend is, unfortunately, stuffed with all the false old chestnuts critics of the subject always trot out: economics is not objective like physics (string theory? hello?!); modelling involves the assumption that there are ‘timeless truths’ in economic behaviour; GDP is not an objective temperature measurement of the economy (I can recommend him [amazon_link id=”0691156794″ target=”_blank” ]an excellent book[/amazon_link] – by an economist – on that issue!)

[amazon_image id=”0691156794″ link=”true” target=”_blank” size=”medium” ]GDP: A Brief but Affectionate History[/amazon_image]

He writes: “Why should bankers ask themselves if a lucrative new complex financial product is safe when the models tell them it is? Why give regulators real power when models can do their work for them?” That question answers itself: because it was more profitable. Surely a sociologist of the City would find that almost nobody in banking gave much thought at all to the underlying economics of financial markets? Financial economists have much to answer for, but there is an odd tendency among critics of economics to attribute extraordinary power to  ‘the model’ rather than to politics or the sociology of financial institutions.

The article argues there should have been more research into the sociology and anthropology of the City. Quite right. But isn’t that what sociologists and anthropologists do? Economists like me have no training or experience in those research methods. I agree, too, that there are economists who disguise their politics as technocracy; I’d call them macroeconomists but some of them take umbrage when I do so. There is tons we don’t know about aggregate behaviour in actual economies. Neither that fact nor its acknowledgement make economics rubbish, or even unscientific. There is tons we don’t know about the natural world too. And by the way, physicists, biologists and chemists all use models. So do historians, just with words instead. Possibly even sociologists.

Don’t read me as saying economics has no criticisms to answer; it certainly does. But it is exasperating to read the same old same old nonsense from a critic who uses the misuse of one sub-field of economics by people in the financial markets to rubbish the whole subject, about which he seems to know very little. So I look forward to welcoming Joris to the Festival, where he’ll be able to hear a lot of economists engaging with the public, and talking about the environment, social mobility, immigration, the scope of government and many other issues.

Meanwhile, I agree with Dani Rodrik’s tweet:

rodrikdani
One reason I wrote Economics Rules is commentary like this, which misleads more than it illuminates https://t.co/y1v2dk5d76
11/10/2015 22:35

and recommend strongly his [amazon_link id=”0393246418″ target=”_blank” ]Economics Rules[/amazon_link]. I might buy a copy for Joris.

[amazon_image id=”0393246418″ link=”true” target=”_blank” size=”medium” ]Economics Rules: The Rights and Wrongs of the Dismal Science[/amazon_image]