Tag Archives: economics

Economics, general equilibrium and the Cold War

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I’m well into [amazon_link id=”0691156646″ target=”_blank” ]Finding Equilibrium[/amazon_link] by Till Düppe and E Roy Weintraub, about the parallel proof of existence of general equilibrium by Arrow and Debreu and separately by the less well-known and unacknowledged Lionel McKenzie. OK, it’s a special interest subject, but I’m enjoying the book, which isn’t at all inaccessible or technical.

[amazon_image id=”0691156646″ link=”true” target=”_blank” size=”medium” ]Finding Equilibrium: Arrow, Debreu, McKenzie and the Problem of Scientific Credit[/amazon_image]

Its subject is the allocation of scientific credit. McKenzie’s proof paper was published first, but he did not win the Nobel and is not recognized now as the first person to prove existence using a fixed point theorem. The book also traces in both the personal stories of the three men and the intellectual history of the time (the 1930s and 1940s) the mathematization of economics. None of the men whose histories are described here started out interested in economics – they were mathematicians (Arrow, Debreu) or physicists (McKenzie). The latter seems to have regretted ever after that he didn’t stick with physics.

I’ll do a proper review when I’ve finished. Meanwhile, it’s interesting to note the role John Hicks’s [amazon_link id=”0198282699″ target=”_blank” ]Value and Capital [/amazon_link]played in stimulating the work of at least two of the three subjects of this book. I have a copy on my shelves, bought in 1981, but it has left no trace of having made any impression on me either in my memory or in the form of margin notes. I must confess also that the bits of graduate micro where we had to plough through the general equilibrium proofs left me absolutely cold, and I had the best possible teachers (Frank Hahn and Andreu Mas-Colell). Although the point that the economy is a connected system is clearly important, the mathematical formalism seemed to me then and now worse than irrelevant – possibly dangerous.

My other first impression of this book is how much more persuasive it is in its account of the role of the Cowles Commission than the earlier work by Philip Mirowski (in [amazon_link id=”0521775264″ target=”_blank” ]Machine Dreams: Economics Becomes a Cyborg Science[/amazon_link]).  Duppe and Weintraub reject Mirowski’s argument that the Bourbaki-influenced group of economists at Cowles were inspired by their work for the US military at RAND corporation, although some (including Arrow) certainly spent their summers at RAND in Santa Monica.

Instead, they suggest that the mainly European emigré, mainly socialist scholars at Cowles (then located in Chicago) needed to prove they were not politically motivated. This was in the context of the House Un-American Activities Committee getting into full swing. There was also a wider tension in American universities between the independence of research funded by peer-allocated competitive mechanisms and doing research at other institutes in the national interest. The ambition to stay out of politics was all the more relevant given the formal equivalence of a general equilibrium solution describing a competitive market economy and a centrally planned economy (with full information, of course). There is no better description of this equivalence than Francis Spufford’s marvellous book from a few years ago, [amazon_link id=”0571225241″ target=”_blank” ]Red Plenty[/amazon_link].

[amazon_image id=”0571225241″ link=”true” target=”_blank” size=”medium” ]Red Plenty[/amazon_image]

Anyway, to say the economists needed to avoid trouble by depoliticising their work is miles away from the Mirowski claim that the economics profession, directed by the military, became an active Cold War combatant, a claim Düppe and Weintraub describe as “a mish-mash of political pre-conceptions and historical confusions.”

This is a sub-plot in [amazon_link id=”0691156646″ target=”_blank” ]Finding Equilibrium[/amazon_link], with the main storyline being about the allocation of scientific credit. I’ll do a proper review when I’ve finished.

Economists and humanity

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Peter Smith sent me his new book T[amazon_link id=”0957069707″ target=”_blank” ]he Reform of Economics: How the complex systems approach is building a realistic and humane alternative to laissez-faire[/amazon_link]. In a letter accompanying it, he said he has two motivations. One is to get economics out of the trap of over-simplifying so that models can use linear algebra and thus be made ‘tractable’. This is one of the things that makes complexity economics and agent-based modelling appealing; virtual economies run on a computer do not need to be solved algebraically.

[amazon_image id=”0957069707″ link=”true” target=”_blank” size=”medium” ]The Reform of Economics[/amazon_image]

The other aim is to make economic methodology something more like normal scientific methodology. Economic method consists of choosing some basic postulates and making deductions from them. The deductions can then be tested against data. Normal science involves both induction and deduction. Careful empirical observation will shape theory.

The book dates the choice of the purely deductive path to Lionel Robbins and his 1935 essay [amazon_link id=”B001037AGS” target=”_blank” ]The Nature and Significance of Economic Science[/amazon_link]. He defined economics as the science of constrained choice, which, “Not only excludes uncertainty, but it also excludes from the scope of economics both institutions and the medium-term evolution of economic systems.” This isolates economics from the institutional framework of the economy, and hence from what determines the availability of resources over time – it makes economics an inherently static subject.

Natural scientists do regard economics as bizarrely non-empirical – I’ve been in multi-disciplinary conferences about both macroeconomics and behavioural choice at which biologists exclaim about how rarely economists discuss data, for all that they might go away and test hypotheses. One of the joys of being on the Competition Commission for eight years was how profoundly evidence-based the process is, and hence a real insight for an economist used to generalising about how companies behave. There aren’t many business people who think about marginal cost curves and production functions.

[amazon_link id=”0957069707″ target=”_blank” ]The Reform of Economics[/amazon_link] is a game of two parts (not halves). It is mostly a critique of economic methodology but also has a useful introduction to agent based modelling. It ends on an upbeat note I very much like:

“Economics is becoming a much more interesting area in which to work and learn; and we have every hope that a more realistic and effective reformed science of economics will also be a more humane one. For, ultimately, economics is about the well-being of humanity.”

Resources on complexity economics

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Following my posts last week on complexity and economics, Professor Leigh Tesfatsion of Iowa State University sent me this very useful website with links to loads of resources on the subject – including an introductory self-study course.

Prof Tesfatsion wrote to me that the complexity approach has real momentum but added: “In macroeconomics, however, bitter resistance has been encountered, particularly from those who have devoted themselves to mastering DSGE modeling.” However, there is also some work on agent-based macroeconomics.

One general book I spotted in this list, one I’ve not read, is Mark Buchanan’s [amazon_link id=”1408827379″ target=”_blank” ]Forecast: What Physics, Meteorology, and the Natural Sciences can Teach Us About Economics[/amazon_link]. Nate Silver’s [amazon_link id=”0141975652″ target=”_blank” ]The Signal and the Noise[/amazon_link] doesn’t feature agent-based modelling but does talk about the macroeconomy as a complex (non-linear multivariate dynamic) system.

[amazon_image id=”1408827379″ link=”true” target=”_blank” size=”medium” ]Forecast: What Physics, Meteorology, and the Natural Sciences Can Teach Us About Economics[/amazon_image]

Serendipity, complexity, and loneliness

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No sooner (literally)  had I written about the complexity economics of the new book by David Colander and Roland Kupers, [amazon_link id=”0691152098″ target=”_blank” ]Complexity and the Art of Public Policy[/amazon_link], than (in one of the many instances of serendipity in life) another book  on complexity turned up in the post, courtesy of its author, Peter Smith. The book is [amazon_link id=”0957069707″ target=”_blank” ]The Reform of Economics: How the complex systems approach is building a realistic and humane alternative to laissez-faire[/amazon_link].

[amazon_image id=”0957069707″ link=”true” target=”_blank” size=”medium” ]The Reform of Economics[/amazon_image]

The book looks like it argues for a more realistic alternative to mainstream economics by actually developing it, using agent-based modelling. In a covering letter, Dr Smith says the intelligent agents: “learn by experience how to respond to market conditions. … They can engage in price exploration, and learn to manage their inventory, plant renewal and cashflow (or go bust), all starting from far-from-equilibrium states.” He also describes his research, and his search for a post-crisis renewal of economics as “a mite lonely.” I think it might be less lonely than he fears.

Slow demise of the economist ex machina

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A small number of economists have been interested in complexity theory and related approaches – agent-based modelling, network models – for a long time, and a growing number for a shorter time. Complex models in the technical sense of non-linear dynamic systems, with many inter-connections and feedbacks, can describe economic or financial data well. Their evolution over time is highly sensitive to initial conditions, and they are sometimes characterised by ordered states, a property known as emergence.

There are some very good books about complexity science, such as Mitchell Waldrop’s [amazon_link id=”0140179682″ target=”_blank” ]Complexity[/amazon_link], or Philip Ball’s [amazon_link id=”0099457865″ target=”_blank” ]Critical Mass[/amazon_link]. Albert Laslo Barabasi’s [amazon_link id=”0738206679″ target=”_blank” ]Linked[/amazon_link] sets out the related network approach. There are also quite a few books specifically about complexity in economics. The Santa Fe Institute has long been involved in complexity models, and Brian Arthur and Herb Gintis have applied them to economics. Paul Ormerod’s [amazon_link id=”0571197264″ target=”_blank” ]Butterfly Economics[/amazon_link], [amazon_link id=”057127921X” target=”_blank” ]Why Most Things Fail[/amazon_link] and [amazon_link id=”057127921X” target=”_blank” ]Positive Linking[/amazon_link] are all very accessible introductions to complexity in economics. Eric Beinhocker’s [amazon_link id=”0712676619″ target=”_blank” ]The Origin of Wealth[/amazon_link] is another. Alan Kirman more recently published [amazon_link id=”0415594243″ target=”_blank” ]Complex Economics[/amazon_link].

A new book [amazon_link id=”0691152098″ target=”_blank” ]Complexity and the Art of Public Policy: Solving Society’s Problems from the Bottom Up[/amazon_link] by David Colander and Roland Kupers is therefore not introducing a new area of research. But it is nevertheless doing two very interesting things.

[amazon_image id=”0691152098″ link=”true” target=”_blank” size=”medium” ]Complexity and the Art of Public Policy: Solving Society’s Problems from the Bottom Up[/amazon_image]

First, it locates complexity models in the context of the history of economic thought, explaining why and how economics turned away from the intuitively complexity-based approach of the classical economists (and the also both Hayek and Keynes ). There is a nice anti-reductionism quotation from Keynes: “Once the complexity of reality is carefully considered, the argument that applied policy concerns can be reduced to economics becomes so unreasonable that only an academic would dare consider it.” Colander and Kupers argue instead for what they describe as ‘activist laissez faire’, an approach which still leaves room for disagreement – as between Keynes and Hayek – but about empirical judgements and tactics rather than completely polarised, mutually exclusive approaches.

The authors link the turn in economics away from messy reality, towards sterile abstraction, to the work of Abba Lerner in the 1930s. They argue that his [amazon_link id=”0678006180″ target=”_blank” ]The Economics of Control[/amazon_link] was one of the founding texts of the viewpoint that came to dominate the discipline, the standard state control economic policy framework. This caught on because it was simple, clear, and cast economists as the experts who could identify what policies were needed to maximise social welfare with their analytically soluble models. State intervention was only needed when laissez faire markets failed – but one could argue that that was almost always. This is the attitude so brilliantly described in James Scott’s [amazon_link id=”0300078153″ target=”_blank” ]Seeing Like A State[/amazon_link]. Thus the stage was set for the dualism between interventionism and free market-ism, between ‘Keynesians’ and monetarists. The account in this book sets the reductionist turn in economics earlier than the conventional wisdom has it – others locate it in the 1940s and 1950s.

[amazon_image id=”0300078153″ link=”true” target=”_blank” size=”medium” ]Seeing Like a State: How Certain Schemes to Improve the Human Condition Have Failed (Yale Agrarian Studies)[/amazon_image]

Aside from the discussion of the history of economic thought, the main contribution of this book is that it discusses the implications of the ‘complexity framework’ for the way we should think about public policy, arguing that it will get us away from the sterility of the markets versus states dualism. Instead, the role of both has to be respected – government in setting the rules and conditions, markets in delivering bottom-up choices in an efficient way. The policy intervention is  itself inside the system.

As the book points out, this is not consistent at all with the standard frame of economics, in which the economist is a deus ex machina calculating the optimal policy and implementing it – a command-and-control framework of thought that has spread far wider than economics to capture all of public policy and even business decision making.This has extracted a high price and I think is certainly at the root of the present dissatisfaction with economics.

The authors argue that the problem in economics itself is mainly with macro and theory, as the applied micro areas of the field have been steadily moving away from assumed rationality, linearity, static equilibrium etc for some decades now – behavioural economics being the obvious example. In 2000, this led Paul David to declare that ‘neoclassical’ economics was dead. The exception, however, is the one bit of economics that all normal people know about because it’s in the news all the time, not least because of the financial crisis and its aftermath. As the authors write: “Issues of morality, the market and the constitutional order should have been central to the policy debate about macroeconomics. They weren’t. The standard frame eliminated them from discussion.” They are wonderfully scathing about modern DSGE macro, a view with which I wholeheartedly agree. “While microeconomics has evolved considerably in the direction of complexity, progress in macro has been very limited.” What students are currently taught in their macro courses is not useful and in fact inconsistent with empirical reality.

Outside economics, in the wider influence the subject and its approach have had on public policy, reductionism still reigns, and probably will until future generations of people who have studied economics have experienced a different kind of curriculum. Colander and Kuper end with a curriculum reform proposal – economics education is a longstanding interest of David Colander, who contributed a chapter to [amazon_link id=”1907994041″ target=”_blank” ]What’s the Use of Economics[/amazon_link]. Role on the roll-out of INET’s CORE curriculum!

However, I think this book is more useful for people in the policy world rather than universities. It could start to chip away at the damaging idea that policy makers are deus ex machina, outside the system (something I spoke about in my Pro Bono lecture The Economist As Outsider), and focus attention once again on the importance of the institutional, cultural and ethical framework within which people make economic decisions.