I read with interest an article that Simon Wren-Lewis has published this week. In it he says:
I want to talk about the latest Oxford Review of Economic issue on ‘rebuilding macroeconomics', and particularly the first article by David Vines and Samuel Wills. The first thing I want to say is that the title is pretentious. Academic macroeconomics is reasonably happy doing what it is currently doing and in that sense there is nothing to rebuild. A better title is future directions for macroeconomics.
I suspect Simon is right: macroeconomics has always had a remarkable ability to be conceited despite its very obvious failings. But the next paragraph is the more important:
The Vines and Wills article suggests two major changes in direction. The first, following Blanchard, is to partly reverse the microfoundations hegemony, by allowing models or parts of models that don't include microfounded models routinely back into the top journals. The second is to focus on models that allow more than one long run equilibrium. I will take each in turn.
Simon then discusses these two issues and I recommend reading what he has to say. What I want to do is pull back further than he did and point out the absurdity of the claims that are being discussed. Simon remains too close to macro to do so, I think, and I stress I am not offering criticism when saying so.
The two claims being discussed are so absurd it is staggering that they need be considered. What is being said is not that the macroeconomy is, in fact, simply the aggregation of the microeconomy, although that, of course, would be wrong in itself. What is being said is that macroeconomics must be based on microeconomics or it is not considered suitable for discussion in peer-reviewed journals, whilst it also almost always assumes that there is one optimal solution to all economic problems.
Let me address the two issues, separately, and then together. Firstly, the presumption that there must be a microeconomic foundation to macroeconomic theory is simply to say that macro must be based on the critical assumptions that underpin micro that are intended to ensure that it can deliver mathematical solutions to problems too complex in reality to be subject to sensible mathematical analysis.
So, macro must presume perfect knowledge of both the present and future, perfectly competitive markets where no one participant can influence prices, perfect access to capital that is available to all who want access to it, and of course an absence of externalities.
And before anyone says both macro and micro can manage deviance from these assumptions, of course I know that. But the point is it considers any situation where such things do not exist to be deviant. And that is wrong. In the real world none of these conditions even remotely exist. Something that even approximated to them would actually define deviance in reality.
But macro is built on these foundations. And the reason is linked to the second issue Simon challenges, which is the general requirement within macroeconomics that models be built where there is just one optimal or equilibrium scenario. That this is, by some odd fluke, one where the conditions that supposedly underpin microeconomics prevail in society, and pure markets meet all need with minimal government interference, with all consequences of all actions arising in the present point in time, is just one of those strange coincidences macro ignores as it pretends that this is not its pre-ordained outcome.
What, I suggest, Simon should have been saying is that macroeconomics is as rigged as recent government reports on policing and institutional racism were rigged to provide pre-ordained outcomes, because that is the reality of the current state of theoretical macroeconomics.
This is why what I do is, I suggest something else. I happened to touch on this theme in the introduction to ‘Money for nothing and my Tweets for free', written this week, where I say, having discussed the weaknesses in macroeconomics:
My approach is, then, to look at the real world first, and to use the insights that theory provides to mould what I believe are pragmatic answers that can exist within the real constraints that society imposes (rightly or wrongly) to provide workable solutions to the actual problems that we face. If that tramples on any theoreticians' toes, so be it.
This conflict with pure theory is almost inevitable, anyway. That is because what I do is applied political economy, and not economic theory. In applied political economy, unlike economics, there is no assumption that there is an ideal form of economy. Market fundamentalists and hardcore socialists will, in that case, be disappointed by my approach. I believe in the private sector, whilst recognising that it is riddled with faults. I also think government is a fantastic tool for delivering many of the things that we need. It just so happens it can also fail to do that. I can live with the paradoxes and inconsistencies. Day-to-day we all do.
What that means is that instead of looking for perfect theoretical worlds, in applied political economy the question is, very often, why do we fail? The answer invariably comes down to the fact that we're human. We're not good at a number of really important things. Complexity is one of them. Pragmatism is another. Compromise is a third. Managing uncertainty is a fourth. We also suffer a number of self-limiting traits. Vanity, greed and belief in our own importance rank high amongst these, and I will acknowledge straightaway that I have been accused of all three before anyone does so for me. These things are the given truths of applied political economy for me. They mean that things will go wrong.
And the distribution of income and wealth and so power in society, which is a given in society at any point in time, has the marked propensity to make things worse, meaning it too is a significant factor to take into account in applied political economy.
My point in saying this is to suggest that economic theory is not always a great tool, by itself, to suggest a way out of the resulting mess. That mess is too complex in its nature and its extent to be captured within any one theory. Nor is any theory necessarily very enduring, because the reality is that the mess we humans create appears to be endlessly capable of adaptation. The emergence of the climate crisis is evidence of that, and changes pretty much every assumption we have made to date.
What I am suggesting, in that case, is that there is no perfect solution to an economics problem. I would have thought we should have learned that by now, but apparently not. Instead economics, on both the left and right, still pursues the idea that there is some ‘ideal state' to which we are headed, whether it is the pure market economy or socialism, or some other ‘ideal'. That though, is not true. Not only does no such ideal exist, as indicated by the fact that all of them have their opponents, but nor are they possible. And the idea that these mythical ideals represent some sort of economic nirvana is in any case just wrong: the propensity for human error will be just as strong in an ideal state as it is now, and without the moderating common sense that is essential if an economy is to work. That is why I look for practical answers to current questions, rather than seek to promote a theory. What I seek to do is mix an understanding of theory with a dose of experience to which I add a portion of ethics to suggest solutions.
The question is what is more useful? Is it macro, based in micro, that is rigged to always suggest pure marker solutions to problems, because that is all it is programmed to deliver, or applied political economy that is intended to find workable solutions to real world problems? I think you can guess my answer to that.
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The key word is ‘management’.
Letting markets run riot is not management in any sense of the word. And talk of combining macro and micro elements is just a way of negating Government intervention and is typical Mont Pelerin cod intellectualism via the back door. God – they’re a persistent lot aren’t they?
I look at what the game of rugby has taught me over the years,
Rugby is chaos – coaching it, refereeing – you have to want to do it. So rules have been introduced and it’s chaos but managed chaos. It’s a game where you have to be involved and stand up and intervene and uphold the laws. And this gets results.
Government has to be the same as a rugby referee in the economy. It cannot be lazy – set it and forget it – all that bollocks. It has to be there. Be as dynamic as the market itself. Policy timelines – forget them – management of the economy needs to be more situational as well as more regulated (rules to uphold an assert).
Of course, we know that chaos is the back bone of the financial sector and get rich quick merchants so they would never stand for that because these are the main beneficiaries of a lack of management.
But I’ve said it all the same.
‘Macroeconomics’?
‘Fighting’ yesterday’s ‘battles’?
Usually the ‘economists’ who use ‘macroeconomic models’ ‘believe’ that the solution to the current macroeconomic problem is the implementation of the ‘correct’ type of demand side policies. That is, how to increase income/output {‘growth’}.
Increase M0, M2 or M3, cut r, or make it negative. Increase G and finance it by ‘borrowing’ from the central bank or by borrowing from the private sector. Or ensure that private credit is extended only for GDP transactions.
All that is lacking is a ‘sufficient’ increase in effective demand!
The neoclassical/Austrian economists, who believe that income/output is ‘supply determined’, will argue that all that is required to generate a large increase the growth of the underlying productive potential of an economy is for taxes to be cut and more ‘competition’, etc be introduced!
Aside from the negative externalities of ‘growth’, what they ignore is the ‘energy supply side’?
It’s ‘too late’?
‘We’ have ten years?
“ . . . our best estimate is that the net energy
33:33 per barrel available for the global
33:36 economy was about eight percent
33:38 and that in over the next few years it
33:42 will go down to zero percent
33:44 uh best estimate at the moment is that
33:46 actually the
33:47 per average barrel of sweet crude
33:51 uh we had the zero percent around 2022
33:56 but there are ways and means of
33:58 extending that so to be on the safe side
34:00 here on our diagram
34:02 we say that zero percent is definitely
34:05 around 2030 . . .
we
34:43 need net energy from oil and [if] it goes
34:46 down to zero
34:48 uh well we have collapsed not just
34:50 collapse of the oil industry
34:52 we have collapsed globally of the global
34:54 industrial civilization this is what we
34:56 are looking at at the moment . . . “
Louis Arnoux.
https://www.youtube.com/watch?v=BxinAu8ORxM&feature=emb_logo
Economics lost its way when it attempted to become a science with mathematical precision. The mathematisation of economics meant only theories that could “prove” a result could be valid. But economics is not like physics. Humans do not all behave in a uniform way like electrons, protons or quarks. Each human can behave differently in different situations and even the same human can behave differently in the same situation the next time it happens to them. No “proof” is possible. Only a direction of travel may be discernible but even this can change in time.
The best that can be done is to try things based on a best guess hypothesis and see if they work and if they don’t try something else. Economics needs to focus on the needs of the population and not just “prove” a mathematically correct answer that bears no relationship to reality as it is lived.
“My approach is, then, to look at the real world first”.
It is a direct condemnation of the discipline of economics that you feel obliged to write this; and it is not ‘macroeconomics’ or ‘microeconomics’ that we are talking about, but the discipline of economics itself. This was not a failure introduced by Adam Smith. who made a serious effort to begin with ‘observation’ of the world, in the aspiration to follow Newtonian method applied to human nature; but of later economists, who became besotted by mathematics, and made the poor judgement that economics could follow its own chosen ‘gold standard’ science – physics – by following theoretical physics alone, and simply discarding the need to establish a rigorous method of testing theory constantly against phenomena in the real world.
In physics nothing in theory is taken seriously until it has passed a rigorous test in experimental physics; the equations in experimental physics depend on the really difficult problem – measuring the real phenomena, and devising accurate, dependable, reproducible methods to do so. Indeed it would probably be fair to say that experimental physics is the more difficult, the more demanding, the more complex, the most resource devouring part of physics – but the theoreticians possess all the glamour, and the glib inspiration for the outside world.
There is no eqiuvalent in economics to experimental physics; they all appear to be desk-bound theoreticians. They have not even figured out how to test reality; they have developed no usable methodology. Wren-Lewis writes this in his article: “Why use SEMs instead of DSGE? Because they are likely to come closer to describing the real world, and they are very flexible to change.” Wren-Lewis is not writing about the measurement of the underlying data here; he is writing about a ‘model’; that is still some way distant from a discipline grappling with the measurement of real phenomena. Remarkably, Wren-Lewis then finds some support for the “microfoundational hegemony” in the work of the brilliant philosopher of science, Imre Lakatos. This remark strikingly resonates with the desire of economists to be considered somehow close to physics; but I trust Wren-Lewis will forgive me if I remain highly sceptical that a rigorous and forensic Lakatos (if he was still with us) would consider microeconomics and its whole structure and methodology in such a favourable light.
Economics has become a self-important, practically useless, desk-bound poor relation of mathematical physics. Mathematical physics built its collosal reputation on one simple ability; prediction. Physics predicts. At the same time the whole world, far beyond either economics – or academia – knows that economics’ credibility as a science, based on the essential, fatal test of all science – prediction – has demonstrably been an unmitigated disaster over the last twenty years at least, and that statement is unchallengeable, given solely the record. The criticism may seem unfairly harsh, but the problem is this; economics has serious influence in the world, an influence that seriously affects the lives of most people, not just in the short term but the long term; and economics is doing nothing to deserve its influence, or even the right to be taken seriously.
It is striking that a large number of economists have realised this for some time; some economists have at least made some attempt to fill the gaping hole in the discipline, and in recent years we have seen the exploration of ideas such as ‘evolutionary economics’, or ‘quasi-rational’ or ‘experimental’ economics, or ‘MMT’.
Thanks John
Can I recommend this talk on complexity economics by J Doyne Farmer of the Santa Fe Institute
https://complexity.simplecast.com/episodes/56-_5xlUKtB
When PSR mentions the ‘chaos’ of the rugby field you might be even closer than you realise. The mathematics used by macro economic modellers is fundamentally unable to deal with the complex, chaotic systems of human behaviour that lie behind economic ‘systems’. Meteorologists and ecologists have understood this for decades as have a very few economists, notably Steve Keen. Also Eric Beinhocker, a regular at Santa Fe, whose book Origins of Wealth should be on the reading list of anyone interested in non mainstream economics.
By accident I did a project on chaotic systems using the maths of chaos and non linearity, 50 years ago… has always struck me that most phenomena of interest and pretty much all human behaviour are non-linear in nature and hence chaotic. However most people find the idea of non linearity counter intuitive – especially accountants! COVID has shown how most people struggle even with exponential behaviour.
Agree with all that
Steve is a rare exception, which is why he has been kept outside the fold
Robin
I’ve been there and done rugby. I love the game, and the people (but worry about the effects on players). I’m a victim of economics however (bad economics) and a student of it who struggles to keep up. Rugby is a game of courage and teamwork.
But even I can see that the same courage and teamwork practiced in economic management (Government working with markets) would produce better outcomes for a greater amount of people rather than those who use it to preserve their ‘first amongst equals’ status.
But the markets have to get rid of THEIR fundamentalism first I’m afraid. In other words they have to learn to respect the Referee (the Government) as we do in Rugby.
That would be a start.
So yes – I believe I am as you say ‘closer that I think’.
Agree with all of that PSR – pretty overwhelming evidence that leaving it to the markets has been a failure and that maybe the referee does have an important role after all. To extend the metaphor, I find that having referee conversations and the cameras all available to the spectators does provide a great insight into what they are doing – a case study in transparency
Orthodox, neo-classical economists with their belief in equilibrium have been a big part of the problem – the high priests of neoliberalism, preaching its religion… with artificial models based on lousy maths and daft assumptions.
For me the small bunch of heterodox (or maybe that should be heretic) economists, who understand complexity, learn from ecology, meteorology and other sciences, and recognise the unpredictability of human behaviour are worth listening to. Their ‘models’ do not pretend to produce one right answer (‘the GDP next year will be…’) but provide insights into what might happen.
As George Box, the mathematician and statistician said, ‘all models are wrong, some are useful’. I’d offer that all models based on equilibrium thinking are wrong, those based on complexity are useful and do a much better job of explaining how and why markets fail.
But looking out of the window is still the best way to see if it is raining!
Agreed
John SW – given your reference to physics, if you’ve not come across it before you’d find the Santa Fe work interesting, where they got physicists and real mathematicians together with economists. Decades ago and still orthodox economics whose maths does not get much beyond statistics and Poisson distributions dominates. Obsessed with equilibrium despite which real life keeps smacking them round the head and showing that they are wrong.
Complexity economics does a far better job of modelling the real world with its instability and booms and busts. Steve Keen’s work and Minsky of course builds on this
See also:
http://tuvalu.santafe.edu/~wbarthur/complexityeconomics
Robin
I just noticed you’ve joined the club if those who have commented more than 1,000 times here
Thank you
Richard.
Thank you Richard
Mind you, I’ve gained far more from your blogs and the commentators than I’ve ever given, so a thank you as well to other members of the ‘club’
🙂
Mr Stafford,
Thanks – I read your comment, and ordered Beinhocker’s book immediately.
Incidentally, it is worth reading Wren-Lewis’s blog that Richard discusses, which includes this comment, on the complexity of non-linearity in models: “However I do query that, quoting Martin Sandbu, ‘there is no question this would be a very big change in how macroeconomics is done’. To just give a personal example, when I taught part of an advanced macro class in Oxford a few years ago, two of the four models I looked at had multiple equilibrium. However it is also true that non-linear models are more complex, which undoubtedly puts researchers off. This brings us back to allowing non-microfounded models to be, at the very least, a preliminary investigation of new theoretical ideas as a prelude to ‘doing it properly’, as most academic macroeconomists would say. My other question is whether, if you want to model the impact of severe recessions on long run output, two or more equilibrium models of the kind that Vines and Wills look at are the answer. It may be simpler and also more realistic to add forms of endogenous growth to a standard model, as various people have done, which gives you hysteresis.”
Wren-Lewis goes on to draw this conclusion, about ‘revolutions’ in economics: ” …. revolutions happen because mainstream economists see that one is needed. The Keynesian revolution occurred because academics and politicians saw that depressions were not inevitable. The neoclassical counter-revolution was a revolution within mainstream academia. Because the microfoundations hegemony is progressive, there will be no revolution. Neither financial crises or pandemics are impossible to model using standard tools.”
Where is the evidence to stand-up Wren-Lewis’s last sentence? I confess that I failed to spot any in the Blog. Actually revolutions, I am inclined to believe, typically happen only when the status-quo finally recognises its position has become completely untenable, and the conventional wisdom then recalibrates its position to protect its credibility and position; that has always been the case in science, probably at least since Galileo.
A critical Namierite eye is probably more useful for critics of economics than it ever was to the study of history …. …. ….
Well spotted
I’d read Simon W-Ls article and indeed have met and spoken to him in the recent past. He is one of the more progressive economists out there but still I’d feel wedded to relatively orthodox views as the sentence you highlight confirms. Put crudely, orthodox economists tend to get their models to fit post hoc seeing crises as always driven by externalities, and/or by tinkering with the assumptions.
To fully accept complexity and chaos as the basis of economic models would require a great deal of unlearning together with an understanding of mathematics which orthodox economists are unwilling and perhaps unable to take on board.
In the Brian Arthur article he is fatalistic about the decades that it takes for new ideas to become accepted. Its a small ray of sunshine, but Andy Haldane (who gets a mention in the article) does appear to be open to complexity though its not yet apparent that its influencing the BofE’s thinking and behaviour
May I offer one word of warning. The problem is not just complexity. Science seeks to simplify the problem it wishes to solve through mathematics. Mathematics simplifies; and the development of its use in banking did nothing to prevent the financial crash.
More important to me, however is the crucial issue of the measurement of data at the point of identification and capture. This is an observational issue. Does economics capture the data it uses? If not, who or what is it relying on? Does it know that all the data is captured? How does it know? Does it capture the right data? Does it understand what data is most important? How does it decide? What principles of measurement does it use? How reliable are they? How do they audit or test the application of the principles of measurement? Who are the economists doing this capture and measurement work? Where are they working? How do they adapt or adjust to radical change in the dynamics of economic transformation (technology, market or even money), where the data may change its form or source? I am not sure I understand the answer to any of these questions, or even where to go to find an answer.
Since we are dealing with money data, In economics I have always felt accountants have a better understanding of the general problem of capturing money data, accounting for it and measuring it (Luca Pacioli was grappling with the problem of money data capture centuries before, even Adam Smith). I remain unclear how economics tackles this problem, either theoretically or in practice.
I have written papers on why accounting data is not fit to be used for economic analysis
Tax accounting data is described by me as CRAp (completely rubbish approximation to the truth) for good reason
I could perhaps have phrased my observation better. I was not seeking to introduce accounting data as suitable for economics purposes; but rather attempting to suggest that accountants, at least by training are (or used to be?) closer to the data that they are trying to measure than economists; and probably at least undertsand the issues relevant to their data, its nature and measurement, better. Economists are too ‘hands-off’ about the gritty details of accessing the phenomena, at the point of capture.
You are right
Economists take accounting data as gospel truth
Accountants know how bad it is
Now We are discussing this matter, I have a supplementary question, that I think relevant. How do economists account for the ‘black’ economy (that which evades all forms of being brought to account for the economic activity)? It may be economists assume it is not significant to the whole economy; In which case, how do they know? I return to my starting point; how do they measure economic phenomena? What counts, and how do they measure it?
They simply accept it
Remember their models do not include money – they work on the assumption of barter and have to them add mao ney in to the model afterwards
And they do not think tax relevant
My patience is inexhaustible on this! In all the criticisms of orthodox economics, there is not much of an alternative on offer which contributes to the stranglehold that orthodox economics seems to have across the politic spectrum (at its worst on the right). Complexity scraps all the bizarre assumptions that orthodox economics makes and in effect starts again. No coincidence that Steve Keen who gets regular mentions here is also an enthusiast.
Also no coincidence that in contrast with orthodox economics and economists and their obsession with GDP, the authors behind complexity are as interested in environment and the wider health of society. Makes them a lot more readable… I’d go so far as to suggest that as long as orthodox, neo-liberal economics lurk as the foundations, attempts to move away from today’s neo-liberal model of capitalism are doomed.
For those interested a few more references:
A good podcast on the subject:
https://complexity.simplecast.com/episodes/56-_5xlUKtB
The proceedings of the last conference at the Santa Fe Institute – probably the home of complexity and a place with an interesting history. The first 2 sessions are a great introduction.
https://www.sfipress.org/books/complexity-economics
To be continued when we get to a pub…
PS For John SW – I started off with a degree in Mechanical Engineering – hence the maths – and ended up working with NGOs and doing a social sciences masters! Some kind of hybrid….
One might also bring in the adages about only managing what gets measured but then measuring the wrong easy-to-measure things, and about it better to be roughly right than exactly wrong.
At a macro level, the focus on GDP (conventional, orthodox, neo-classical) economists) rather than broader measures of well being is arguably about measuring the wrong things and excluding many potentially more important factors. Similarly at corporate level, the focus only on financial measures and shareholder value (finance directors and accountants). As Richard would point out, in both cases the data is not just too narrow but often poor quality.
And John SW – if you are dismissing science and mathematics as all being about simplification, that is a touch sweeping. The particular mathematics being used by the City and their ‘models’ were every bit as deluded and flawed as those used by conventional economists. Reductionist, with bizarre assumptions about things they did not understand or could not measure, trying to make exactly right predictions.
The whole point about complexity, recognising wider ‘systems’ and the maths that lies behind it, is an acceptance that the world is far more varied, dynamic and unpredictable. Its the opposite of simplification or reductionism, but that is quite a frightening prospect to those who want precise controllable answers. That does include of course most politicians and members of the public. The best we can do is look for patterns and be ready to deal with what might emerge – resilience rather than optimisation. True for both companies and societies.
This could be a very long pub conversation!
I look forward to them!
Don’t we all!!!
” if you are dismissing science and mathematics as all being about simplification, that is a touch sweeping.” No, my target was rather the use of mathematics in the development of financial engineering by the banks, as you later mentioned. My underlying point was that mathematics can itself be a dangerous master. At the same time simplification, it seems to me is essential to mathematics (I acknowledge I am not a mathematician); and when mathematics could not produce the results in dynamics because of complexity, Maxwell developed statistical mechanics (Maxwell-Boltzmann).
I think I am suggesting that in science, ‘au fond’ observation comes first; mathematics is just the best language to express the observation, if your purpose is to make predictions; and prediction is the root of the matter. Maxwell, with the generous modesty typical of his genius, once said self-deprecatingly to an over-enthusistic admirer, that all he had done was to mathematicise the observations of Faraday.
I think I have now exhausted everyone’s patience on this.
A good read. I’ll try and follow it up. It does come down to the ‘story’. As you say
“That is why I look for practical answers to current questions, rather than seek to promote a theory. What I seek to do is mix an understanding of theory with a dose of experience to which I add a portion of ethics to suggest solutions.“
Which is why I hold your daily work here with high regard.
I don’t know if that is worth publishing so will add the following link from the Guardian today, which is the MSM doing its part to manage that Story.
https://www.theguardian.com/lifeandstyle/2021/mar/30/who-is-lending-the-british-government-all-this-money
The crucial part of this particular charade at gaining a focus group type of data collecting to then use selectively
“ Post your answers (and new questions)… A selection will be published on Sunday.”
The crucial part is that these comments are currently HIDDEN unless you have REGISTERED with the Guardian. Not to contribute but to just read. There are currently nearly 350!
This is the FIRST time I have seen this contraption implemented at the Guardian.
Are they really interested in the answers and posts there when they have gone out of their way to hide them?
I submitted an answer….
I was hopping you would.
Now let’s see if I’ll be able to read it in their ‘selection’ on Sunday.
There’s nothing at all sinister about being registered with the Guardian, DG. I’ve been registered for a decade or more. You just can’t comment on anything unless you’re registered.
BTL comments are usually available for all to read, but as this is in answer to a reader’s query for a specific regular item I suspect that they don’t want the answers read by all and sundry until the Notes & Queries they apply to have been published.
It’s not like normal BTL where contributors can discuss points with other contributors.
I’m cheered to see that the two posts they have as ‘top pick’ at the moment are quite sensible.
Are you (just) saying: proceed inductively?
Yes, to a fair degree