The Pseudoscience of Economics

Modern economics is obsessed with modelling. An overwhelming majority of academic papers on the subject work like so: they take data, and use data to construct formal mathematical models of economic processes. Models mostly describe a situation, and describe how that situation would be changed by a given set of events; a very simple example is that as the supply of a good diminishes, its price will increase. Another is that deficit spending increases the national income. A mathematical model is a predictive tool created to demonstrate the outcome of events in a massively simplified alternate universe.

As someone who rather enjoys voyages of the imagination, the use of mathematical models in economics is intriguing. The pretension that through using formal mathematical techniques and process  we can not only accurately understand, but accurately predict the result of changes in the economy is highly seductive. After all,we can accurately predict the future, right?

Wrong. The wonderful and terrible and confounding thing about our world is that it is a deeply unpredictable place, at least in the economic sphere where each number (for instance “aggregate demand” or “aggregate supply”) in an equation may loosely refer to millions of huge, complex and dynamic events. When you’re using huge simplifications to describe reality, those simplifications may miss the important details, and your projections may go askew.

Not all modelling is equal. Newton’s model of gravitation (since superseded by Einstein’s relativity) makes relatively accurate predictions about how gravitation works, and what would happen to an object dropped 500 metres above the Earth. NASA used Newton’s equations to fly to the Moon. Of course, even in physics there are occasionally divergences and oddities (which is why there are quite often unrepeatable or anomalous experimental results, for instance the recent experiment that seemed to show neutrinos travelling faster than the speed of light). So economics — with its fixation on creating models of situations, and using these models to attempt to predict the future, mimics physics, chemistry and biology, where data is collected, and used to produce theories of physical processes which allow a modestly accurate representation of the future.

The key qualitative difference, though, is that mathematical economic theories don’t accurately predict the future. Ben Bernanke — the chairman of the Federal Reserve, and one of the most-cited academic economists in the world told the world that subprime housing was contained. That is the economic equivalent of Stephen Hawking telling the world that a meteorite is going to miss the Earth, when it is really going to hit. Physicists can very accurately model the trajectories of rocks in space. But economists cannot accurately model the trajectories of prices, employment and interest rates down on the rocky ground.

The thing that I believe modern economists are most useful for is pointing out the glaring flaws in everyone else’s theories. Steve Keen has made a public name for himself by publishing a book entitled Debunking Economics, in which he explains the glaring and various flaws in modern economic modelling (DSGE, New Classical, etc).

Economics is a complex and multi-faceted subjects. Economists must be in some measure, philosophers, historians, linguists, mathematicians, statisticians, political scientists, sociologists and psychologists, and many other things. The trouble is that at some stage in the last century the multi-faceted multi-dimensional economics (like that of Xenophon) was hijacked by mathematicians who tried to turn this huge and delicate subject into an equation. Yet economics — and economic decisions, from the macro to the micro level — is a human subject. It is subtle and psychological and sporadic. A human subject requires human language, human emotion, human intuition.

The grand theoretical-mathematical approach to economics is fundamentally flawed. Trying to smudge the human reality of economics and politics into cold mathematical shackles is degenerative.

So what to do if you want to understand the economy?

Follow the data, consider the history (similarities and differences between the past and the present) and explain your conclusions simply, as you would to a child. Consider philosophical definitions: what is money? What is demand? What is supply? What is value? How does demand affect supply? What are the global patterns of trade? Why have they emerged this way and not an alternative way? Consider possibilities. Admit the limitations of your knowledge and explore the boundaries. Stop forcing the construction of absolutes, grand frameworks, grand theories. No theory will ever be robust to everything nature will throw at it, but simple microeconomic heuristics (opportunity cost, cost-benefit analysis) combined with data-focussed historical analysis may be more robust than cold, dead mathematics.

As Heraclitus noted:

No man ever steps in the same river twice

No two situations are identical. And in this universe even tiny differences can have huge effects on the outcome of a situation. This is the butterfly effect, a term coined by Edward Lorenz, and derived from the theoretical example of a hurricane’s formation being contingent on whether or not a distant butterfly had flapped its wings several weeks before.

The pseudo-scientific school of mathematical economics hungers and craves for a perfect world, where each river is the same, where there is no butterfly effect, where human preferences are expressed in equation form, where there is no subtlety or ambiguity or uncertainty.

It is a dreamworld constructed by and for people with Asperger’s Syndrome.

41 thoughts on “The Pseudoscience of Economics

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  3. Economics (the discipline) should not be confused with economic logic. The former doesn’t always use the latter. Economic logic is a powerful tool for understanding the world. However, as you illustrated, much of the empirical work and modeling in economics is garbage.

    • Yeah, my main gripe is with modelling. It is intriguing to me that that process is described as “empirical”, when it is actually the opposite. It is not about making judgments based on observations, but instead creating pseudo-observations (models).

  4. I find fascinating our beginning to model a holographic view of the universe. Of importance, is we pursue the correct model, and appreciate a complexity possibly beyond computational power. At best are models which simply find accuracy more often than not. One can get rich in Vegas by just being right 53% of the time. How it is someone predicts a future far in advance is still a fact, and discovering that mechanism may prove to be the most useless pursuit today, but as we increase computational abilities, not so. It holds the clues to artificial intelligence. Economic equations are a good start, and Vegas is a good source of financing.

    • You can get rich playing derivatives by being right 53% of the time (mathematically it’s very similar) but that kind of activity creates systemic fragility (intermeshed balanced sheets, default cascades, etc). It’s the side effects that are dangerous. Some models are fairly successful in (as Taleb puts it) mediocristan. Otherwise, the mathematicians could never have taken over the economics profession. The problems models have in extremistan are the blowback from their success in mediocristan. And in the 21st Century, more and more of our world is extremistani.

  5. John, what you’re drawing attention to here I believe is bigger than economics and/or math and I’m not sure that it’s necessarily about craving a “perfect world”, but perhaps a human need to fixate on an ideology (writ as formula in certain disciplines) that explains cause and effect.

    In a certain political realm, suppose we have leader A who has believes X and sticks with that belief no matter how tough the going gets; and suppose we have a leader B who believes X one day and Y the next day. One school of thought would brand leader A with such words as “courage” and “conviction” while leader B is labeled as a flip-flopper, pushover, etc. A different school of thought might brand leader A as headstrong and in denial of reality while leader B tailors his views to correspond with an evolving arsenal of evidence he collects at the street level.

    This is just the politics version of what you describe above. Surely there are other mirror versions of the very same dynamic in sociology, anthropology…any active trader in any financial market must continuously stand ready to switch views as conditions warrant.

    At the core human condition level, I think we can reduce this to a single basic idea: how able are you to acknowledge when you are wrong? It requires a certain level of humility and candor for an individual to even entertain the thought that he or she might have gotten something wrong. And the more prestige/salary/power/influence a person accumulates, the harder this becomes.

    • Experience in financial markets is excellent at teaching this principle. To succeed, it helps to be able to turn on a dime, and tailor your actions to a new reality.

    • More and more, I am impressed with Americans not seeking to be led, understanding the difference of being represented. My hope is we begin to understand ambition’s boundaries relax once your family is provided for. The unbridled quest for power is psychotic, and paired with an equally psychotic mate, we get what we get. I have decided not to donate to the revenue flow of any business that pays over a certain base wage of, say, the janitor. Billion dollar bonuses is simply obscene. Maybe that is a factor of ten or 100, I have not decided. No laws passed, just what I will not do.

  6. Well said Aziz.

    One of the most insidious and nefarious properties of scientific models is their tendency to take over, and sometimes supplant, reality. – Erwin Chagraff

    Erwin may as well be talking about mathematical models used in economics ;)

    A theory has only the alternative of being right or wrong. A model has a third possibility: it may be right, but irrelevant. – Manfred Eigen

    The US housing bubble is the most evident example where economists failed miserably. I mean — what arrogance to think that they can model risk (which has an inherent human attribute to it)?

    Nassim Taleb said it well: The problem with the ‘‘tails’’ is that they are not tractable and will be subjected to severe measurement errors. Even if we assumed, generously, that we had the right distribution, small errors in the calibration of the parameters lead to disproportionately larger and larger effects in the tails. Since these tail events determine a large share of the properties of almost all socio-economic data, we are left in the dark about the most important information.

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    • I think everyone involved in econ is a little bit aspie, even people like me who reject/critique the mathematical approach.

      I had a long argument with Nassim Taleb about Asperger’s Syndrome. He associated it with people like Myron Scholes who create intricate models that have no basis in reality, and seemed to imply that it was always a bad thing.

      I noted that sometimes being detached from the mainstream/norm can allow you to travel to somewhere brilliant and new, and have thoughts more conventional thinkers would never dream of. I think the economist Vernon Smith who is a critic of the mainstream like me, as well as a self-professed sufferer of Asperger’s is evidence that sometimes Asperger’s in economics can be a good thing.

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  9. The next time FO-SHO asks me about my economic knowledge I will just point him to this article. Thanks, Aziz!!

        • You do realize he is talking about econometrics, of which I have used very little to none in our discussions.

          econometrics (ih-kon-uh-me-triks) – the application of statistical and mathematical techniques in solving problems as well as in testing and demonstrating theories.

          FO-SHO -1

          Jon – 0

        • @ FO-SHO I’m not interested in getting into a dick measuring contest with you.
          But it’s a little be premature to set the score at 0 to 1 especially when there is no moderator and especially when you can’t or won’t even address most of the things I say in my posts.

        • Both of you have made some good points. While I tend to agree more with FO-SHO, Jon certainly argues his case strongly. It is an entertaining series of exchanges.

        • Just being cheeky. Jon, I apologize.

          So, Jon, a serious questions for you:

          “How does an economy solve a boom and bust brought on by the over-expansion of credit.”

      • “Just being cheeky. Jon, I apologize.

        So, Jon, a serious questions for you:

        “How does an economy solve a boom and bust brought on by the over-expansion of credit.”
        Contract the credit. Stop printing money to go to wars of choice.

  10. Its a problem in all of the social sciences, phenomenology asserts that a human science is not possible. Of course the natural sciences also suffer from scientism, a strident desire to make science the only approach to all truths. It is often forgotten that science is a art, in the sense that it is something that flawed humans with built in assumptions, needs, desires, beliefs, status positions, cultural filters (now becoming global) and a sociology doing it. They pretend ‘objectivity’ is possible and a god like detached science is possible. Martin Heidigger rightly asserted that man is ‘thrown in the world’ and completely embedded in their own socio-cultural time and place, escape is impossible.

    Any economist who criticises the power elite, status qua is rejected by default because they threaten power…better to serve power for a livelihood, status and power.

    • There are layers and layers of wrong knowing. It’s been 30+ years since I read Being and Time, but didn’t Heidegger go further than asserting that man is embedded in his own socio-cultural time and place to asserting that he is embedded in his own phenomenological time and place? That’s what I call a “point of view” and it goes way further than socio-cultural bric-a-brac. There’s the biological, the physical, and God [literally] knows what else is involved in situating what i call i in this realm.

      Escape is even more impossible than it is, to coin a new [Yogi] Berra-ism. The putative escapee is precisely that from which it would escape. The only escape from point of view is perfect-white-joy-light: http://scribbledinangst.com/archives/01-01-2006_01-31-2006.html#33 And you can’t get there from here.

      Sorry to get so esoteric.

    • I am appreciating th inclusion of Intelligent Design, and even read some philospohies that elevate Consciouness as one of the moving forces of nature. But let us not be too hard on the older “atheism” that pervaded scientific inquiry. They truly believed a scientist must insist on finding something other than miraculous occurence driving their experiment’s results. They feared relaxing this discipline would lead to tragic error.

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  12. The false models used by economists are only part of the problem, huge though it is.
    The greater issue is that many economists have totally prostituted themselves to the top 1%, and have made a very comfy living by telling the very rich exactly what they want to hear.
    The whole “rational market” delusion, spawned by the Chicago school when the dot-com bust was still echoing in everyone else’s ears, did more to cripple the global economy than any other series of ideas. Those idiots are the worst economists since John Law.

    • Yes, I agree with the point that the profession of economics has become an echo chamber for the 1%. I think what we forget however is that a big slice of the 1% are made up of bureaucrats/planners/academics/thinktankers who believe in much bigger government. So it is not just the Chicago School that has served as an echo chamber for wealthy interests.

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  14. For days now, I’ve been stuck on the issue of austerity policies and the common view that austerity in government spending is not helpful in recovery from recession. I think Krugman, and many who agree with him about government spending increases and printing money, hold that the main problem in the economy is the reduction in aggregate demand. But once we insure as a society that all who need help are getting that help, one way or another, any additional government stimulus spending to try to increase aggregate demand, seems to be simply overriding the inclinations of the people in the society not to spend their reserves. So when the government increases spending in the form of stimulus, is it not then going against the demonstrated will of the people?

    • Well government can spend on things that the nation otherwise does not, e.g. defence and infrastructure, so not necessarily, but I take your point. It is forced growth, and that is where malinvestment and bubbles come from.

      I think the reality of our debt-based system is that it needs spending to be maintained at a certain level, and it prefers spending to be increased in aggregate size, otherwise you get debt-deflation, which can spiral. It is a system that seems to favour bubbles and malinvestment.

  15. I fail to see why an austerity or an investing (national spending) policy will be of greater or lesser benefit to the whole of our macroeconomy. The former takes the tax payers money and uses it to partly repay debts from the banks (which gives the banks a bail-out opportunity to begin to start lending money again). The latter borrows more from the banks only to cause it to circulate and return to the them as reserves on savings. In either case the same money continues to make full macroeconomic circuits. If it helps government employed workers, it subtracts from householders not so employed. If it is invested in building construction, then the socialogical employees of the nation get a cut in their earnings. These things all ballance out, exactly! because the same sum of money is what circulates and is involved.

    Clearly something else is stopping progress in our social system and that is the amount that monopoly of the natural and man made resources is causing the high prices of goods to reduce consumer’s demand for these goods. It would be sufficient if the natural resources were freely available, the man made ones would then follow. By taxing these natural resources (the access to land in particular) each monopolistic withholding action and denial of the right for using the opportunity of nature would become more accessible becuse holding valuable land out of use for purposes of speculation in its rising value, would no longer be worthwhile.

    Its not money, its access to land that counts!

  16. Pingback: Incomprehensible Bullshit « azizonomics

  17. Don’t hate on Asperger’s, dawg. But yeah, Econ sees itself as the grand vizier of social science. Don’t forget Keynes believed Eugenics was the most important social science (even over economics).

  18. Pingback: Sorting Through Mixed Reactions to Malala Yousafzai (Or: A Brief Rant on the Centrality of the Humanities for a Flourishing Democracy) | IJFAB Blog

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