Empiricism in Economics

It has long been held that there are two kinds of economics:

  1. Rationalist economics: starting out with theses about philosophy, money and reality (etc) and using logic and reason to reach conclusions about the present and predictions about the future.
  2. Empiricist economics: starting out with data and creating mathematical models representing these data, and using these models to reach conclusions about the present, and predictions about the future.

In traditional circles, the first class tends to include the various schools of Austrian and Marxian economics, and the second class tends to include the various schools of Keynesian and Monetarist economics.

Today, I want to put an entirely new spin on empiricism in economics, by focussing away from modelling. The process of mathematical modelling is just as rationalist as using logic and reason.

Why?

Economies are nonlinear systems.

From Wikipedia:

In mathematics, a nonlinear system is a system which is not linear, that is, a system which does not satisfy the superposition principle, or whose output is not directly proportional to its input. 

Effectively, a nonlinear system is one in which mathematical modelling mostly does not work. This, in a nutshell, is the reason why professional economists within the academic system, at the Federal Reserve, and within the IMF and the World Bank are often so desperately incorrect with their predictions, as we have seen so many times in the last few years. 

This is because nonlinearity is a direct result of incomplete information. Any map or model built will not be an exact replica of reality, and as Benoit Mandelbrot showed tiny divergences in an unmodelled (or unknown) variable can result in a humungous variation in the output of the system (i.e., the economy).

So in dealing with nonlinearity the model always fails — sometimes by a fraction, and sometimes by a huge amount.  The notion of accurate modelling was famously taken to a logical conclusion by the writer Jorge Luis Borges in On Exactitude in Science:

In that Empire, the Art of Cartography attained such Perfection that the map of a single Province occupied the entirety of a City, and the map of the Empire, the entirety of a Province. In time, those Unconscionable Maps no longer satisfied, and the Cartographers Guilds struck a Map of the Empire whose size was that of the Empire, and which coin- cided point for point with it. The following Generations, who were not so fond of the Study of Cartography as their Forebears had been, saw that that vast Map was Useless, and not without some Pitilessness was it, that they delivered it up to the Inclemencies of Sun and Winters. In the Deserts of the West, still today, there are Tattered Ruins of that Map, inhabited by Animals and Beggars; in all the Land there is no other Relic of the Disciplines of Geography.

So if accurate modelling in complex dynamical systems such as economies is effectively impossible without mapping every input what hope can there be for empiricism in economics?

We have to approach it from another angle: if it is impossible to model economies in a laboratory, through equations, or in a supercomputer, the real world must be the testing-ground for ideas.

Actors in economies should be free to experiment. Good ideas should be free to succeed, and bad ones to fail. The role of the government should be to provide a level playing field for experimentalism (and enough of a safety net for when experiments go wrong) — not pick winners or “manage the economy”. People with ideas must be able to access capital so that those ideas can be tested in the market place. If experiments go badly, that is no bad thing: it just means that another idea, or system, or structure needs to be tested. People should be free to go bankrupt and start all over again with a different mindset and different idea.

The corporatist model that most nations around the world have adopted, or fallen into (i.e. “capitalism” led by governments and large corporations) is nothing like this. Small businesses struggle to access capital. Young men and women are thrown onto the scrapheap of unemployment without a chance to develop skills, or entrepreneurial ideas, or even sell their labour, and pushed into leeching off the wealth of the nation through welfare. Large banks and corporations whose business models have failed are routinely declared “infrastructurally important” or “too big to fail” and bailed out to leech off the nation.

This is not empiricism. This is a disaster. To restore society, we must restore empiricism into economies.

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