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A review of James Kwak’s Economism

A review of James Kwak’s Economism

Economism: Bad Economics and the Rise of Inequality, James Kwak, Pantheon, 2017

I just finished reading James Kwak’s Economism: Bad Economics and the Rise of Inequality. Here is a quick review of the book.[1]

Imagine a first-year economics student. After attending six lectures in introductory economics, and carefully studying the first six chapters of his economics textbook, he gets comfortable with the basic supply-demand model. Bedazzled by the potential uses of this simple model and explanatory power of economics in general (looking at the covers of economics made fun books convinces him about this), he starts thinking that the supply-demand model is the only thing that he needs to know. As a firm believer of market solutions to everything, he quits school in order to give it back to you, the people. He becomes a politician (or advisor, author, columnist, the president…) and starts applying what he learned from an introduction to introductory economics to real world problems. Because he skipped all other courses, he does not have any idea about how to conduct research on these important societal problems. So he bases all of his policy decisions (or suggestions) on the basic supply-demand model and a little bit of armchair reasoning. James Kwak’s book, Economism, is a critique of this student’s abuse of basic economics.

More properly, Economism is a book on the dangers of applying simplistic economic models to complex real-world problems. According to Kwak, economism is the act of trying to explain all social phenomena and to solve all societal problems with basic economics.

“[Economism] rests on the premise that people, companies, and markets behave according to the abstract, two-dimensional illustrations of an Economics 101 textbook, even though assumptions behind these diagrams virtually never hold in the real world.” (Chp.1)

You might ask: But who does that? Is there really anyone out there who acts like a university dropout president (politician, advisor, author, columnist…)? Kwak’s book provides enough evidence to show that economism is a real problem. And if you think about it, you might find your own examples of economism. Think about those politicians, columnists, experts, and journalists who talk about taxes, minimum wages, regulation, inflation, healthcare etc. Think about how TV and radio programs, podcasts, blogposts, tweets, etc. help an oversimplified supply-demand logic to reproduce and invade people’s brains. And think about how easy it is for anyone to have an illusion of understanding economics. If you can Google it, you can think that you know it! Search for tax policy, drug policy, minimum wage policy, or any other thing you like. You’ll get a quick answer and a fix for your problem. Anyone who is willing to learn some economics but does not have the time to do it properly can be infected with economism quite quickly. So Kwak’s attempt to warn us concerning the dangers of economism is a valuable endeavor.

Of course, Kwak is not the first person to warn us against the abuse of basic economics. Noah Smith, for example, wrote about economism in 2016. He called it 101ism. See for example, Most of What You Learned in Econ 101 Is Wrong, and 101ism. And here is something from Paul Krugman:  101 Boosterism. Last year, Dani Rodrik also warned us against misuses of economic models in his Economics Rules. Also note that there is a huge literature in philosophy of economics that discusses the limits of idealized and abstract models in economics. Given this background one expects a lot from a book length treatment of economism, or 101ism.

My expectations were very high. This is probably why I am disappointed. I knew in advance that in the book Kwak would be discussing how economism misleads us concerning issues such as the minimum wage, tax policy, and financial regulation. So I expected a detailed and careful discussion of these topics. Something that would go beyond the blog posts and columns cited above. Moreover, I really wanted to learn about the origins of economism. I wanted to learn who to blame, and why. On top of this, there was a lot of buzz on my twitter feed which also raised my expectations. I did not expect Kwak to dive into philosophy of science, but I was expecting that he would have some serious discussion of the limits and merits of simple, abstract, idealized models. At least I was expecting Kwak to go beyond just reminding us that economic models are unrealistic, and that they employ simplifying assumptions.

Even though Kwak uses considerable amount of space and several supply and demand graphs to demonstrate the possible ways in which that Econ 101 models may mislead us, he does not show the reader how one should really think about the issues discussed in the book. His argument basically boils down to the following claim: Econ 101 thinking is erroneous because the world is more complex than the basic model, and the empirical evidence concerning the matter is mixed. For example, Kwak (in Chp. 9) summarizes economism’s claim concerning labor markets as follows: “The minimum wage causes unemployment and harms poor people”. And here is how he summarizes how things are in reality: “The minimum wage (around current levels) has little impact on unemployment and reduces poverty”.[2] Or, he summarizes economism’s claim concerning financial markets as follows: “People only buy financial products that are good for them”. And he argues that the more likely reality is “many people make poor choices about complex products such as Option ARMs”. Fair enough. But how should one avoid economism and think about these issues? Does Kwak have an answer to this question?

First note that Kwak does not argue that economics is useless or that economists should abandon their beloved simple models. He argues that

“The answer to economism is not to reject economics altogether. Rather, the immediate antidote to economism’s simplistic model of reality is more and better economic analysis, which can help identify the fundamental drivers of social phenomena or select the most effective solutions to difficulty problems” (Chp.9)

“Recognizing that economics does not provide a single simple answer to all questions is a crucial step in throwing off the blinders of economism” (Chp.9).

So Kwak seems to think that economic models help us understand the world. But he does not tell the reader how. The world is complex. All economic models are similar to the basic supply-demand model in that they simplify and employ unrealistic assumptions. Kwak does not help us in finding our way from simple models to more complex reality. If we would like to avoid economism, how should we approach the subject matter? What is the appropriate way to use economic models? Not clear. Kwak does not really attempt to answer these questions. We learn that we should be careful about the dangers of economism, and that is about it.

What about the origin and sources of economism? Kwak has a whole chapter on that. He makes some strong claims, such as the following:

“For a worldview like economism to take root and grow, it must serve a significant social group.” (Chp.3)

“[Economism] matters because it is one important vehicle that interests groups have used to pursue their objectives during the past half century.” (Chp.3)

“Economism exists because people organizations saw how they could use economic principles to their advantage.” (Chp.3)

“Today, economism reflects the preferences and interests of the very rich more than those of ordinary citizens” (Chp.9)

“The great achievement of economism has been to repackage a political ideology [market fundamentalism or neoliberalism] as a lightweight, easy-to-use, seemingly neutral framework for seeing the world.” (Chp.9)

Basic argument here is that economism benefits the wealthy, thus it must have been intentionally promoted by them. Unfortunately, Kwak does not provide enough evidence that these and other related claims concerning the origins of economism are right. The evidence he provides is basically about some connections between economists, institutions and people with money who funded some of these people and institutions. This lays down some of the connections, but it is not enough. Maybe it is impossible to provide a convincing account of the origin of economism in one chapter, but I was supposing that this was one of this book’s promises. So I was disappointed. To be fair, Kwak cites his resources. In order to get a better sense of the development of economism (especially in USA) one could read: The Idea Brokers (James Smith), The Power of Ideas (Lea Edwards), Building Chicago Economics (eds. Robert Van Horn, Philip Mirowski, and Thomas A. Stapleford), The Road from Mont Pèlerin: The Making of the Neoliberal Thought Collective (eds. Philip Mirowski and Dieter Plehwe), and other works cited by James Kwak.

After reading the book, we learn that economism is bad. Also, we are provided with a list of names and institutions[3] that we could blame. I’ll only mention the names of the economists that pop up: Ludwig von Mises, Friedrich von Hayek (Nobel Prize 1974), Milton Friedman (Nobel Prize 1976), Gary Becker (Nobel Prize 1992), George Stigler (Nobel Prize 1982), and Richard Posner. Unfortunately, Kwak does not discuss the actual contributions of these economists to research. I cannot help thinking that maybe Kwak also got trapped by the simplistic thinking that he criticizes. Remember, he wished to argue that real economics is not like simplistic Econ 101, and that actual research in economics is superior to simplistic Econ 101 thinking. Could it be that the actual contributions of these economists are much more sophisticated and important than they appear in Kwak’s book? Let me just remind you that the list contains four Nobel laureates.

So what is my verdict? I enjoyed reading the book. It introduces the reader to the debates about minimum wages, tax policy, health policy, and financial regulation. Also, the chapter on the origins of economism could be considered as a good first reading on the topic. Nevertheless, I was disappointed because I was expecting much more from the book. So I’ll recommend the book with just one warning: If you would like to have a better understanding of how economists think and how to avoid economism and all that, this book will not help you much. If you are going to read this book, also read Dani Rodrik’s Economics Rules (see my review here). Dani Rodrik provides a much more sophisticated (and accessible) account of economic models and guidelines for using them appropriately. You could also supplement this book with other popular books. For example, you could read Ha-Joon Chang’s Economics: The User’s Guide, which champions a pluralistic approach to economic issues.

If you are wondering about the remedy for economism, remember the economics student who got infected because he quit learning economics too early. The first and most important remedy for economism is to keep on studying economics. A good economics education will teach you that if you try to apply a model without taking into account the specifics of the particular real-world problem you are dealing with, you are very likely to misunderstand the problem and its solution. After all, a good Econ 101 is the best cure for 101ism. [4] Naturally, I would also add some philosophy of economics to the recipe.

Thank you for reading.

Notes:

[1] All references are to the e-book edition of the book (sold by Google Play Books)

[2] Also see: The Curse of Motivated Reasoning against Econ 101 by Ryan Bourne, James Kwak on Minimum Wage  by David Henderson, and James Kwak Sure Doesn’t Understand The Economics Of The Minimum Wage by Tim Wortstall.

[3] Kwak also list the following institutions: Volker Foundation, Mont Pelerin Society, Foundation for Economic Education (FEE), The American Enterprise Institute, The Heritage Foundation, The Cato Institute, and The Manhattan Institute. Moreover, Kwak points out that authors like Henry Hazlitt and Jude Wanniski helped the spread of economism.

[4] Kwak argues:

“Paying more attention to topics such as economic history, institutions, behavioral economics, common market failures such as asymmetric information, and empirical methods could help dilute the intellectual hegemony of the competitive market model.” (Chp.9)

But, students of economics learn about most of these topics. Also one of the first things that one learns in economics courses is that assumptions matter. True, there could be more emphasis on institutions, economic history, history of economics thought, and economic methodology. There is much room for improvement in economics education. But this does not justify the now widespread belief that economics education is harmful. I am almost sure that James Kwak would not agree with such a statement, but his book might contribute to this belief.


Some other reviews of Economism

Using and Abusing Models in Economics: A Review of Rodrik’s Economics Rules

Using and Abusing Models in Economics: A Review of Rodrik’s Economics Rules

“There is much to criticize in economics, but there is also much to appreciate” Dani Rodrik (in Economics Rules, p. ix)

Dani Rodrik’s new book Economics Rules: The Rights and Wrongs of the Dismal Science will be available soon. Here is an early quick review of the book.

If you do not have much time, here is the main message of this review: Economics Rules is an excellent book; a must read for economists, philosophers of economics, and policy makers, and of course for economics students. And if you consider yourself as a critical economist, a heterodox economist, or a social scientist who is critical of the way in which economists work, behave, etc., the book has a lot to offer to you too (probably a lot to disagree about, but also a new perspective on economic models). While Dani Rodrik defends economics against popular lines of criticism; he also presents his own critique.

If you have more time, please read on.
[If you prefer a PDF version, it is available @Research Gate ]

The Book

9780393246414_300Economics Rules is a book on the nature of economics and economics models. It defends economics against main lines of criticism. It argues that what makes economics powerful is its diversity of abstract and unrealistic models—but this is not a Friedman 1953 type of defense of unrealistic assumptions, as you’ll soon see.

In Economics Rules, Rodrik tries to show that critics have been criticizing economics for the wrong reasons. Economists, on the other hand, were right in defending economics, but they (well, at least most of them) have been doing it all wrong. In order to make his case, Rodrik presents an alternative account of economic models. He argues that this alternative account will provide economists “a better story about the kind of science they practice” (p. ix)—a story that will render most popular lines of criticism useless. As Rodrik puts it Economics Rules explains “why economics sometimes gets it right and sometimes doesn’t” (p. 4) and defends the core of economics—”the role that economic models play in creating knowledge”—but criticizes “the manner in which economists often practice their craft and (mis)use their models” (p. 6).

Rodrik argues that abstract theoretical models are useful, but they are also limited by the assumptions they make. Economic models do not provide us with fundamental economic laws. Their results are dependent on the conditions described by their assumptions. Thus one should be careful in generalizing a model’s results. A common mistake in economics, he argues, is to mistake a model, with the model. In fact, same applies to critics. Popular lines of criticism against economics models also mistake a model, with the model. Critics argue that economic models are too abstract and too detached from the world by way of comparing a model with the real world. However, Rodrik argues that this criticism misses the point because it ignores the diversity of models in economics. Economists’ toolbox is filled with a variety of models, and which (combination) of these models are relevant depends on the case at hand. Thus, he argues, by focusing on one model at a time many critics fail to see what makes economics so powerful.

Economics Rules is filled with interesting and thought provoking ideas and examples from economics, but (I think) its main contribution is Rodrik’s alternative account of economic models. For this reason, in what follows I will only discuss Rodrik’s account of economic models.

Unrealisticness of Economic Models

In the aftermath of the 2008 economic crisis, many economists raised concerns about the way in which economics is practiced. Probably, everyone remembers Paul Krugman’s article in The New York Times Magazine. He argued:

“[…] the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth. […] When it comes to the all-too-human problem of recessions and depressions, economists need to abandon the neat but wrong solution of assuming that everyone is rational and markets work perfectly. The vision that emerges as the profession rethinks its foundations may not be all that clear; it certainly won’t be neat; but we can hope that it will have the virtue of being at least partly right.” (Paul Krugman, in How Did Economists Get It So Wrong?)

Krugman’s piece sparked a debate concerning the nature of economics and usefulness of abstract mathematical models that utilize a set of extremely unrealistic assumptions—such as perfect rationality. The debate concerning how economists got it so wrong is still going on—see for example, see Jeff Madrick’s Seven Bad Ideas: How Mainstream Economists Have Damaged America and the World (2014), or Philip Mirowki’s Never Let a Serious Crisis Go to Waste: How Neoliberalism Survived the Financial Meltdown (2013), among others.

2008 crisis is one reason why economists have become worried about the assumptions they make, but it is not the only reason. Developments in behavioural-experimental economics and neuroeconomics were also pushing economists in a direction that many of them would prefer not going: discussing philosophical issues concerning the nature and scope of economics. Nevertheless, the challenge was powerful and some economists tried to defend their field against criticism coming from these new research areas (e.g., see Gul and Pesendorfer’s The Case for Mindless Economics). For example, the debate concerning neuroeconomics produced at least two journal special issues (1, 2) and one book entitled The Foundations of Positive and Normative Economics: A Handbook (Chaplin and Schotter 2008). (For the story of behaviroal economics and the challenges it presented, I recommend Richard Thaler’s excellent book: Misbehaving: The Making of Behavioral Economics). And there was the students: Revolting against the way in which economics was taught; demanding a more pluralistic economics education and more real world content. This started with the post-autistic economics movement (later changed its name) and after the economic crisis student revolt spread out. Post Crash Economics Society, for example, demanded that economics education should reflect the post-crash world. Now there is a global network for students, called Rethinking Economics who are working to transform economics education for the better

Although debates concerning the explanatory power of economics became popular in the last decade—especially after the 2008 crisis—such debates were not foreign to economists. History of economics is full of debates like this. Take for example the marginalism controversy in 1940s (for a good review, see the 2nd chapter of Jack Vromen’s Economic Evolution). But heterodox economists started criticizing the assumptions that economists much earlier than that. Consider the Methodenstreit (method debate) between Carl Menger and the German Historical School in late 19th century (Carl Menger’s defense of economics is presented in his Investigations—originally published in 1883). Or consider Thorstein Veblen’s criticism of the hedonistic conception of individuals in economics and its psychological foundations in his in Why is Economics not an Evolutionary Science? in 1898 (read at your own risk!).

To cut the long story short, heterodox economists and other social scientists have long argued that economics is disconnected from reality. They thought that it is way too abstract, unrealistic, value laden, atomistic, reductionist etc. Many still argue that that—because of these reasons—economic models cannot explain real world phenomena. That economic models are too abstract and unrealistic—also, mathematical and sometimes mathy—is still the most popular criticism against mainstream economics. And it is in fact true that theoretical models in economics utilize unrealistic assumptions: Perfect rationality, perfect foresight, perfect competition, etc.; you name it! Economics also ignore obviously important explanatory—historical, sociological, institutional, psychological, biological, neural, etc.—factors. In fact, economic models look like fictional worlds, fairy tales, or just so stories that have nothing to do with the real world. But does this mean that economics is useless?

The question is whether we can trust economic models and economists on important policy matters that affects millions of people. Or more generally, can we learn anything from abstract, unrealistic economic models? If so how? Economics Rules is yet another attempt to settle the answers to these questions. In order to do so, it presents an account of economic models that accept the aforementioned properties of economic models and argues that it is because of these properties (simplicity, abstraction, unrealisticness, etc.) that economics is a powerful science.

Models are Experiments

Rodrik’s Economics Rules starts with an account of what models are and what models do. Not surprisingly, Rodrik argues that models are simplifications. Economic models isolate specific mechanisms and how these mechanisms work under certain conditions. These conditions are specified by the assumptions of the model.

Rodrik’s account of models has a close resemblance to Uskali Mäki’s account of models. The method of isolation helps economists theoretically remove the influence of some elements on a set of other elements in a given situation, so that they can focus on their desired set of relations in isolation. This makes models similar to experiments. In laboratory experiments, scientists physically isolate the environment from the influence of other factors in order to study the relationships they wish to understand. So, they engage in material isolation. Models are similar to experiments in that they utilize isolation; but that is theoretical isolation rather than material isolation.

“Models are the laboratories of economic theorists. This is a claim most economic theorists will accept, and many of them have explicitly made it. Just as laboratory scientists design and examine the artificial worlds of experimental situations in their laboratories, economic theorists design and examine the artificial worlds of their theoretical models.” Uskali Mäki (in Models are experiments, experiments are models)

Rodrik agrees with this view of models. He argues:

“As with real experiments, the value of models resides in being able to isolate and identify specific causal mechanisms, one at a time” (p. 24)

All this, however, does not fully explain how we can trust economic models that utilize unrealistic assumptions. How can it be that a model that does not describe reality in a faithful manner can help us explain real world phenomena? And how can we know that causal mechanisms specified by a certain highly abstract model is working in the world? This is not an easy question. In fact philosophers of science and particularly philosophers of economics have been struggling to answer this question for a long time (see the reading list at the end of this review).

Rodrik’s answer partly comes from his depiction of critical assumptions and causal mechanisms specified by the model. Despite the fact that economic models are abstract and unrealistic, Rodrik believes that there should be some grain of truth in a model. Although he does not explicitly say this, successful models depict real causal mechanisms—or real tendencies (more on tendencies later). And by way of studying these real mechanisms (or, tendencies) under different conditions, models teach us about possibilities, and likely outcomes that we may encounter in the real world.

I made a similar argument in The Invisible Hand in Economics (Routledge, 2008). Using examples of Schelling’s models of segregation, models of emergence of a medium of exchange and game-theoretical models of conventions, I argued that highly abstract economic models (in my case, invisible-hand models) provide partial potential theoretical explanations. They are theoretical, because they abstract from the specifics of any particular case (there are exceptions to this of course, like applied models that are fine tuned to the particular case at hand). They are partial, because they are limited by the assumptions (isolations) they make. Each model starts with a specific question and represents only specific aspects of reality. A particular model is very unlikely to provide a full explanation of a specific case at hand. They are potential because they may or may not help us in explaining particular cases. As Rodrik argues, the problem of external validity is not specific to physical experiments, theoretical (or, thought) experiments also suffer from this problem. Thus we cannot know right away whether the results of the model can be generalized and carried to the real world (also see Robert Sugden’s Credible Worlds on this). Once we make sure that the model (or, a combination of some models) applies to a particular situation—that is, it represents the case at hand in a satisfactory manner—we may use the model in explaining that particular case. This commonly requires knowledge about the specific case at hand, and sometimes input from other sciences. But why do we trust in highly abstract models? The reason we believe that some of these models (providing partial potential explanations) have a chance of enlightening us about the real world is that we think that they represent a real causal (or, structural) relation—albeit in isolation.

I think Rodrik would agree with most of this. Nevertheless, here is what Rodrik says:

“The correct answer to almost any question in economics is: it depends. Different models, each equally respectable provide different answers. Models do more than warn us that results could go either way. They are useful because they tell us precisely what the likely outcomes depend on.” (p. 17) “The value of models resides in being able to isolate and identify specific causal mechanism, one at a time. These mechanisms operate in the real world alongside many others that obfuscate their workings is a complication faced by all who attempt scientific explanations. Economic models may even have an advantage here. Contingency—dependence on specific postulated conditions—is built into them” (p. 24).

By utilizing a different set of assumptions each model helps economists to study the possibilities in the real world. Thus, in Rodrik’s account, unrealistic assumptions help economists investigate likely outcomes in different settings. However, Rodrik argues, one should still have a reality check: Some assumptions are critical and model results will be true “only to the extent that their critical assumptions approximate reality” (p. 17). “For a model to be useful in the sense of tracking reality, its critical assumptions also have to track reality sufficiently closely” (p. 26). Note however that this concept of critical assumptions is not entirely clear (more on this later).

Tendencies

So, Rodrik argues that each model focuses on some aspects of the real world rather than others. For this reason, he argues, in economics it is more appropriate to talk about tendencies. This emphasis on tendencies echoes John Stuart Mill and Nancy Cartwright. Although Rodrik does not explicate his conception of tendencies in a way that would satisfy philosophers, his basic point is that what we learn from models is context-specific: Model results help economists explore tendencies in the sense that models help us specify likely outcomes of certain isolated causal factors in different settings. Thus, Rodrik argues, it is a mistake to forget this. One should not carelessly generalize a model’s results, because its result are dependent on its assumptions. Rodrik claims that “economics is a social science, and society does not have fundamental laws” (p. 45), thus economists should not behave as if they have discovered fundamental economic laws.

Models as Fables

Rodrik’s characterization of economic models does not end here. He also uses another analogy: Economic models are like fables. Of course, Rodrik is not the first economist to use this useful analogy. See, for example, how Ariel Rubinstein explains the similarity between fables and models:

“As economic theorists, we organize our thoughts using what we call models. The word “model” sounds more scientific than “fable” or “fairy tale” although I do not see much difference between them. […] A good model in economic theory, like a good fable, identifies a number of themes and elucidates them. We perform thought exercises that are only loosely connected to reality and that have been stripped of most of their real-life characteristics. However, in a good model, as in a good fable, something significant remains.” (Rubinstein, in Dilemmas of an Economic Theorist, p. 881)

In contrast to Rubinstein, Rodrik makes a good use of the fable analogy in defending explanatory power of economic models. According to Rodrik, fables are similar to economic models because, fables are simple, fictional (not real), have clear story lines and morals:

 

Economics Rules for the BLOG_2[Source: Rodrik’s slides]

The most important part of the analogy is that there are a multiplicity of fables—sometimes with contradictory morals—each for a different situation. But why is this the most important part of the analogy?

“There are countless fables, and each provides a guide for action under a somewhat different set of circumstances. Taken together, they result in morals that appear contradictory.” (p. 20)

Economic models are like fables in the sense that different models give us different and sometimes contradictory results. The moral of the story—policy conclusions we can derive from the model—is context-dependent. Because different models utilize a different set of assumptions, each model tells us about how the specified mechanism might behave under different conditions. Thus, although economic models are simplifications, using a variety of models economists are able to explore a wide range of possibilities. The same mechanism can produce different results under distinct conditions.

The interaction of the rational and economizing agents give us different results in different models. Rodrik gives several examples. For example, he compares firms in a perfect competition setting with firms in a prisoner’s dilemma setting. The difference is: The first setting (model) describes competition among many firms and the latter is used to describe competition among two large firms. Under perfect competition profit maximizing rational firms will bring about a Pareto efficient result. However, in a prisoner’s dilemma setting, Rodrik argues, the market “is not at all efficient” (p. 15). Each model represents two “different versions of how markets function (or don’t). None of them is right or wrong” (p. 16).

So, we have a diversity of models that sometimes contradict each other. However, according to Rodrik, just like simplicity and unrealisticness of economics models, the diversity of models is not a bug, it is a feature. Having multiple models—each representing a different set of circumstances—is why economics is a powerful social science. One may think of models as providing us with a menu of explanatory factors, or a menu of possible explanations. By exploring the model world by way of changing the assumptions of previous models and by developing new models, economists expand their menu of possible explanations. The cluster of models that are relevant to the case at hand become economists’ toolbox in providing explanations to particular cases. By choosing and fine tuning a (or, a set of) model(s) among the long list of available models, economists try to explain particular cases. The longer the list of models, the wider their menu of possible explanations, and the higher their chances to explain the case at hand. This is why the diversity of models in economics is not a bug, but a feature.

Understanding with theoretical models

I may be biased here (you’ll see why), but I think, Rodrik’s most important contribution in this book is to clearly show—with a lot of examples—how the collection of economic models contribute to our understanding despite the limitations of each individual model.

Let me insert another shameless reference to my own work here. Together with Petri Ylikoski from the University of Helsinki, we wrote a paper entitled Understanding with Theoretical Models. The argument in this paper has some similarities to Rodrik’s argument—although in our case it is filled with philosophical jargon. In this paper we have presented a number of claims concerning the epistemic contribution of theoretical models in economics (and elsewhere). Let me list some of the arguments in this paper together with how I think Rodrik’s argument as an economist parallels (confirms?) our thinking:

  • One should not evaluate theoretical economics models in isolation from other models. This is a mistake that many philosophers and critics—and sometimes economists—make. To put it like Rodrik, they focus on a model, think that it is the model, and criticize it because it is not sufficiently similar to the real world enough.
  • A theoretical economic model’s contribution to our understanding can only be fully understood if it is considered in a context of a family of related models and of competing explanations for the same phenomenon. In Rodrik’s words, it is the diversity of economic models that gives power to theoretical reasoning in economics.
  • Theoretical economic models provide modal understanding: they tell how things could be. They also teach us what cannot happen by showing that certain mechanisms cannot generate the specified outcomes. In fact, theoretical modelling should be understood as how-possibly reasoning. In Rodrik’s terminology this is to say that economics models helps us answer “what questions?” such as “what is the effect of A on X?” and investigate the answer of this question in isolation under different conditions. By way of doing this they teach us about likely outcomes, possibilities: “Just as social reality admits a wide range of possibilities, economic models alert us to a variety of scenarios.” (p. 209)
  • A theoretical economic model provides us with an essential understanding of certain causal mechanisms—albeit in isolation. By developing a variety of models economists provide us with a more detailed understanding of mechanisms and the possible ways in which they may interact under different conditions. This makes it easier to adapt the mechanisms specified by economic models to particular cases—in providing explanations to a particular case in hand. In Rodrik’s words: “[Economic models] are contextual and come in almost infinite variety. They provide at best partial explanations, and they claim to be no more than abstractions designed to clarify particular mechanisms of interaction and causal channels.” (p. 114, emphasis added).
  • Main contribution of economists in developing a variety of theoretical economic models is to refine, systematize, and expand the menu of possible explanations. Or in Rodrik’s words: “The multiplicity of models does not imply that anything goes. It simply means we have a menu to choose from and need an empirical method for making that choice.” (p. 73-4)
  • Scientific understanding consists of an ability to make correct what-if inferences. Theoretical economic models contribute to our general ability to construct an explanation, new models expand the scope of our explanatory understanding. They allow us to make what-if inferences about a wider set of phenomena. In Rodrik’s words: “What makes economics a science is models. It becomes a useful science when those models are deployed to enhance our understanding of how the world works and how it can be improved.” (p. 83) “Knowledge accumulates in economics not vertically, with better models replacing worse ones, but horizontally, with newer models explaining aspects of social outcomes that were unaddressed earlier. Fresh models don’t really replace older ones. They bring in a new dimension that may be more relevant in some settings.” (p. 67)

I am happy to see that a prominent economist like Dani Rodrik, at least partially, confirms our intuitions concerning theoretical models in economics. Moreover, he presents a lot of examples from history of economics and current debates on economic matters that will help us fine tune our intuitions.

Critical Assumptions

Although I agree with most of what Rodrik says, I also have some small complaints. One of them concerns Rodrik’s conception of critical assumptions. As mentioned earlier Rodrik thinks that there should be some grain of truth in theoretical models: Model’s critical assumptions should reflect reality. But what are critical assumptions? How can we decide whether an assumption is critical, or not? Although Rodik gives some hints, this is not entirely clear. He argues:

“We can say an assumption is critical if its modification in an arguably more realistic direction would produce a substantive difference in the conclusions produced by the model” (p. 26)

This is not very helpful, because one can think of many examples where the results of a model changes as a response to changes in many of its assumption. Is rationality a critical assumption? Is perfect competition a critical assumption? Is “convex preferences” a critical assumption? Is assuming a Cobb-Douglas production (or utility) function critical? The list can go on. Changing these assumptions—making them more realistic—will give us different results under some settings. So how are we going to decide which assumptions are critical?

Although Rodrik gives some examples, I do not think that he resolves this matter satisfactory. But there may be a reason for this. Rodrik argues that “what makes an assumption critical depends in part on what the model is used for” (p. 29). However, as Rodrik—and, Robert Sugden, Uskali Mäki, and David Colander—argues economists do not always provide a users’ guide to abstract theoretical models. More often than not they are silent about what the model could be used for. Moreover, economists sometimes use the same model for different purposes. For this reason identifying critical assumptions may not be as easy as it sounds. It is probably an art, or a craft—requiring economic intuition, experience, etc.—as Rodrik argues: “Good judgement and experience are indispensable, and training can get you only so far” (p. 83). (Note here that Rodrik provides some guidance in the 3rd Chapter of the book.)

How to evade criticism?

So how does Rodrik help economists evade criticism concerning economics? In order to learn that—and many other things–you need to read the book. But here is a chapter by chapter guide to the book.

Chapter by chapter guide to Economics Rules

  • Chapter 1: What Models Do. The first chapter of the book discusses what models are and what models do. It is in this chapter that Rodrik introduces the variety of models thesis and argues that both unrealistic assumptions and mathematics are useful in economic modelling. He also dismisses the idea that economic models should be more complex and tries to show why we should appreciate the simplicity of economic models.
  • Chapter 2: The Science of Economic Modeling. In the second chapter, Rodrik makes the case for economics as a social science—distinct from physics. He argues that economics does not have fundamental laws, and economists should not behave as if they have discovered the fundamental laws of economics and society. This chapter also presents a review of what makes models scientific: Models clarify hypotheses, enable accumulation of knowledge, imply an empirical method, and help economists generate knowledge based on shared professional standards. Moreover, in this chapter, Rodrik explains the importance of “second best” thinking, the difficulty of testing economic models, and why knowledge accumulation in economics depends on the development of new models (including explorations of older models—i.e., by way of changing some of their assumptions). Finally, in this chapter, Rodrik presents his take on the Reinhart and Rogoff debate.
  • Chapter 3: Navigating among Models. In this chapter, Rodrik guides the reader in navigating among models using his own growth diagnostics Then he goes on to explaining the general principles of model selection: How to verify (i) critical assumptions of models, (ii) mechanisms specified by a model, (iii) direct implications of models, and (iv) incidental implications. This chapter also discusses lab experiments, (randomized) field experiments, natural experiments and the problem of external validity.
  • Chapter 4: Models and Theories. As its title suggests, this chapter discusses the relationship between theories and models. Rodrik demarcates between three questions: What questions (“what is the effect of A on X?”), why questions (“why did some particular event take place?”) and big, timeless questions (“what determines the distribution of income?”). Rodrik argues that economic models answer what questions. Answering why questions requires using particular models or a set of models fine tuned to the specific case at hand—and maybe input from other sciences. Big questions require universal theories, and according to Rodrik it is impossible to formulate universal theories in social sciences. One important argument in this chapter is that general economic theories are frameworks for organizing our thoughts, “rather than stand-alone explanatory frameworks” (p. 116). In order to show this, Rodrik sweeps through history of economics; exemplifying his argument with discussions of theory of value and distribution, and theory of business cycles and unemployment. Later in the chapter he discusses how theories are used in order to explain specific events; using the example of the rise of inequality in US. These types of explanations in economics, Rodrik argues, are not like universal theories, rather they are specific to particular cases. Finally Rodrik argues that economics is a modest science that mostly tries to answer what questions, investigating one cause at a time.
  • Chapter 5: When Economists Go Wrong. In this chapter Rodrik explains what happens when economists mistake a model with the model and warns against the apparent agreement among economists concerning certain policy proposals. In is in this chapter that Rodrik discusses the financial crises and its aftermath, and the case of Washington Consensus. This chapter clarifies that mistaking a model (more appropriately, economists’ preferred models at the time) for the model is the most important reason why economists go astray. In the case of the financial crisis, the preferred models were models that support the efficient market hypothesis. In the case of Washington Consensus, the preferred models were the models that assume that the main drivers of growth were saving and access to investable funds. So how did economists get it so wrong in both of these cases? Not because they did not have appropriate models (they did), rather they became overconfident concerning some models, and ignored others. They have confused a model, with the In brief, Rodrik argues that economics is not the problem, economists are. Here are some of the mistakes that economists makes: Mistaking a model with the model, overconfidence in a (set of) model(s), false sense of understanding concerning the way in which markets work, market favoritism, inability to connect models with the real world and—for empirical economists—empirics without models.
  • Chapter 6: Economics and Its Critics. In this chapter, Rodrik responds to critics. He argues that idealization, abstraction, utilization of unrealistic assumptions, methodological individualism are not problems as long as one appreciates the diversity of economic models and accepts the fact that each economic model is an attempt to understand some real world relationships in isolation. Market favoritism is not a problem of economics, and does not require a remaking of economics; it is rather a problem created by some overconfident economists who do not appreciate the diversity of economic models. It is true that economic models cannot be tested like the models in physics, but this is because economics is a social science. Economics deals with this “problem” by way of “expanding the collection of potential applicable models, with newer ones capturing aspects of social reality that were overlooked or neglected by earlier ones” (p. 183). Similarly, because economics is a social science economic models should not be expected to provide precise predictions; rather economics help us make conditional predictions. Contrary to what many critics say, economics is more pluralist than it appears—exemplified by behavioral, experimental and institutional economics. Finally, this last chapter has a discussion concerning whether economic thinking and marketization undermine social values.
  • Epilogue: The Twenty Commandments. This chapter presents, Ten Commandments for economists and ten for non-economists: these summarize the basic messages of the book for economists and non-economists.

Conclusion

In sum: Economics Rules is an excellent book; a must read for mainstream and heterodox economists, philosophers of economics, policy makers, and of course for economics students.

Let me end the review with Rodrik’s Ten Commandments for economists:

Ten Commandments for Economists

  1. “Economics is a collection of models; cherish their diversity.
  2. It is a model, not the model.
  3. Make your model simple enough to isolate specific causes and how they work, but not so simple that it leaves out key interactions among causes.
  4. Unrealistic assumptions are OK; unrealistic critical assumptions are not OK.
  5. The world is (almost) always second best.
  6. To map a model to the real world you need explicit empirical diagnostics, which is more craft than science.
  7. Do not confuse agreement among economists for certainty about how the world works.
  8. It’s OK to say “I don’t know” when asked about the economy or policy.
  9. Efficiency is not everything.
  10. Substituting your values for the public’s is an abuse of your expertise.”

(Rodrik 2015: 213-4).

Note: All references are to the Kindle (UK) edition:

Rodrik, Dani (2015). Economics Rules: Why Economics Works, When It Fails, and How To Tell The Difference. Oxford University Press. Kindle Edition.

Further Reading

Here is a reading list for those who would like know about what philosophers and philosophers of economists has to say about these matters (in no particular order).

Textbooks

Handbooks

 

Wade Hands’ Review of The Invisible Hand in Economics

Wade Hands’ Review of The Invisible Hand in Economics

Here is the last paragraph of Wade Hands’ review of The Invisible Hand in Economics (History of Political Economy 2010; 42: 388-390):

“In summary, I found Aydinonat’s book to be a very important contribution to the literature. This is not to say that I would not quibble about specific details of his argument – but it does provide a very useful, and quite coherent, framework for thinking about the explanatory power and adequacy of invisible hand-type explanations. Such explanations are so pervasive in economics – for some they define economics – and yet we previously lacked any coherent framework for situating them within the broader context of scientific explanations in general. Aydinonat has provided us with a badly needed framework for investigating these issues. The Invisible Hand in Economics will not be the last word on invisible hand explanations, but it will become an obligatory reference point for any future research on the subject, and I recommend it to anyone who would like to better understand this very important class of models. “

If you’d like to read the full review you must visit History of Political Economy’s web site.