Good article by Ross Gittins on Economics and Equilibrium

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Ross Git­tins has writ­ten a very good overview of the fail­ings of neo­clas­si­cal eco­nom­ics in today’s Syd­ney Morn­ing Her­ald:

Self-right­ing mar­kets and oth­er shib­bo­leths

The arti­cle men­tions the Dahlem Report, but does­n’t pro­vide a link to it. For those who would like to read it, here it is.

I also wrote a post on the Dahlem Report short­ly after it was writ­ten, and helped pub­li­cise it by plac­ing it on my blog. Giv­en that its tone was in some ways even more dis­mis­sive of con­ven­tion­al eco­nom­ics than I am, the title for this post was obvi­ous:

And you think I’m ornery? The Dahlem Report

There are, as Ross implies,  many dis­si­dent groups with­in eco­nom­ics, but these are nor­mal­ly overshadowed–and crowd­ed out of pub­lic commentary–by the dom­i­nant “neo­clas­si­cal” school. As a result, most of the pub­lic takes what this school says to be all there is to “eco­nom­ics”.

Crit­ics like Paul Ormerod, me, and many oth­ers have railed against this over the years–in pub­lic talks, in lec­tures to stu­dents in any sub­jects where we have some con­trol over con­tent, in books like my Debunk­ing Eco­nom­ics or Paul’s But­ter­fly Eco­nom­ics–but we’ve large­ly been ignored by the pub­lic, since the econ­o­my seemed to be work­ing just fine. Just as neo­clas­si­cal eco­nom­ics said it always would.

And then along came the Glob­al Finan­cial Cri­sis.

A lot of the prob­lems in neo­clas­si­cal eco­nom­ics emanate from its methodology–the phi­los­o­phy under­pin­ning how neo­clas­si­cal econ­o­mists build mod­els of the economy–and I cov­er this in a sam­ple chap­ter from my Debunk­ing Eco­nom­ics which is avail­able online:

There is mad­ness in their method

The key point that Git­tins focus­es upon is the obses­sion with equi­lib­ri­um. To aca­d­e­mics from oth­er dis­ci­plines, this obses­sion appears quaint. Most sci­ences have con­cepts too, but they don’t attempt to mod­el the sys­tems at the heart of their dis­ci­pline as if they are always in equi­lib­ri­um. They have instead devel­oped meth­ods to analyse the behav­iour of these sys­tems when they are not in equilibrium–which is almost all the time (and when they do mod­el equi­l­bri­um, their con­cepts of equi­lib­ri­um are much broad­er than that which applies in neo­clas­si­cal eco­nom­ics, which implies that all agents in the sys­tem are in a state of rest).

Instead, neo­clas­si­cal econ­o­mists reflect their iso­la­tion from the broad sweep of intel­lec­tu­al his­to­ry by being igno­rant of these very meth­ods. I find this stunning–because the most basic such method is part of the edu­ca­tion of any engi­neer, physi­cist, or math­e­mati­cian, even if they only do an under­grad­u­ate degree in their sub­ject and nev­er become aca­d­e­mics. This method is “Dif­fer­en­tial Equa­tions”, and any engi­neer, physi­cist, or math­e­mati­cian has to do at least an intro­duc­to­ry course in these in order to get a Bach­e­lors Degree.

Yet econ­o­mists can grad­u­ate with PhDs with­out ever com­ing across them.

Many neo­clas­si­cal econ­o­mists think they know about these–after all, the core con­cepts in neo­clas­si­cal eco­nom­ics con­cern things like “Mar­gin­al Cost” and “Mar­gin­al Rev­enue”, which are the dif­fer­en­tials of “Total Cost” and “Total Rev­enue” with respect to out­put: “We don’t know about dif­fer­en­tial equa­tions? Bah, what non­sense!”

In fact, dif­fer­en­tial equa­tions are very dif­fer­ent beasts from sim­ple dif­fer­en­ti­a­tion, since they con­sid­er the rate of change of vari­ables not with respect to each oth­er, but with respect to time (I’m tempt­ed to pro­vide a Wikipedia link to the con­cept of “time” for the ben­e­fit of any neo­clas­si­cal read­ers who don’t know what it is… but I’ll restrain myself). They make it pos­si­ble to mod­el how the economy–or any oth­er system–will behave when its not in equi­lib­ri­um.

Instead, even Nobel Prize win­ners seem to believe that if they aban­don the fan­ta­sy that the econ­o­my is in equi­lib­ri­um, they will be unable to mod­el its behav­iour. Wit­ness this state­ment from Paul Krug­man on his blog when he gave some back­ground to his recent crit­i­cal essay on eco­nom­ics:

Actu­al­ly, let me put it this way: the econ­o­my is a com­plex sys­tem of inter­act­ing indi­vid­u­als — and these indi­vid­u­als them­selves are com­plex sys­tems. Neo­clas­si­cal eco­nom­ics rad­i­cal­ly over­sim­pli­fies both the indi­vid­u­als and the sys­tem — and gets a lot of mileage by doing that; I, for one, am not going to ban­ish max­i­miza­tion-and-equi­lib­ri­um from my tool­box [my empha­sis]. But the temp­ta­tion is always to keep on apply­ing these extreme sim­pli­fi­ca­tions, even where the evi­dence clear­ly shows that they’re wrong. What econ­o­mists have to do is learn to resist that temp­ta­tion. But doing so will, inevitably, lead to a much messier, less pret­ty view.

Then this guar­an­tees you’re nev­er going to under­stand com­plex sys­tems Paul: the very start­ing point of com­plex sys­tems analy­sis is the mod­el­ling of systems–such as the Lorenz Attrac­tor that is the basis of mete­o­rol­o­gy–which are nev­er in equi­lib­ri­um.

Iron­i­cal­ly, in that same essay Krug­man notes that mete­o­rol­o­gy might be a valid mod­el for eco­nom­ics to fol­low:

Third, on an inter­est­ing point raised by Dis­cov­er (via Mark Thoma): won’t we even­tu­al­ly have a true the­o­ry that’s as beau­ti­ful as the full neo­clas­si­cal ver­sion? Well, one thing’s for sure: we don’t have that beau­ti­ful final the­o­ry now, so the cur­rent choice is between ideas that are beau­ti­ful but wrong and a much messier hodge­podge. But my guess is that even in the long run it won’t be all that neat. Dis­cov­er sug­gests gen­er­al rel­a­tiv­i­ty ver­sus New­ton­ian physics; but a bet­ter mod­el may be mete­o­rol­o­gy, which as I under­stand it starts from some sim­ple basic prin­ci­ples but is fiendish­ly com­plex in prac­tice [my empha­sis].

Well Paul, to under­stand mete­o­rol­o­gy, you’re going to have to give up on equilibrium–or rather on the fan­ta­sy that a com­plex sys­tem can be mod­elled as if it is in equi­lib­ri­um. There are, for exam­ple, 3 equi­lib­ria in the Lorenz Attractor–all three of which are unsta­ble. Equi­lib­ri­um is a state in which the Attrac­tor will nev­er be.

I also find it remark­able that intel­li­gent peo­ple like Krug­man can be so igno­rant of devel­op­ments out­side their own field of endeav­our. Notice the com­ment he made that not apply­ing the stan­dard neo­clas­si­cal eco­nom­ics sim­pli­fi­ca­tions like equi­lib­ri­um “will, inevitably, lead to a much messier, less pret­ty view”.

Pret­ti­ness itself should not be an objec­tive of sci­ence. But nonethe­less, some of the pret­ti­est objects in sci­ence are the result of non-equi­lib­ri­um dynam­ics. The Lorenz Attrac­tor is clear­ly one–take a look at it and you’ll see why peo­ple often talk of “the But­ter­fly Effect” when describ­ing the insta­bil­i­ty of the weath­er. But there are many oth­ers.

I think my own non-equi­lib­ri­um mod­els of the econ­o­my have a sim­i­lar beauty–here for exam­ple are two from my mod­el of Min­sky’s Finan­cial Insta­bil­i­ty Hypoth­e­sis. The first is of an econ­o­my with­out a gov­ern­ment sec­tor which under­goes a debt-dri­ven Depres­sion:

The fate is not pretty–the econ­o­my col­laps­es as debt rises–but the image is “pret­ty”.

Both the image and the fate of the next mod­el are pretty–this is an econ­o­my start­ing from the same ini­tial con­di­tions, but which has a gov­ern­ment sec­tor that prac­tices counter-cycli­cal fis­cal pol­i­cy and there­fore pre­vents a debt-induced cri­sis:

The above is the time path of employ­ment and wages in this mod­el, which is actu­al­ly a 2D slice through the 4‑dimensions of the mod­el: (1) the wages share of out­put; (2) the employ­ment rate; (3) the debt to out­put ratio; and (4) gov­ern­ment spend­ing as a per­cent­age of out­put). This next view shows 3 of those dimen­sions (exclud­ing gov­ern­ment spend­ing), and the 2 dimen­sion­al view of the pre­vi­ous sim­u­la­tion is shown as a shad­ow below the 3D shape):

So the out­put of non-equi­lib­ri­um mod­els can be “pretty”–it’s just the pic­ture they craft of cap­i­tal­ism that isn’t pret­ty. It isn’t a sys­tem that auto­mat­i­cal­ly reach­es equi­lib­ri­um and ensures the best out­come for the largest num­ber of peo­ple. It may not be “pret­ty” in that way, but it is the world in which we live.

As Git­tins argues in his piece, we have no choice but to under­stand that sys­tem, and the neo­clas­si­cal obses­sion with equi­lib­ri­um is pos­si­bly the major rea­son why we have not under­stood it to date.

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