September 24, 2016

Out of science

Comment on David Ruccio on ‘Phlogiston, the identification problem, and the state of macroeconomics’

Blog-Reference

In his recent paper ‘The Trouble With Macroeconomics’* Paul Romer puts DSGE and its main proponents (Lucas, Sargent, Prescott) to rest. In the final section ‘The Trouble Ahead For All of Economics’ he appeals to emotions: “It is sad to recognize that economists who made such important scientific contributions in the early stages of their careers followed a trajectory that took them away from science. It is painful to say this so when they are people I know and like and when so many other people that I know and like idolize these leaders.”

While it is true that DSGE and its proponents are out of science it is NOT correct to give the impression that an accident happened at some point on the way which led from science to non-science. The fact of the matter is that DSGE has always been out of science because economics has always been out of science. The leaders of the DSGE/RBC program have done exactly what they were supposed to do: “It is a touchstone of accepted economics that all explanations must run in terms of the actions and reactions of individuals. Our behavior in judging economic research, in peer review of papers and research, and in promotions, includes the criterion that in principle the behavior we explain and the policies we propose are explicable in terms of individuals, not of other social categories.” (Arrow, 1994, p. 1)

This definition of the subject matter translates into the following set of hard core propositions/axioms: “HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states.” (Weintraub, 1985, p. 147)

The critical axioms are HC2 and HC5. Krugman put it nicely: “... most of what I and many others do is sorta-kinda neoclassical because it takes the maximization-and-equilibrium world as a starting point.”

It is obvious to anyone with a modicum of scientific instinct that the axiomatic starting point of orthodox economics is methodologically forever unacceptable. The axiom set consists of blatant nonentities but each student generation has swallowed it without turning an eyelid. Lucas, Sargent, Prescott certainly did. This is scientifically disqualifying.

In order to be applicable HC3, which translates formally into calculus, requires a lot of auxiliary assumptions, most prominently a well-behaved production function.*** Taken together, all axioms and auxiliary assumptions crystallize to SS-DD-equilibrium or what Leijonhufvud famously called the Totem of Micro/Macro.

Needless to stress that ALL THREE elements of the standard tool (SS-function, DD-function, equilibrium) are nonentities. The usual concept of a function is NOT applicable in economics. It was the heterodox economist Georgescu-Roegen who raised some methodological doubts long ago: “But why should economic laws ... be expressed by analytical functions?” (1966, p. 123)

The fact that neither SS/DD functions nor equilibrium exist leads with inescapable consequence to the identification problem in Econometrics (see Romer Sec. 4).** Romer takes this insurmountable technical difficulty as methodological silver bullet in order to finish off DSGE/RBC. It should be noted, though, that the identification problem has its roots in the Walrasian axiom set HC1/HC5 which is the accepted common ground of orthodox economics.

The real and ultimate scientific error/mistake of Lucas, Sargent, Prescott et al. consists in accepting the very definition of economics. The failure of DSGE therefore calls (i) for a paradigm shift, i.e. a new definition of the subject matter, and (ii), the replacement of the silly supply-demand-equilibrium totem of economics (2013; 2014).

To throw DSGE/RBC now unceremoniously out of science is only the first step because textbook supply-demand-equilibrium, which is built upon the same maximization-and-equilibrium axioms, is rubbish since Jevons/Walras/Menger. By sticking to the post-real microfoundations HC1/HC5 economists are since 140 years out of science. Romer is right: there is trouble ahead for ALL of economics.

Egmont Kakarot-Handtke


References
Arrow, K. J. (1994). Methodological Individualism and Social Knowledge. American Economic Review, Papers and Proceedings, 84(2): 1–9. URL
Georgescu-Roegen, N. (1966). Analytical Economics, chapter General Conclusions for the Economist, pages 92–129. Cambridge, MA: Harvard University Press.
Kakarot-Handtke, E. (2013). How to Get Rid of Supply-Demand-Equilibrium. SSRN Working Paper Series, 2263172: 1–24. URL
Kakarot-Handtke, E. (2014). The Law of Supply and Demand: Here it is Finally. SSRN Working Paper Series, 2481840: 1–17. URL
Weintraub, E. R. (1985). Joan Robinson’s Critique of Equilibrium: An Appraisal. American Economic Review, Papers and Proceedings, 75(2): 146–149. URL

* Paper of Sep 14, 2016
** See also Wikipedia
*** See post ‘Putting the production function back on its feet

Preceding 'The identification problem and the dumping of the old guard'