Monday, May 02, 2005

More Challenges for Max

Max takes issue with my last post, and perhaps with most of the economics profession as well:

Andrew Samwick sums up everything that is wrong with economics as practiced in the nation's economics departments (as opposed to departments of urban planning, public policy, geography, sociology, political science):

"What does it mean to "see the economics" in a given situation? Economics consists of exactly two ideas: optimization and equilibrium."

Insofar as optimization and equilibrium do not explain behavior and outcomes, which is to say a ton, "economics" is useless, if not toxic. I should say that theories founded on optimization and equilibrium as employed by Steve Levitt, Samwick, and others can be illuminating, in and of themselves, but I don't think I've ever seen such a breathtakingly narrow characterization of economics.
This raises two issues that bear further comment. First, what have I left out? The challenge for Max, and anyone else who wants to play, is to enumerate other ideas in economics that are as fundamental as optimization and equilibrium that should be included in the statement. Certainly "behavior" and "outcomes" aren't ideas in the way that I have used the term (if that was the intent of including them). The Comments section is open and awaits your entries.

Second, Max has the proposition inverted. Neither Freakonomics nor my last post are an attempt to "see the economics" to the exclusion or even the diminution of other disciplines that may be relevant in understanding a given situation (unless statistical evidence bears that conclusion out). On the contrary, what Levitt has done is to show that economics (characterized by me, not necessarily Levitt, as optimization and equilibrium) is relevant in situations where it might not seem to apply: baby naming, teacher cheating, sumo wrestling, criminal activity, and others. As I noted in the previous post, this ability to spread the insights of economics into new areas has been the hallmark of the Chicago School and Levitt is its leading member in this generation.

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Max said...

You left out disequilibrium and non-optimizing behavior. You left out institutions. You left out historical context. You left out psychological explanations that are not founded on utility maximization. A sociologist once told me, "You (economists) individualize everything." So you left out group behavior. I've probably left out other things myself.

I think the sort of economics you do refer to has its uses. I also think there's a lot more to economic behavior than is revealed by optimization and equilibrium.

rjw said...

I made a critical remark on your comments on max's blog, so I guess it's fair I expand on my comments:

let's start by saying that yes, equilibrium and optimization are powerful tools , particularly as they allow explicit mathematisation and model construction.

It also means that economists start with an assumption of rational behaviour (constrained optimization) so the focus is on incentives, which is generally no bad thing.

And also, let me note that you have said in your post that you don't preclude 'non-economic- contributions to explanations of social and economic situations .. which is an important point.

so where the problem? my thoughts:

- firstly, tools charactersing equilibria are only one part of the story. situations where there are many equilibria (eg nash equilibria) may require a good understanding of the history, or context if economists are going to add anything useful.

In other words, the function and development of many social structures is enlightened by economic models (I have game theory clearly in mind as one prime example), but it is a tool that needs to be complemented by other insights (and other methods) to be at its most powerful. (Im thinking of the work of jon elster here)

And my contention would be that by limiting the subject to equilibrium and optimisation you are downplaying the importance for the education of economists of having a broad appreciation of history and historical development.

This legitimises a situation where graduate economists have a syllabus so skewed that they can solve complicated dynamic programming problems, but may have nothing intelligent to say on (I pluck random examples) how banking systems developed... paradoxes in rationality... the history of technology...the philosophy and methodology of science and how it differs from social science)

In short - I think economists are partly programmed to believe that if it ain't maths, its not too relevant. Of course - real economists grow up - but too many go away from economics with an unbalanced view of what the subject is about and what it can contribute.

- second example... individual behaviour ... for a very long time the the economic model of rationality has been what we might call 'thin' - constrained optimization on the basis of given preferences, in a context where interaction with other agents is solely through the price mechanism.

It therefore has tended not to look much at a number of things:

- how beliefs and preferences are formed, and in particular how beliefs and ideologies come to be shared.

- in partiular, how context and social/economic position shapes beliefs.

- issues of status and group formation, and strategies of social closure

Now you may say this is not inherent in the economic approach - it can be expanded to look at these things - true to some extent - but certainly these issues have been underplayed.

- A third example - conflict - despite the attention in economics to resource allocation, the focus on equilibrium and optimisation for a long time drew attention away from issues of conflict over resource allocation (hey - aren't initial allocations given?) and the the structural interplay of conflict and coordination in captalism

On this, see the laughably narrow understanding of many (not all) economists of how trade unions develop and function, their impact on labour markets. It's remarkable in this context how little emphasis many economic syllabuses place on analysis of comparative systems (eg comparative financial systems, comparative labour market systems etc)

Now - let me qualify all this, as there are positive angles too

- there are many economists who do not suffer from this narrowness of vision, and who have made huge contributions - often using conventional economic tools - in each of these areas.

And in fact, using a common language and set of tools as hermeneutics, amongst academic, has allowed certain ideas formerly not 'mainstream' to become part of standard discourse and debate (eg theores of labour marget segmentation translated into, partly, efficiency wage models) because they can now be communicated using 'orthodox' language.

Economics has become much less narrow in recent years - and much richer - with the development of models of asymettric information models, game theory, as economists have found diminishing returns in developing the techniques and have started to apply them more widely to actually tackling practical problems.

And as a research programme, trying to apply the simple tools and asking simple economic questions in new contexts (gary becker... and now levitt) has proved fruitful, even if one does not buy all the conclusions.

I could of course carry on in the critical vein...... the history of economic thought is not taught much (hey - progress is linear no ? we have better maths now, so those olds guys are outdated....) , with the result that economists are often not aware how economists ideas have themselves been shaped by historical episodes and contexts.

And the result? How many people read smith, keynes, kalecki, friedman or knight in the original ? Not too many. And the attitude that these writers don't need to be read is reinforced by the idea that economics = techniques (optimisation, equilibrium) and techniques get better over time - so don't waste your time with those dusty books.

In sum, my concerns are probably mainly about the education of economists generally, than research in economics. It is a disservice to students to pretend that economics is all optimization and equilibrium. Even more so if at the same time one is trying to maintain the position that it is scientific.

Andrew Samwick said...

There is a distinction between "what economists work on" or "what economists think is interesting" and the essential ideas in economics. The latter is supposed to be a far narrower set of concepts.

The former would include historical context and institutions, which are concepts relevant for understanding optimization and equilibrium but are not fundamental ideas in economics or the unique contribution of economics to understanding a given problem.

Some economists believe that the departures from optimization and equilibrium are the most interesting problems to study. Wonderful. I'll look forward to expanding the set of essential ideas in economics to include their work when they come up with frameworks that are as useful as the two I mentioned.

You have decided to interpret optimization as being equivalent to utility maximization and excluding group behavior, not me. What I wrote was that optimization leads to an equating of rewards and costs at the margin. I did not restrict those rewards to be financial or individual in nature. Nor have I suggested that optimization requires agents to be fully rational or to even conform to the standard utility maximization problem.

Most importantly, I have not suggested that economics is always the most useful framework to analyze a given issue or that other disciplines have little to offer. I have simply agreed with the premise of the Chicago School that optimization and equilibrium are relevant in many instances (like those in Levitt's work) that would ordinarily not appear to be within the realm of economics.

ed said...

1. I think that the idea of budget constraints is a third fundamental idea of economics. It may seem too obvious and trivial to matter, but in fact it has important implications, and they hold even if we don't have optimization or equilibrium (see Deaton and Muellbauer's book).

2. I don't really see that much "optimization" or "equilibrium" in most of Levitts work. It's mostly just statistics applied to interesting questions along with some ideas about incentives. I think you could drop any assumptions about optimization or equilibrium without changing most Levitts work that much at all.

rjw said...

well, if optimisation and all possible developments of the rational actor model are all subsumed into economics, then it seems to me that a lot of people in other disciplines (history, sociology, political science) have been doing a lot of economics all along without knowing it. (As these fields also make extensive use of the notion of rational behaviour)

economics certainly priviledges the rational choice model - to be sure - but to imply sole ownership seems to be going a bit too far.

At root though my objection is to characterising a field of study solely in terms of the tools and analytical concepts that it uses.

"Economics consists of exactly two ideas: optimization and equilibrium"

Why define a field of study in terms of its tools, rather than the concerns and issues with which that subject has been concerned with? I don't see the a priori justification for that.

But if you are just making the more limited case that equilibrium and optimisation are core ideas that strongly affect the way economists approach and think about issues, and that this emphasis is powerful, then you are claiming much less, and I don't disagree.

The notion of opportunity costs is perhaps a possible addition, though I guess one might consider it is already implicit. Similarly, the notion of efficiency is central, though one might consider it subsumed in optimisation (though then you have to distinguish social and private optima)

wooleewoos said...

Several comments appear (to me) have very specific ideas in mind as to what "equilibrium" is. Economists do spend a lot of time thinking, especially in games, on what is a reasonable notion of equilibrium.
Morever, the work of Lucas and others makes painfully clear that just calling something a "disequilibrium" is hardly progress. Unemployment is maybe one of the best examples. The ostrich-like position of those who insisted on talking about unemployment as a disequilibrium phenomena didn't help much. Finally, starting in the 1970's people started writing down the problems where worker and firms had a tough time finding each other, and given these constraints workers wouldn't accept any old wage offer, not would firms accept any old worker. Each side thought about what passing on current opportunities would get them (optimiziation), and given this, equilibrium could display unemployment. The most important aspect of this is that we finally just dealt with the true problem facing the unemployed individual and the firm wishing to fill a vacancy. This does NOT mean that the equilibrium is necessarily "good" in any welfare sense, but its does focus you on what the sources of difficulty facing household and firms actually are.

Equilibrium is no siren call to irrelevance. Rather it's just a requirement that 1) reources aren't flying in our out of the window 2) people have the right (conditional) expectations.

The latter can be criticized, but for my money , the most useful advances in bounded rationality have been made my serious economists (Rabin, Sargent etc.). These guys also have te advantage that don't wish to romanticize science by acting like beard-scracthers looking to score brownie points in some coffee-shop. They're just careful guys who want to help economists TRACTABLY represent alternatives to the standard rational choice set up. If only the critics were half as useful.

OHenry said...
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