What went wrong with economics?

The July 18th issue of The Economist is focused on the economic crisis and the economic theory that failed to prevent or, for most, even foresee the crisis.  The cover is telling--a book labeled "Modern Economic Theory" that is melting away, with the words "Where it went wrong-and how the crisis is changing it" beneath.  That sounds like the magazine intends to investigate the sources of the crisis in modern economic theory. But does it?  Only in a sort of halfway approach.  There's a lead-in on "what went wrong with economics" (page 11).  It claims that economics as a discipline "deserves a robust defence" and that "so does the free-market paradigm." 

There is, to be quite clear, very little real justification for those statements.  Both, in my view, have failed us, in that the free-market paradigm does not work.  Without substantial state processes and institutions that impose restrictions on free markets--such as regulatory agencies looking out for consumers, anti-trust enforcement preventing singular companies from growing so large that they can have a systemic effect on the system--we will have skullduggery llike the Madoff ponzi scheme and market control such as that exerted by the several large banks who have essentially set anti-consumer/pro-rent policies in lockstep over the last few years, while engaging in speculative behavior and abetting tax avoidance in many cases like UBS's that are bad for the system and bad for ordinary Americans but good for greedy bankers.

What does the lead-in admit to, then (if it still thinks economic and free market theory are worth defending)?  It acknowledges that the discipline is subject to three critiques:

1) it helped cause the current economic crisis

2) It failed to see it coming

3) It doesn't know how to fix it.

In my book, that doesn't leave much out.  A theory that actively causes harm, can't prevent it, and can't cure it is not much of a theory. 

Comments

[Geoff]

I'll link to this as soon as you fix the typo. :)

[Jack]

Theories are the conjectures of men (women too is some cases, but I'm using men in a generic sense.) Man looks about his environment and tries to understand what is going on for any number of reasons. He begins to theorize about the relationships between the events that are readily observed in the environment, but not fully undersood. Some people are more observant than others. Some recognize the limitations of suppositions concerning the unseen aspects of their environment. The causal relationships between observed events are those unseen phenomenon, but they are of the greatest interest to the observers of the events in question. They want to understand why one event seems to follow another. They want to know the antecedents of events. Men begin to offer theories about these antecedents to events.

These theories become the means by which we begin to understand our world. They can also be utilized to provide explanations of our world and the many subsets which we construct. Theories with good predictive validity are highly valued and thought to approach the status of a law of nature, a law about realtionships between events. Men who can provide such theories, which may appear to have predictive validity, are held in high regard in our society. They achieve the status and title of Scientist. We can rely upon what they tell us about the world we live in.
When these scientists and their theories are focused upon economic phenomenon they become highly valued in a monetary sense. What will men do to achieve such a valued status?

That question becomes significant when we begin to recognize that there are certain aspects of any environment that do not lend themselves readily to measured observation. In such cases our observations become difficult to describe and especially difficult to subject to comparative analysis. Those who seek to understand the relationships between these events and phenomenon in our environment need to over come this defect in description. Scientific understanding and analysis of events requires this. Science cannot procede without effective measurement of the phenomenon observed. Supposition begins to enter into the efforts to understand these phenomenon and the relationships between them. These suppositions are often introduced into the measurement of these phenomenon. The true scientists recognize the short comings of these suppositions and admit to the lack of veridical measurement and the concomitant potential distortion to the descriptions given. Other scientists develop theories
based upon their suppositions and often point to the superficial support for their theories without recognizing the limits of their own suppositions. It is especially within the fields of social science wherein these suppositions occur due to the enormous difficulties in measuring social phenomenon. Accuracy is king and veridical measurment is essential, but elusive. Predictive validity becomes the goal of such sciences. Do economic theories have predictive validity? Are economic theories offered to us as a means of understanding events or rather as a means of effecting events? Effecting economic events has far greater value than understanding economic events and greater utility than predicting economic events. Economic theory can fall prey to the laws of obfuscation through ignorance or design.

To be continued.

[LindaMBeale]

Geoff--you don't like my new abbreviation for July? I like it much better than "Jul."..... But typos were the least of my problems with typepad over the last few days. It introduced some new features that gobbled my comments, caused endless seas of useless html code to appear in middle of postings that took me, literally, hours to ferret out and remove, etc. What's a little typo to all that?

[LindaMBeale]

Jack--good points. can't wait for the rest.

[Jack]

Contd.
So in trying to understand what went wrong when the economy failed one must recognize the limitations of social science as applied to economic phenomenon. Economic theories seem never to reach the status of a Law of Science. There is often little predictive validity to such theories. Efforts to measure the validity of such theories are often little more than marshalling those specific observations available to the theorist that are actually the basis for the theory. "Free market" economics, for example, applies something of an ontological argument in defence of its validity. Certain economic phenomenon have been observed. The relationships between those phenomenon are supposed or implied by the observers. The argument is that all good economic outcomes have certain antecedents that, when taken as a whole, is described as the free market. In effect, the free market is good because it produces good outcomes, therefore all good outcomes are the result of the free market. The possibility of a good outcome under certain conditions described as the free market has metamorphosed into a conclusion of only good outcomes from such conditions. The possibililties deduced from some observations have become certainties dependent upon those observations.

Here is where we come back to the point that a theory of science can be used to understand and explain, predict or effect an event or a set of events. It is the latter of those possiblities that falls within the realm of applied science. It is the former that is the demonstrative basis for the acceptance of the validity of the theory and the appropriateness of its application in an effort to control and direct outcomes. This is where we find "free market" theory, able to explain economic relationships, but unable to predict the outcomes of those relationships, but intent in effecting such relationships and their outcomes. It is the absence of any semblance of predictive validity in free market theorization that should have fore warned its proponents of its inadequacies.

The inability to foresee the inadequacies of free market theory may have been the result of ignorance, but given the brilliance with which its theorists laid out the basis for the theory's promulgation ignorance seems unlikely. As noted previously economic theory can have great monetary value if it can be well demonstrated to have predictive validity. Economic theories has even greater value if they can be utilized to effect economic outcomes. Therein lies the tale.

[Jan Theodore Galkowski]

"In effect, the free market is good because it produces good outcomes, therefore all good outcomes are the result of the free market. The possibility of a good outcome under certain conditions described as the free market has metamorphosed into a conclusion of only good outcomes from such conditions. The possibililties deduced from some observations have become certainties dependent upon those observations." I'd go farther: How is an economic hypothesis falsifiable? Is it falsified using cross-validation? Is it falsified when policy based upon it fails? How do you separate its failings from exogenous factors, politics being one of the most important? Is it "falsified" when it becomes unpopular?

I think "free markets" are a part of how Americans see themselves, in the absence of a long tradition of what it means to be American. Alas, we have no Illiad to capture and convey those values, but, rather, Proctor&Gamble ads, Fox News, MSNBC, Jon Stewart, and the Washington Post.

[Jack]

The test of the validity of a theory is not that the hypotheses that it generates can resist falsification. It is rather that the opposites of those hypotheses, the null hypothesis, can be rejected, thereby, adding weight to the confirmation of the hypothesis. This difference seems so subtle that I'm not certain that I can define how it differs. The issues with economic theories, as well as all other social sciences, is that the confounding variables and exogenous factors are infrequently totally identifiable and controlled. They are often not even fully understood. It is an area of "research" ripe for obfuscation due to its inherently uncontrollable factors and immeasurable parameters.

[LindaMBeale]

Interesting point, Jan. We have used "free market" quite freely over the last few decades, to describe everything from the way Wall Street works, to the way we think jobs are created or even--to a substantial extent that seems remarkable in hindsight---to describe the way various systems of law work. I think you are right that it has become a cultural norm, "part of the way Americans see themselves"--in part because a great deal of money has been spent to inculcate that norm. Cf, the John Olin Foundation's expenditures to "teach" judges about economics, to support the George Mason law school's fixation on friedman economics, to support training of younger students in Chicago School economics. I once had a student in his second year of law school tell me how confused he was in first year--all this new material, things he had never thought about before. Then, he told me, he took in the first semester of his second year a course in law and ecnomics, and found that the efficient market theory could be applied to everything (no matter that it actually failed to predict--no one was talking about that in those days except "kooks" like me). To him, it was like finding an ancient map to a treasure. Now, he said, he had a tool for understanding all the disciplines of the law. He could just apply efficiency theory and economics would tell him what was right and wrong. This talk, by the way, was during his experience in my tax class, where I was challenging him to see BEYOND the typical law and economics approach to understand where concerns for democratic institutions, fairness and other moral issues should dethrone the Chicago School's thinking.

[chin fuil an]

“What went wrong with economics” is: Economics lacks at least one fundamental foundation. Installing this fundamental will elevate Economics to another platform.

What is this fundamental? It is something that sciences cling on tightly, but economics does not. So, economics has departed from this fundamental, perhaps unconsciously.

What is it then? It is the Fundamental Axiom or Law of Causality, simply means: Cause gives rise to Effect, In=Out, Debit=Credit, a Source for every Outcome, etc which are common senses or self-evident truths.

Tell us in what way the Economics runs away from this fundamental? If you ask: You win, I win, everyone wins, who is the loser or provider of wealth? Most of economists will tell you that there is no loser. The Economics textbooks also say so. But it cannot be no loser, as it violates the fundamental Law of Causality. So, we must insist for the presence of loser, as dictated by the Fundamental Law of Causality. On this insistence, one great researcher by the name of HNM had successfully uncovered the mask of the loser after an effort of several decades. Needless to say, he has restored the Fundamental Law of Causality back to the economics and make it a strong and real science. Using his new theory, all events in the past or present could be explained with ease, and that it could even provide future policies and directions for our world.

If you are really interested to find out more, please write to me via my email: chinfuilan@yahoo.com