Sunday, March 20, 2016

Economics doesn't need new theories; it needs to eliminate theories

David Sloan Wilson's latest article at Evonomics misunderstands the state of (macro)economics and Noah Smith's empirical tack. The key to understanding Smith is this sentence:
Ten million cool theories are of little use beyond the “gee whiz” factor if you can’t pick between them. Until recently, econ was fairly bad about agreeing on rigorous ways to test theories against reality, so paradigms came and went like fashions and fads.
... and this blog post. Smith is calling for what I will call negative empiricism: theory rejection. There's more from Smith here.

Wilson's response is:
By Smith’s own account, the field of economics is experiencing an empirical revolution. Unlike the past, it has become necessary to test theories against reality. That places the field of economics many decades behind the field of evolution and numerous fields in the human social sciences that have been rigorously evidence-based all along. 
Emphasis mine. You can tell that Wilson has misunderstood Smith by using the word "necessary". Wilson should have said: Unlike the past, it has become possible to test theories against reality. That was Noah's point; that's the issue. There are ten million theories because there was no way to reject them.

Now I agree with Wilson's call for a framework -- I've made it on this blog several times (e.g. here). In fact, I've made exactly the same kind of statement as Wilson. Here's me:
Also, I was inspired to do this because of Noah Smith's recent post on why macroeconomics doesn't seem to work very well. Put simply: there is limited empirical information to choose between alternatives. My plan is to produce an economic framework that captures at least a rich subset of the phenomena in a sufficiently rigorous way that it could be used to eliminate alternatives.
Here's Wilson:
The main reason that the so-called orthodox school of economics achieved its dominance is because it seemed to offer a grand unifying theoretical framework. Too bad that its assumptions were absurd and little effort was made to test its empirical predictions. Its failure does not change the fact that some unifying theoretical framework is required to prevent the “ten million cool theories” problem. What Nick Hanauer, Eric Liu, and I are saying (Smith misses that our arguments are cut from the same cloth) is that a combination of evolutionary theory and complexity theory offers the best prospect for a unifying theoretical framework.
But note the misunderstanding again (emphasis mine). It's not that little effort was made. The data was uninformative. It was not possible to reject theories. You literally could not tell if the assumptions were absurd as far as the macroeconomic outcomes were concerned. Maybe they were absurd at the micro scale, but there is no reason to believe that absurd micro assumptions necessarily result in an absurd macro theory. In fact, one of the ways macroeconomics might be tractable is if it doesn't matter what you assume about agents. Maybe the relatively simple traditional utility maximizing rational agent framework would work out.

For example, treating molecules as point particles with zero size and no internal structure (absurd) is perfectly acceptable if you have an ideal gas. If we had discovered atoms before the thermodynamics of gasses, and happened to follow Wilson's approach, we'd conclude that statistical mechanics is absurd. It treats atoms as if they have no electrons or nuclei! How silly!

But then because Wilson misunderstands the empirical problem in macroeconomics, he suggests his own (along with Hanauer and Liu's) even more complex framework!

Smith is skeptical because the data has only recently starting to eliminate possibilities and he believes enlightenment will come from empirically testing theories -- not new theory fads:
To me, that seems like a much bigger deal than any new theory fad, because it offers us a chance to find enduringly reliable theories that won’t simply disappear when people get bored or political ideologies change.
Wilson's evolution as a framework (as well as Hanauer and Liu's list of assumptions) are exactly the new theory fads Smith is talking about.


Now you may ask how the information transfer framework fits in here. Well, the primary thing is that the information transfer framework is a much simpler framework than even the framework Wilson calls the "so-called orthodox school of economics". Because it is simpler, it can be rejected. The data becomes informative. It's not some new "more realistic" or "more complex" approach. It's a simplification. And it seems to work.

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