Friday, May 27, 2016

New economics: now with all new unfounded assumptions!

 Not sure the traditional economics is charitably represented here, but I for one don't see the difference between assuming column A and assuming column B. If I had my druthers, we'd go with column C. Chart modified from Eric Beinhocker's chart reproduced at Evonomics.

One of the more maddening things about the public discourse on economics is that it seems a large fraction of it is based on simply exchanging one set of theoretical assumptions for another [1]. The force multiplier of annoyance is the fact that these theoretical assumptions assume things you should be using your theory to understand. If I was to write this as symbolic logic, we'd have:

p
∴p

The above table is reproduced (and greatly enhanced by the addition of a fifth third column) from this article at Evonomics, but the problem runs the gamut from assuming complexity and nonlinearity (here, here, here or here) to assuming things about monetary policy (e.g. here) to assuming what a recession is (e.g. here).

Really the assumptions in the table above, or about complexity, or about recessions are models that should be constructed from more fundamental assumptions. Those fundamental assumptions should follow the admittedly subjective rule of being arguably self-evident. For one thing, they should not include assumptions about human behavior!

An example from physics might be illuminating. What are the underlying assumptions of classical physics? That continuous motion exists and it doesn't matter where it happens in space. In more technical language, we assume calculus and space translation invariance (aka conservation of momentum). Newton expressed these in terms of the time derivative of momentum, but the basic story is calculus plus momentum. Newton did not assume what matter is made of, how the solar system worked, or Kepler's laws.

Can we construct a comparable assumption for economics? In the sense that physics is the study of motion, economics is the study of exchange and prices. And prices would be irrelevant if everything that was wanted ("supply") was in the possession (i.e. in the same location in time and space) of the wanting entity ("demand") and things never changed. Therefore we can assume (at a minimum) that when the instances of supply and instances of demand match, we have a scale invariance (a subset of conformal symmetry, see here or here) between supply and demand that leaves prices invariant. Additionally, we can assume prices should only change if supply and/or demand change.

The information transfer approach takes the statement "instances of supply and instances of demand match" and makes it probabilistic (probability distributions of supply events and demand events match and we have a large number of events), allowing us to talk about the information entropy of those distributions and deriving an equation (here or in my paper) that holds in general that is consistent with that conformal symmetry:

$$p \equiv \frac{dD}{dS} \leq k \; \frac{D}{S}$$

Analogous to the way Newton defined force (a concept people vaguely intuited), we're defining price (a concept in my opinion people have only vaguely intuited) as the LHS of the equation. We call equality "information equilibrium".

Now it is possible to make other assumptions about economics. Another strong contender is that economics is the study of strategic decisions over a set of options made by people who have one kind of stuff and people who have another kind of stuff. That would lead to game theory, but the "strategic decisions" component does make some assumptions about human behavior (i.e. that we make strategic decisions).

The information transfer approach may not be correct. Economics may not really be about matching supply with demand. However, it at least makes the kind of assumptions you should be making [2] -- and doesn't assume the answers to questions about the impacts of policy, institutions, individual behavior or recessions that should be the focus of economics.

...

Footnotes:

[1] This just makes me think of this quote from Ghostbusters II:
Dana: Okay, but after dinner, don't put any of those old cheap moves on me. It's different now.Peter Venkman: Oh, no! I have all NEW cheap moves.
[2] This aspect is closely related to the fact that you can understand the different "schools" of economics in terms of extra assumptions beyond the information equilibrium assumptions.

1. "For one thing, they should not include assumptions about human behavior!"

"doesn't assume the answers to questions about the impacts of policy, institutions, individual behavior or recessions that should be the focus of economics."

These statements really bring the bacon home.

You think you are talking about economics. I'm afraid you are a physicist talking about physics using an economic analogue.

It's like Newton expressing his three laws in terms of the growth of plants.

1. So we've figured out that economics is like the growth of plants?

If you have some better way to explain things that are as empirically accurate with its predictions as this method, please let us know! Billions of people are suffering in poverty -- we need to understand how this system of monetary exchange we've adopted without thinking too much about it beforehand.

2. So what is your prescription for alleviating the poverty of the billions?

"without thinking too much about it beforehand."

?????

3. I wasn't the one claiming to know for sure how economics doesn't work. As I clearly state above, the information transfer approach may not be correct.

If you say something is wrong with no evidence, you should expect to get called on it.

Monetary exchange was adopted at different points in history and in different places on Earth (in e.g. China and Lydia) without first studying how it worked. That's fine, but it has left us with the mess of trying to figure out how the airplane works while we're flying it.

2. "As I clearly state above, the information transfer approach may not be correct."

Jason,

You are always telling us how well IE fits the data which is the same as saying you think you have viable model.

Whether you're sure or not about how your model works or any other model works why does that stop you have something to say about how to solve the poverty problem. You have opinions about every other thing and seeing this is your cause celebre and given you have a working model which you say matches the data why haven't you an opinion about solving world poverty.

I didn't say anything was wrong. All I said is you are a physicist doing physics not economics.

And if your model is as "empirically accurate with its predictions" as you say it is, why haven't you a prescription for solving world poverty based on this empirically sound model?

The question I asked was a fair one.

1. You have hit on exactly the point. I've written nearly 1000 posts on these ideas including some dead ends but always bringing evidence for why something is right or wrong.

That's why it's risible for you to say that my approach is incorrect without any evidence at all. And since you are anonymous, it can't be some argument from authority; even in that case, that's not really a valid argument.

And I have written in several places on optimal policy, but one of the things I've found is that policy doesn't seem to matter in terms of economics. Nothing seems to change the fact of unemployment or recessions so we just need to have a UBI or strong safety net.

2. Jason,

You still haven't responded to my question.

And again, I say, I didn't say you were wrong.

I said you are a physicist doing physics using economics.

3. "Nothing seems to change the fact of unemployment or recessions so we just need to have a UBI or strong safety net."

This is another statement that brings home another piece of bacon.

Despite saying what an empirically sound model you have, you admit the fact that unemployment and recessions are unavoidable.

4. Of what use is your model if it cannot explain unemployment and recessions?

5. You did say I was wrong:

"You think you are talking about economics. I'm afraid you are a physicist talking about physics using an economic analogue."

The "you think" in that sentence means that I am thinking incorrectly and the "I'm afraid" means you think there is something wrong. Or were you saying:

"You think you are talking about economics. And you are! I'm afraid you are a physicist talking about physics using an economic analogue. And it's amazingly insightful!"

Was that how I was supposed to interpret that? Ha!

Regarding the rest ...

Do you know that recessions are avoidable? Is there some evidence for this?

What if recessions are unavoidable? Unavoidable recessions would then be a property of correct economic theories.

And I didn't say there aren't explanations -- there are many times I explore this on my blog. The most succinct one is here. I don't have all the answers there, but at least it's a stab at it backed up by evidence.

6. Please explain to me how your model explains unemployment and recessions.

7. Also you have avoided responding to my question about solving world poverty.

8. I fail to see the usefulness of answering someone who already believes the approach is wrong and knows the correct approach. I can forecast that you'd think that a solution to world poverty from me is wrong (without providing evidence) and that my model doesn't explain unemployment and recessions (also without providing evidence).

What's my motivation? This character that I'm playing that is deeply earnest and cares about being right on the internet -- does he have a void in his life that he tries to fill by arguing with anonymous commenters? Sounds unbelievable to me ... so what is my motivation?

9. I would say that you want to engage in a conversation with your epistemic peers, however, until you firstly drop the hubris and secondly entertain actually dealing with reality, then that probably won't happen.

10. But you started with a baseless claim that my approach is "physics" and that's not how economics works, or quoting directly:

"You think you are talking about economics. I'm afraid you are a physicist talking about physics using an economic analogue."

My "epistemic" peers would insist on providing evidence to back up their claims.

If you find somewhere my approach fails, I'd love to hear about it. And I'm not sure where hubris comes in because, as I say above:

"The information transfer approach may not be correct."

That doesn't sound like excessive pride or self-confidence. Now if I said the information transfer approach will revolutionize economics, that might be hubris. I did say something like that at least once, but it's usually self-deprecating sarcasm.

Regarding reality, how do you know I am not dealing with reality unless you've already assumed you know how economics works or have some proof (that still hasn't been provided) that the IE approach is wrong? "Dealing with reality" and "you being right" might not be simultaneously true! They could be (hubris!), but who knows for sure at this point?

11. If you not dealing with unemployment and recessions then you not dealing with reality.

12. Where did you make that up from? I said policy may not be able to avoid recessions or unemployment. That doesn't mean I'm not "dealing" with them -- in fact that is precisely dealing with them.

Here are searches on my blog for both "unemployment" and "recession", having 350 and 381 hits respectively on the Google:

http://informationtransfereconomics.blogspot.com/search?q=unemployment

http://informationtransfereconomics.blogspot.com/search?q=recession

13. Where does your model explicitly deal with and (even attempt) to explain unemployment and recession?

It seems to me your model is no different in structure than the general class of neoclassical models which assume unemployment and recession away - except your model is dressed in entropic drag.

3. We haven't solved the problem of poverty because too many people profit from the poverty of others. Pay day lenders, and the private prison industrial complex are two that come to mind.

Since most economists never talk about those things it is safe to assume that economists don't give a crap about poverty

1. It's unfortunate because those are both fairly short term exploitation profit opportunities. Collectively, we'd all profit more if everyone had more money.

I give the benefit of the doubt that even right wing free marketers believe their own crap about it being better for everyone (it might be a post hoc rationalization). The problem is that economic policy is set more by business interests (as short sighted as those prison corporations and payday lenders) than economic research.

Even Milton Friedman (!) believed in a UBI.

2. Im not sure what you mean by short term exploitation. Do you mean that the source of profit doesn't last long or that the these types of schemes don't last long? I agree that each individual "mark" is a short term source but the system does a great job of creating more and more marks, while the financial system the rest of us use continues to be inaccessible to many since they don't qualify.

If you mean that these are fly by night businesses that dont last Id just say that they have been around forever in many different forms and, as John Oliver showed on one of his weekly shows a few months back, they have the support of a lot of other powerful people in politics and banking... which gets to your comment about how and who chooses econ policy

Regarding a UBI, there has been a lot of discussion about UBI vs JG (Job Guarantee) for the last 8 years and while I may tend to personally favor a JG I would enthusiastically support a UBI. I do think though in our country too many voters already think people are getting something for nothing (even though welfare has been gone for 20 years) and a UBI wouldn't sit right with them, regardless of the arguments economists make.

3. I think I should have probably said "short sighted" rather than "short term" -- there are better solutions out there that are better for almost everyone.

4. Agreed! We have way too many people who only think about their profit from whatever immediate transaction they are making and no longer term concern as to whether this will continue beyond next month. These are often the people who aren't vastly wealthy.

Additionally, exercising your power over other individuals rather than being smarter or more creative seems to be the primary means of acquiring vast quantities of wealth (and keeping the cash flows going) all through our societies.

I dont have any specific ideas how to change that but one thing that must happen is people need to have the veil of "economic analysis" lifted and see its just politics. So any solution means putting new people in power all over the world.