Monday, October 17, 2016

What should we expect from an economic theory?

Really now ... what were you expecting?

I got into a back and forth with Srinivas T on Twitter after my comment on an Evonomics tweet. As an aside, Noah Smith has a good piece on frequent contributor at Evonomics David Sloan Wilson (my own takes are here, here, here). I'll come back to this later. Anyway, Evonomics put up a tweet quoting an economist saying "we need to behave like scientists" and abandon neoclassical economics.

My comment was that this isn't how scientists actually behave. Newton's laws are wrong, but we don't abandon them. They remain a valid approximation when the system isn't quantum or relativistic. Srinivas took exception, saying surely I don't believe neoclassical economics is wrong in the same way Newton is wrong.

I think this gets at an important issue: what should we expect of an economic theory?

I claimed that the neoclassical approximation was good to ~10% -- showing my graph of employment. Neoclassical economics predicts 100% employment; the current value is 95%. That's a pretty good first order estimate. While Newton has much better accuracy (< 1%) at nonrelativistic speeds, this is in principle no different. But what kind of error should we expect of a social science theory? Is that 10% social science error commensurate with a < 1% "hard science" error?

I'd personally say yes, but you'd have to admit that it isn't at the "throw it out" level -- at least for a social science theory. What do you expect?

Now I imagine an argument could be made that the error isn't really 10%, but rather much, much bigger. That is hard to imagine. Supply and demand isn't completely wrong, and the neoclassical growth model (Solow) isn't completely inconsistent with the Kaldor factsThis experiment shows supply and demand functions at the micro level.

Basically, neoclassical economics hasn't really been rejected in the same way Newton is rejected for relativistic or quantum systems. Sure, there are some places where it (neoclassical economics) is wrong, but any eventual economic theory of everything is going to look just like neoclassical economics where it is right. Just like Einstein's theories reduce to Newton's for v << c (the speed of light setting the scale of the theory), the final theory of economics is going to reduce to neoclassical economics in some limit relative to some scale.

But there lies an important point, and where I sympathize with Srinivas' comment. What limit is that? Economics does not set scope conditions, so we don't know where neoclassical economics fails (like we do for Newton: v ~ c) except by trial and error.

This is where economic methodology leaves us wanting -- Paul Romer replied to a tweet of mine agreeing about this point ...
As a theoretical physicist, I try to demonstrate by example how theoretical economics should be approached with my own information transfer framework. The ITF does in fact reduce to neoclassical economics (see my paper). But it also tells us something about scope. Neoclassical economics is at best a bound on what we should observe empirically, and holds in the market where A is traded for B as long as

I(A) ≈ I(B)

i.e. when the information entropy of the distribution of A is approximately equal to the information entropy of the distribution of B. This matches up with the neoclassical idea of no excess supply or demand (treating A as demand for B).

Now it is true that you could say I'm defending neoclassical economics because my theory matches up with it in some limit. But really causality goes the other way: I set up my theory to match up with supply and demand. Supply and demand has been shown to operate as a good first order understanding in the average case -- and even in macroeconomics the AD-AS model is a descent staring point.

Throwing neoclassical economics out is rejecting a theory because it fails to explain things that are out of scope. That is not how scientists behave. We don't throw out Newton because it fails for v ~ c.

It seems to me to be analogous to driving Keynesian economics out of macroeconomics. Keynesians did not fail to describe stagflation and e.g. the ISLM model represents a descent first order theory of macro when inflation is low. Maybe it's just that there's more appetite for criticisms of economics (per Noah Smith above):
There's a new website called Evonomics devoted to critiquing the economics discipline. ... The site appears to be attracting a ton of traffic - there's a large appetite out there for critiques of economics. ... Anyway, I like that Wilson is thinking about economics, and saying provocative, challenging things. There's really very little downside to saying provocative, challenging things, as long as you're not saying them into the ear of a credulous policymaker.
Driving out neoclassical economics seems to be politically motivated in the same way Keynesian economics was driven from macro. It's definitely not because of new data. Neoclassical economics has been just as wrong as it was in Keynes time. However, it has also been just as right.

We have to be careful about why we reject theories. We shouldn't reject 50% solutions because they aren't 100% solutions. Heck, we shouldn't reject 10% solutions because they aren't 100% solutions.

And to bring it back to my critique of David Sloan Wilson that I linked to above: we shouldn't plunge head first into completely new theories unless those theories have demonstrated themselves to be at least similarly effective as our current 50% solution. Wilson's evolutionary approach to economics hasn't even shown a single empirical success. It can't even explain why unemployment is on average between 5 and 10% in the US over the entire post-war period instead of, say, 80%. It can't explain why grocery stores work.

Neoclassical economics at least tells us that grocery stores work and unemployment is going to be closer to 0% than 100%. That's pretty good compared to anything else out there**.


** Gonna need explicit examples if you want to dispute this.

37 comments:

  1. Neoclassical economics saying unemployment is zero is not an error. It is an assumption.

    "the final theory of economics is going to reduce to neoclassical economics in some limit relative to some scale'

    How can you say this when NCE doesn't deal with reality. It is a complete abstraction.

    What you call out of scope I would call reality.

    Scale and scope are red herrings.

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    1. "Neoclassical economics saying unemployment is zero is not an error. It is an assumption."

      1. Newtonian physics doesn't say its problems at v ~ c are errors. It is an assumption (of Galilean invariance).
      2. Zero unemployment is actually not an assumption. Agents in neoclassical economics will adjust their reservation wage until they find employment. That is how zero unemployment is achieved.
      3. Regardless, most modern economists view neoclassical Econ as an approximation.

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    2. In NCE, markets are assumed to be perfectly competitive.

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  2. "I claimed that the neoclassical approximation was good to ~10% -- showing my graph of employment. Neoclassical economics predicts 100% employment; the current value is 95%. That's a pretty good first order estimate."

    It's like a theory of medicine which says don't treat disease because eventually you'll die. That's a 100% agreement with facts.

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    1. Actually a better analogy is that it is like a theory that you shouldn't treat disease because you'll eventually get better.

      And that is an improvement over bloodletting!

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  3. I agree with Anon.

    I really really like your work on this site Jason. I really appreciate you using your obviously significant analytical skills to take on economics and I think you are on to something here, but I do think you are being quite generous to NCE with your comment on unemployment. Patting them on the back because their "theory" tells us that employment is going to be way closer to 100% than 0% is faint praise. Why does their theory get credit for such a prediction? NCE actually treats currently unemployed people as being employed at "leisure" if you dig deep enough.

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    1. Thanks.

      There are a couple of reasons I am defending NCE here. One, as I say above, is that the ITF is roughly equivalent to NCE in the information equilibrium limit.

      A second is that it is "scientific" to drop a first order approximation is not how science works ...

      And third, to drop it with nothing to replace it sets you back to (as I say in the comment above) bloodletting.

      NCE gets the credit for that prediction because no other theory makes it (at least no other theory that isn't built from the roots of NCE ... e.g. Keynes uses classical Econ to come up with a model where there is persistent unemployment).

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    2. You defend NCE because IT is equivalent to NCE.

      That's the only reason.

      You use scale and scope arguments to divert attention from the point that neither NCE nor IT deal with reality.

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    3. Anonymous, not sure what you are talking about. Any good theory is going to have scales and a scope. Macroeconomics has a scale -- that's what "macro" is for. Unfortunately Econ tends not to give well defined scope. Anonymous commenters, doubly so!

      "Dealing with reality" has a certain scope, but you don't tell us what that is. Does economic theory have to predict the existence of iPhones? Cell phones? Communications devices? Products? At what point does this theory "deal with reality".

      I am assuming this is the same anonymous commenter that's commented here before. You should read my post about doing better than DSGE, the FOMC, and BVAR models. Capturing reality much better than mainstream Econ!

      Also as the world's leading expert on the IT framework, I can tell you it is not equivalent to NCE. Only approximately, and in certain cases.

      But it seems regardless of what I say, the IT model will never give you fulfillment and meaning. I'm guessing you are still reading along because you just enjoy arguing. But that's fine; I do too!

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    4. I dont want to be pedantic here but I think one of the problems I have with crediting NCE for making a prediction regarding unemployment is that it looks to me like its more an observation than a prediction.

      If you look at the roots of NCE, it is describing a barter economy where everyone has something to trade so by definition everyone is employed... self employed. That is the starting point. It has evolved to be mostly a monetarist version of barter, where the unit of account is simply another good to exchange.

      I think there is very good evidence that the barter story is wrong and the origins of money from barter is wrong.

      Yes, there was a time when most people were self employed and we didn't have a measurement called "unemployment" but extrapolating models from that world to todays world will give you many wrong answers.

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    5. Not sure we are all on the same page with what neoclassical economics is. I am talking about the rational utility maximizing agents that still comprises the micro part of the neoclassical synthesis (with the macro part being Keynesian economics). Neoclassical economics is independent of the existence of money (you could have monetarist macro or Keynesian macro with neoclassical micro). It is mostly about rational utility maximization ... i.e. neoclassical econ = classical econ + marginalism + utility. It doesn't really exist until the early 1900s.

      [Aside: the IT framework is basically a form of generalized marginalism which is why it matches up with NCE in some cases.]

      I am using "predicts" as a generic term for outcome of the theory (either a retrodicton or prediction). By saying NCE predicts 100% employment, I mean the solution to a generic model results in 100% unemployment (working for wage w > 0 improves marginal utility over working for w = 0 if you are not already maximizing your utility by not working, i.e. you meet the definition of unemployed because you want to find a job). This is not one of the assumptions, but is derived from the theory.

      As far as I can tell, no other economic theory comes up with this result (at least that doesn't incorporate NCE). This is probably because most numerical econ theories are based on NCE.

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  4. " Does economic theory have to predict the existence of iPhones?....""

    It's a fair point. My point is about the way you use scope and scale arguments.

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    1. You keep using those words. I do not think they mean what you think they mean.

      I'm guessing you have a problem with the way I try to be clear, precise, and logical about theoretical models by pointing out the scales involved and the models' scope.

      Do you have any writings on the subject? Why do you think unemployment closer to 0% than 100%?

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    2. "Throwing neoclassical economics out is rejecting a theory because it fails to explain things that are out of scope."

      Is unemployment out of scope for a macroeconomic theory?

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    3. Not sure you quite understand what is meant by scope. I have to interpret your question because it obviously misses the point. The unemployment rate is in scope, large deviations towards high unemployment are out of scope.

      Your question is like asking if velocity is out of scope for Newton's laws. Of course not. But velocities v ~ c are.

      You still didn't answer my question: without resorting to NCE, why do you think the unemployment rate is closer to 0% than 100%?

      (n.b. NCE is telling us something about the unemployment rate, so it is in scope.)

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    4. "Throwing neoclassical economics out is rejecting a theory because it fails to explain things that are out of scope."

      "The unemployment rate is in scope, large deviations towards high unemployment are out of scope."

      These two statements seem to be at odds.

      Who is it that rejects NCE because it is out of scope?

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    5. I think you misunderstood what I said. I did not say people were rejecting it because it is out of scope. No one except me and Noah Smith even talk about scope.

      What I said was that some people wanted to reject all of NCE despite it being out of scope for the things those people want to reject it for. For example, rejecting NCE for saying employment is closer to 0% than 100%. Another example would be rejecting it because it gets individual behavior wrong, but nearly all economics is about the behavior of N >> 1 people. You don't reject it for getting individual behavior wrong.

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    6. People reject NCE because it assumes away the feature that is one of the most of interest in macroeconomics, that is, unemployment.

      NCE doesn't say the unemployment is closer to 0% - it says unemployment IS zero %.

      NCE also ignores other structural features such as feedbacks between supply and demand schedules.

      NCE is based on a bunch of assumptions which have nothing to do with reality.

      NCE assumes all agents are rational hence, think alike. There are times when economic agents (in reality) do think alike and are irrational - the madness of crowds.

      These are not matters of scope.

      You only use scope in this way to validate your model.




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    7. Again, you are not referring to NCE as it is understood today by economists -- as an approximation.

      You are continuing to say Newton's laws are wrong because the don't consider the speed of light. Before Einstein, that was true. But modern physicists don't assume Newton's laws work at v ~ c in exactly the same way modern economists don't assume u = 0.

      It's not like search costs are impossible to understand in NCE -- and they lead to u > 0%.

      You are living in the 19th century. The neoclassical synthesis comes in the middle of the 20th century.

      And what you say are not matters of scope are *precisely* matters of scope.

      (Additionally, the IT framework has recessions that arise exactly because of the "madness of crowds" -- agents acting the same way create correlations that reduce entropy. ... And note that this is precisely a matter of scope -- deviation from information equilibrium.)

      NCE does not assume u = 0. It assumes agents maximize utility, or minimize desperation as you put it. Unemployment that is closer to 0% than 100% results.

      It is always amazing to me that people who despise NCE can end up making NCE arguments. You basically have to start from a place where humans are insane or stupid in order to get away from NCE ... But haters of NCE want others to think they care about humans (I agree unemployment is a major social welfare problem).

      Remember: Marx was basically an NCE before the math. He thought Econ worked that way. But he just thought the normal functioning of NCE led to revolution.

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    8. "You are continuing to say Newton's laws are wrong......

      Where did I say this? Things must be getting desperate in Seattle.

      So now you're talking about the neoclassical synthesis and not neoclassical economics? Please make up your mind.

      "And note that this is precisely a matter of scope -- deviation from information equilibrium."

      Then scope used in this way is a useless concept.


      " You basically have to start from a place where humans are insane or stupid in order to get away from NCE "

      Things are desperate in Seattle. It's your arguments that are beginning to border on the insane and extreme.

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    9. The Newton's laws analogy was pretty clearly an analogy. You are effectively saying Newton's laws are wrong because they don't consider the speed of light. That's how Popper felt, but it's not how modern physicists approach Newton's laws. By saying NCE is wrong, you are approaching NCE in exactly this same way that isn't how modern economists view it.

      The neoclassical synthesis has all of the same assumptions you identify as problematic about unrealistic people that NCE has. Neoclassical synthesis includes neoclassical microeconomics and Keynesian macroeconomics. If NCE was so problematic, how can it operate just fine with Keynesian economics?

      Then scope used in this way is a useless concept.

      Hahahahaha! Ok, now you literally are saying Newton's laws are wrong because it's useless to talk about their scope being v << c.

      It's your arguments that are beginning to border on the insane and extreme.

      Really, now? Neoclassical economics is defined by the assumption of intelligent rational agents. To get away from that assumption, you have to assume irrational (insane) or unintelligent (stupid).

      I thought you wanted to get away from NCE! You're going to have to have stupid and/or insane agents in your description, then. Otherwise, whatever your description is, it is approximated by NCE.

      You remind me of the emails I still occasionally receive from people saying "Einstein was wrong" or "quantum mechanics is wrong". Well, whatever your new ground-breaking idea is, it's going to have to reduce to quantum mechanics or special relativity in some limit because they are consistent with some basic facts about the universe.

      NCE is consistent with some basic facts about the economy: the unemployment rate is typically closer to 0% than 100%, supply and demand appear to describe markets on a basic level. Whatever your theory of economics, it's going to have to reduce to something that looks like NCE in some limit.

      There is no escaping it. It'll be in there, inside any correct theory of economics, wearing it like a glove.

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    10. "You are effectively saying Newton's laws are wrong because they don't consider the speed of light."

      I am not saying this at all - either effectively or in actuality.

      "By saying NCE is wrong"

      Firstly, when I use the term NCE I mean neoclassical economics, not the neoclassical synthesis as you have appeared to slide over towards. Secondly, I am not saying NCE is wrong, I am saying it bears no relationship to reality.

      "If NCE was so problematic, how can it operate just fine with Keynesian economics?"

      Who says it does?

      "Hahahahaha! Ok, now you literally are saying Newton's laws are wrong because it's useless to talk about their scope being v << c."

      I said scope in the way YOU use it to defend the validity and applicability of YOUR model. I make no reference to Newton either directly or by inference. This is purely your inference based on your prejudiced logic, stilted by the need to defend your model.

      "NCE is consistent with some basic facts about the economy"

      NCE assumes away unemployment. NCE assumes markets always clear. NCE assumes perfectly competitive markets. NCE assumes economic agents with perfect rationality with perfect foresight. Get it right.

      "There is no escaping it. It'll be in there, inside any correct theory of economics, wearing it like a glove."

      Only because economics has to deal with markets and people. NCE also deals with markets and people (as economic agents), that's the only necessary commonality. The devil will be in the detail.









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    11. First, a point of logic. If I consider the microeconomics of the neoclassical synthesis to be in essence the same thing as neoclassical economics (which I do, and in fact, it is), then I am not sliding in any direction. If A = B, then if I say A, then I say B, I did not "slide" from A to B -- it's just a different name. If you consider the microeconomic component of the neoclassical synthesis to be different from neoclassical economics (which you seem to do despite the fact it is not) then you are sliding from A to B.

      In short, I am a different person than you, so things that would be changes of position in your mind are not changes in my mind.

      But in general, I think I see the issue. You don't quite understand what neoclassical economics is. You say:


      [1] NCE assumes away unemployment. [2] NCE assumes markets always clear. [3] NCE assumes perfectly competitive markets. [4] NCE assumes economic agents with perfect rationality with perfect foresight. Get it right.

      I guess 1 out of 4 ain't bad, but only the last one is correct (kind of).

      Here are the actual assumptions of neoclassical economics

      A. People have rational preferences between outcomes that can be identified and associated with values.
      B. Individuals maximize utility and firms maximize profits.
      C. People act independently on the basis of full and relevant information.

      https://en.wikipedia.org/wiki/Neoclassical_economics

      Assumption A is the existence of utility. Assumption B is the assumption of maximization. Assumption C is roughly your 4th assumption (the only one you got right).

      However, your other three assumptions are wrong. Neoclassical economics does not assume perfectly competitive markets (your #3). In fact, they tend to think a central government, regulations, or taxes will cause markets to be imperfect. That brings us to your #2: if markets are imperfect, they will not clear. So #2 isn't an assumption; it only holds in the case of perfectly competitive markets. This brings us to your #1. If markets don't always clear, then the labor market will not necessarily clear. That means your #1 only holds in NCE if there are perfect markets. This is why the right wing tends to say things like unemployment insurance increases unemployment.

      Your assumptions #1-#3 represent the optimal state in NCE, but are not assumptions of NCE -- they are derived (it is the content of the First Welfare Theorem).

      You need to get it right.

      And let's just both agree that you don't know what you are talking about RE: scope, because everything you've said about it is wrong.

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    12. I think if you quietly sat down and thought about things correctly and study the theory correctly, you will see that the way I have characterized NCE is not at variance with the way it is characterised in the Wiki explanation.

      The First Welfare Theorem requires perfect competition in markets and all that entails (the other assumptions I mentioned).

      If you want to understand economics I suggest you look beyond Wiki and take a complete and proper course in the subject.

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    13. "If I consider the microeconomics of the neoclassical synthesis to be in essence the same thing as neoclassical economics (which I do, and in fact, it is)..."

      I'm afraid this displays a gross misunderstanding of the subtleties of the neoclassical synthesis and how the neoclassical synthesis developed at the hands of Hicks, Modigliani, Metzler, Patinkin, Samuelson and Tobin et al.

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    14. Oh dear god. The Wikipedia article is just a citation of this link by an economist:

      http://www.econlib.org/library/Enc1/NeoclassicalEconomics.html

      Obviously you don't seem to put a lot of thought into your reading.

      The First Welfare Theorem requires perfect competition ...

      The First Welfare Theorem (FWT) assumes perfect competition. If perfect competition is not true, then the FWT is not (necessarily) true. The fact that the FWT assumes perfect competition does not mean neoclassical economics assumes perfect competition.

      I'm afraid this displays a gross misunderstanding of the subtleties of the neoclassical synthesis ...

      Neoclassical economics used utility functions, optimization, and rational agents for macro and microeconomics.

      Neoclassical synthesis used utility functions, optimization, and rational agents for microeconomics.

      A lot of subtleties there.

      But who cares about the subtleties? As I said: even if I am wrong, I don't see a difference between the two so I am not "sliding" anywhere. I don't care if you replace every mention of "neoclassical synthesis" with "neoclassical economics".

      You care about the subtleties, and if you switched from one to the other, it would be a "slide".

      But you didn't "switch", I did. I said A = B, and alternately refer to A or B. So who cares? How does this advance the argument here in any way?

      I said neoclassical economics has some benefit in telling us that the unemployment rate should be closer to 0% than 100%. In a world of total crap empirical results, that's pretty good! And the conclusion of my post above says that there really might not be much better -- that economics is totally useless for policy. The most useful thing may be neoclassical econ and it's shit.

      Now let me do your job for you ...

      In order to demonstrate what I am saying is itself shit, you have to take out the actual argument I am making. This means you can say:

      1. Neoclassical economics doesn't say unemployment is 0%
      2. There is another theory that isn't neoclassical economics that says unemployment is closer to 0% than 100%
      3. There is a more accurate theory of economics that leads to useful policy conclusions

      You agree with me on #1 (i.e. that #1 is wrong and neoclassical econ does in fact say the unemployment rate should be closer to 0%). You tried to come up with something for #2, but you essentially just re-defined "utility" as "desperation", re-deriving neoclassical economics. And #3 is an empirical question; I haven't seen any data or analysis coming from you.

      So now you're just dissembling about definitions when really you just don't like what I have to say. Which is fine. You should just say that! Don't hide behind a bunch of attempts at a technical or logical argument.

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    15. I suggest you formally undertake a study of economics. You are missing many details and connections and breadth.

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  5. "Dealing with reality" has a certain scope, but you don't tell us what that is. Does economic theory have to predict the existence of iPhones? Cell phones? Communications devices? Products? At what point does this theory "deal with reality"."

    It strikes me that the job of NCE isn't to "deal with reality" but to rather hide it. I would submit that the most important reality of our social world is that a tiny minority owns essentially everything and is in a position of extraordinary power over the vast majority. Where is this essential fact in your NCE equations? People need to live and will by hook or crook find some way to survive. Desperation keeps the unemployment rate under 50% and we don't need an elaborate mathematical theory to tell us that. The real question a true social science needs to answer is why it is that the majority of the human species lives in poverty or deep insecurity given our massive productive capacity. The answer isn't in obtuse supply and demand curves but in the obvious fact of concentrated minority power.

    Jim
    https://commentsongpe.wordpress.com

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    1. You've just renamed marginal utility "desperation" -- and we're back to neoclassical economics. Saying people maximize utility or minimize negative utility (minimize desperation) are just different framings of the same thing.

      I have no disagreement with the political and social implications of a minority controlling the vast majority of the wealth and power. In the IT model, concentrations of wealth lead to lower entropy distributions and could potentially reduce growth via this mechanism. I've long considered the slowdown in growth in the 1980s was intimately linked to the rise of inequality (in the US). In the It model, lower inequality is higher entropy, which is a better economy.

      However, we can't just assume these things are true. Saying something is "obvious" means there should be copious amounts of unambiguous data to back it up. However, despite many people looking for a connection between inequality and everybody being worse off, there aren't any unambiguous signals in the data. There are hints, and maybe eventually proof will be found, but the impact of inequality on the unemployment rate, inflation, interest rates, output, growth rates, or any other macroeconomic measure is inconclusive.

      But declaring something to be true by fiat is not science -- it's just ideology or religion.

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    2. Concentrated minority power, i.e. wealth inequality, is an unquestionable fact. Credit Suisse has estimated that the top 0.7% own 45.2% of global wealth while the bottom 92% have just 15.5%. Similar ratios apply in the US and other countries. If the goal is understanding, then a fully scientific starting point would be to analyze the system on that basis—as one of concentrated minority power. If we hypothesize self-interest as the guiding motive, then the key driver would be the self-interest of the empowered minority. It’s not a great leap to propose that its prime interest would be to defend and maximize its power (wealth) and to live luxuriously. From this perspective we can draw an important insight into the likely behavior of any unequal system—that it’s likely to be deeply hostile since the existential risk to the self-interest of the propertied minority is the propertyless majority. We would expect, then, to find substantial evidence of the minority using its power to suppress the living conditions of the majority. And we do.

      You say that “the impact of inequality on the unemployment rate, inflation, interest rates, output, growth rates, or any other macroeconomic measure is inconclusive.” This isn’t a tenable position. Billions live in poverty and unemployment / underemployment is very high when you take into account the great numbers in informal employment. “Desperation” (marginal utility) keeps a lid on the unemployment rate but I’d submit the most important macroeconomic measure is the actual state of our world in comparison with our massive productive capacity. This, I believe, is conclusive evidence of the impact of inequality. An impact that derives directly from the system’s hypothesized motives.

      NCE hides all of this behind obtuse jargon and unneeded mathematical complexity. Minority power—inequality—becomes a mere side-effect rather than the definitional element of the system. The claim NCE is science is therefore hardly scientific.

      Jim
      Commentsongpe.wordpress.com

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    3. Concentrated minority power, i.e. wealth inequality, is an unquestionable fact.

      I never questioned this.

      This, I believe, is conclusive evidence of the impact of inequality.

      You don't present any evidence besides the existence of poverty, which is a case of question begging (the original usage). The fact that poverty exists is logically equivalent to saying inequality exists (nobody -- or everybody -- is poor in an equal society).

      Therefore your argument is that inequality is conclusive evidence of the impact of inequality. This is circular.

      As a side note, your assumptions I labeled #1 through #3 above are based on perfect competition, which means that all individuals and firms are equal -- i.e. there is no inequality. Therefore even in NCE, inequality should have an impact.

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    4. My argument isn't circular although you're right that I haven't provided a "smoking gun" proof of the "crime". I claim that wealth (minority power) causes poverty (substandard living conditions as measured in comparison to productive capacity). I'll back it up here with just 2 bits of circumstantial evidence as I don't have space to elaborate on the exact methods that are applied today. (I do provide it in my book and a brief summary on my site.) First, minority power has a clear self-interest motive to suppress the majority (as per my previous comment) and, second, the minority has a consistent bloody record of doing exactly that throughout the entirety of recorded civilization. Motive and history are usually sufficient to convince most juries.

      I wonder what exactly NCE proposes to tell us given a starting assumption that everyone is equal. Maybe we wouldn't be far off if the starting point was the reality of minority power and the self-interest that drives it.

      Cheers

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    5. "starting assumption that everyone is equal"

      NCE doesn't assume that. That's more like the representative agent model.

      NCE just assumes everyone has equal information (actually, it assumes everyone has full information, from which we can derive that everyone has equal information). This is definitely not true, and the works of e.g. Stiglitz and Akerlof head down the path of showing the impact on markets.

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  6. I think people are right to zero in on your point about 100% employment being a bit silly, for two reasons. First, you are kind of implicitly conflating percent with percentage points. Being with 10% of the actual employment rate would indeed be a good result. But being within 10 percentage points - a tenth of the range of possible values - is not so great. Second and more importantly, basic Walrasian econ doesn't 'predict' employment to within 10 percentage points because it doesn't predict that employment will change at all. If it indeed tracked movements of employment while remaining within certain bounds, that would be good. But it makes an unconditional prediction of 100% employment whether recession, boom, recovery, industrialised or non-industrialised, cases which historically have exhibited anything from 1%-50% unemployment. So a prediction of 100% tells us basically nothing. It's like a medical prediction which says you will always be healthy. True the vast majority of the time, but tells you nothing about how health work and fails when you need it most!

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    Replies
    1. Taking your second point first, I agree that it's not a useful "prediction" for what people want to get out of economics. That is essentially part of the rhetorical question posed as the title: "What should we expect from economic theory?" Maybe NCE is the best we can do, and if so it is useless for policy.

      However, the underlying point I am trying to make is exactly how little we really know about how economic systems work. I consider some kind of theory that tells us unemployment will typically be small a major advance over what was previously moralizing over debt, trying to hold all the gold, or just rambling nonsense. My fear is that if we abandon the basics of supply and demand, we'll just end up with rambling nonsense again.

      Regarding your first point, I do understand what you are saying (i.e. a 10% error in a 5% unemployment rate means getting it to within half a percentage point). However, the key here is understanding what scale we are talking about.

      Call the size of the civilian labor force N.

      Then the neoclassical theory tells us the total number of people employed (E) for large N >> 1 is

      E(N) = N + c₀ + c₁/N + c₂/N² + ...

      E(N) = N (1 + c₀/N + ...)

      E(N)/N = 1 + ...

      So the proper scale with which to look at your error is relative to 1 (= 100%) in neoclassical economics, not the unemployment rate.

      The unemployment rate itself would be the scale with which to compare your error if you were using, say, a natural rate-like theory such that

      U/N = c₀ + c₁ (δN/N) + c₂ (δN/N)² + ...

      where c₀ is your natural rate (= 0.05, i.e. 5% or so). In that case corrections are compared to c₀.

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    2. Jason,

      Where you say N>>1, do you mean 1 as a proportion, i.e. 100% or do you mean 1 the absolute number?

      What does E(N) mean?

      What is c1, c2 etc.?

      Thanks.

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    3. N is the civilian labor force, so for the US this is on the order of 160 million people and 160,000,000 >> 1.

      E(N) is the total number employed as a function of the size of the civilian labor force.

      The coefficients c1, c2, etc are constants/parameters of the theory resulting from a Taylor expansion in terms of the small parameter 1/N that would be e.g. fit to data.

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