Are Static Neoclassical Models Useless?

If somebody presented you with a static snapshot of weather patterns, it would be clear that the model was fairly useless; as it didn’t capture dynamics, it would have nothing to tell you about the weather. Similar problems apply to neoclassical models: once you attempt to incorporate dynamic events, they don’t just become ‘wrong’, they become completely irrelevant.

Comparative Advantage

I posted recently about how CA is irrelevant for developing countries, but I’d like to expand: it is completely irrelevant for arguments about protectionism. The problem is that if you take into account the effects of tariffs on the productivity of the industries they are aimed at, it has nothing to say – not just for developing countries, but for any industry whatsoever. CA assumes that every country has an innate productive capacity in each industry that does not change over time. If you froze the world, CA might be a persuasive argument for free trade, but in a dynamic economy it completely irrelevant.

Supply-Demand

Say the price of a necessity goes up due to a supply shortage. Modelling this as a simple ‘price increase’ suggests that demand would go down. However, if people are expecting the supply shortage to continue or worsen, then isn’t it more probable that demand will go up? Mainstream economists might have an answer: the price increase can be modelled as a movement of the supply curve, whilst the new information about the supply shortage can be modelled as a movement of the demand curve:

(D1 to D3, S1 to S2)

Problem solved. Except this movement of the demand curve leads to a higher price, which in turn would cause people to alter their expectations of the shortage, leading to another movement, and so forth. This may be a highly specific example, but it touches on a central Sraffian criticism of these models, which is that the curves cannot move independently; a change in one creates ripple effects that violate ceteris paribus. Thus, taking a picture of the state of them at any one time tells you as much as a photo of a moving train tells you its velocity.

IS/LM

Both ‘curves’ are partially derived from expectations – one from expectations of returns on investments, and one from expectations of future needs for liquidity. Therefore, a similar criticism to Demand-Supply applies – movement of one curve alters expectations and so affects the other. This creates a feedback loop that simply cannot be captured by two intersecting curves. At any one moment, the diagram might be said to be ‘right’ (putting aside other objections), but this doesn’t mean it is useful.

I expect economists won’t appreciate a whistle-stop tour of their models that claims to have debunked them, but at the same time I expect they’d agree that the above ‘weather’ example would so obviously flawed that it would not need to be refuted formally. In order to avoid special pleading, economists will have to argue that the economy is at or close to equilibrium, rather than a dynamic system. I do hope nobody claims this after 2008 (or the recurrent crises for centuries before that).

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  1. #1 by atm0spheric on January 8, 2012 - 2:43 pm

    The early 20th century wonks were where maths was before game theory.

    Of course there were expert game players then, but their skills did not transfer to the formal, respectable disciplines of economics until the mathematical basis was understood and published.

    Fortunately, that didn’t stop outstanding economists sharing their insights. Sadly, it did impede the acceptance of their wise advice.

    The early 21st century wonks are where mathematics was before chaos theory.

    We have expert meteorologists and other less well known practitioners of the mysteries of pattern recognition in chaotic systems, but it will be a while before their skills are formalized and become part of respectable economics.

    Fortunately that doesn’t stop outstanding economists sharing their insights. Sadly, it does impede the acceptance of their wise advice.

    • #2 by Unlearningecon on January 8, 2012 - 2:57 pm

      I agree with some of what you said but I’m not sure of the overall point you’re trying to make, particularly in the last sentence. Are you defending economists or criticising them?

  2. #3 by atm0spheric on January 8, 2012 - 5:28 pm

    My message is sympathetic to economists. There are conflicting views amongst economists, and I have more sympathy with those who relate their conclusions to simple concepts than those who fit models to observations. These latter are not bad people, and not bad amateur mathematicians, but they simply do not have the mathematical tools to deal with the multi-variate, stateful, non linear, high order systems they are trying to model. As a result of this deficiency in the available mathematics, there is no provable right answer, and as a result no impediment to disagreements fueled by professional pride, reputation, affiliation, error or exogenous manipulation. So politicians and committees responsible for economic decisions lack clear direction from the body of economists on the best course of action.

    I am also sympathetic to many politicians, but there are many others who use the lack of clear economic direction to work mischief. I unequivocally criticize them.

    My limited point is that we should not expect too much from our economists, and that we should probably follow flair rather than spurious wonkishness.

    My personal belief – not lightly held but not argued here, is that the economists we should listen to most carefully are those who are secure enough in their own understanding to not only tell us how we got here, but who with basic logic underpinning their prescription, have mapped a course out of here for us; a course that has not been arrived at by reversing the time coordinate of the model of their way in. At least they are not applying the linear ‘near equilibrium’ model.

    (See New America Foundation White Paper by Alpert, Hockett and Roubini.)

    I am reluctant to generalize about economists. They disagree, and not always nicely. It is self evident that some of them are right and some wrong; the three quoted above were the first to stick their necks into my unrefined sphere of awareness with a carefully argued, detailed and in my opinion credible statement of what we then needed to do to get out of the mess. Nowhere have I seen a rebuttal of anything like the same quality and as far as I am aware, barring the consequences of time lost since it was written, in general terms at least it still maps the fastest way out. I know quality when I see it, I applaud these three for it, and I buy their plan.

    But sadly it seems (to me), the people who matter do not share my insight.

  3. #4 by richard lawson on January 8, 2012 - 6:16 pm

    I agree. Clearly the world economic is a complex system with a multitude of interrelated parts, and understanding the system, or trying to begin to get some kind of approximation of it, demands the use of computer models as complex as the models used to understand the global climate. Where are the models? I know they exist, Steve Keen is using one, but generally economists seem to think it is OK to just deliver their opinion, and politicians even more so.

    It is crazy that Osborne can just stand up and say the UK is like a family budget without being howled down by the listeners. He frightens people with large deficit and debt numbers, but there are many facets to be taken into account, many qualities to our debt, and comparisons to be made with other countries.

    It’s time that economics grew up and entered the IT age.

    IMhO.

    • #5 by atm0spheric on January 8, 2012 - 6:32 pm

      Yes but in defense of UK politicians, belatedly, HSR looks like going ahead. It is of limited economic value beyond stimulus, but at least it is of some value (ignoring the other issues). Also, a call has been made for their private sector to look at the prospect of ‘free’ reliable-as-clockwork tidal power from a Severn barrage. Again there are other issues, but frankly, unlike politicians, wildlife will adapt almost instantly to their different environment without any risk of a double dip. It will work much better if we let them make a small sacrifice for us than if we try to manage them as well as our own affairs.

  4. #6 by Paul Rosenberg (@PaulHRosenberg) on January 8, 2012 - 10:15 pm

    Back in 1970s, I was a math TA, mostly dealing with econ majors who’d put off taking calculus in hopes the requirement would just go away. This also meant, by little more than sheer accident, that I ended up hanging out with a couple of econ teachers as well (and beating one of them pretty regularly at pinball). I simply could not get over the fact that calculus was so important to the discipline, since it was so obviously inappropriate conceptually. Why not some form of iterative math?

    Sure, I knew some of the basics of eye-roll-inducing stuff, like Catastrophe Theory. I didn’t expect that go over too well. But how about much more approachable stuff, like just about anything from John Conway, whose work–or play–was regularly discussed in Scientific American’s “Mathematical Games” column at the time? I got back blank stares from the pinball player.

    The other guy had actually spent some time working with a develpment bank in Indonesia, out in the fieldm no less. He was pretty skeptical of taking any sort of models too seriously, which also seemed pretty sensible to me.

    Bottom line: I’ve still got this strange feeling that the entire field of economics is hopelessly behind times & the likelihood of ever catching up is very dim, indeed.

  5. #7 by Brendan Lowe on January 8, 2012 - 11:13 pm

    It’s always amusing how many non-economists who have some mathematical ability are always so quick to express their incredulity at how obviously incorrect the tools economists use are for the problems economists attempt to solve. Never do the seem to ask themselves why it is that economists have not figured this out after many decades of hard work, yet an outsider knowing extremely little about economics can figure it out in a matter of minutes.

    Anyway.

    Your argument about CA and free trade is weird. Yes, you can change your comparative advantage with a tariff. CA isn’t an argument, it’s an explanation and a description. But why would you want to change your comparative advantage with a tariff?

    Your argument about supply and demand models is equally weird. It looks like supply and demand does capture the effect of each change on the economy. It can’t predict how many of these changes occur, or when they’ll stop, but it’s not designed to do so. Furthermore, this limit does not seem to be much of a problem. Supply and demand models are obviously imperfect, but they work really well. Or do you think that if the demand for a good rises, the price will fall, due to the dynamics of changing expectations? And that’s what we want out of a model. It’s why we model in the first place. Because understanding the world as it is is virtually impossible, so we create these incomplete, imperfect models that nevertheless allow us to learn, solve problems, and understand things we could never understand without the models. Unless you have a superior model that can capture these “dynamic” elements…?

    • #8 by Unlearningecon on January 8, 2012 - 11:39 pm

      Erm, why do you assume I am a non-economist? As my ‘About’ details, I am an economics student, so I have a clear knowledge of what is taught.

      Let me sum up your first paragraph: non-economists don’t understand economics – they are ignorant, attacking straw men, etc. Standard stuff, heard it all before, and I’ve written about it in my FAQ and Straw-man posts.

      ‘Your argument about CA and free trade is weird. Yes, you can change your comparative advantage with a tariff. CA isn’t an argument, it’s an explanation and a description. But why would you want to change your comparative advantage with a tariff?’

      Yep, CA is an explanation of a static economy that has no relevance to free trade arguments in a dynamic one. That was my point. My other point was that you’d want to increase your productivity with a tariff, for obvious reasons.

      The point about demand supply: it is based on a ‘Ceteris Paribus’, partial equilibrium analysis that is violated by various things happening due to the interlinked nature of the economy. If you base something on CP then violate it, your analysis is incoherent.

      ‘Supply and demand models are obviously imperfect, but they work really well.’

      Really? Despite the volatility of asset prices, quite apart from the ‘fundamentals’? Despite the fact that only 11% of GDP is produced under conditions of increasing marginal cost? Despite the fact that the curves cannot move independently? See more here.

      ‘Unless you have a superior model that can capture these “dynamic” elements…?’

      Firstly, ‘you can’t do better’ is not a valid argument in favour of a flawed model. Secondly, I have not created any dynamic models myself, but David Orrell has a go in his book, Economyths, and Steve Keen has created a great model of Capitalist economies called Minsky that has no trouble modelling the 2008 crisis. There is a vast field of mathematics devoted to dynamic modelling, which economics would do well to pay attention to.

  6. #9 by Brendan Lowe on January 9, 2012 - 12:07 am

    I was talking about people like Paul Rosenberg when I was talking about non-economists, although I really do wonder what kind of education you’ve had, to think the things that you do, and to have your intellectual standards.

    Non-economists don’t understand economics. They’re not economists. They don’t study economics, except casually. If that was all it took to understand economics, no one would bother to become an economist. Surely this isn’t controversial.

    On CA:

    Ok, I have no idea what you’re talking about. What does “dynamic” mean as you use it, and why the hell would it invalidate CA? Do…do you understand CA? CA is a point about opportunity costs and economic efficiency versus technical efficiency. Static vs dynamic analysis, as I understand the meaning of those terms, has nothing to do with this. Your point that CA can change–is dynamic–doesn’t change the fact that CA explains all trade everywhere at all times, and furthermore that free trade is the optimal policy for all nations. Obviously while a tariff increase the productivity of one industry, it does so at the expense of other industries, reducing overall economic efficiency, and furthermore, political incentives imply that tariffs will eventually reduce the protected industry’s productivity as well–look at the auto industry.

    On S&D and CP:

    No. Geez. Your argument fails because it violates CP. You “proved” CP does not hold by not holding it! It’s circular. CP implies that you ignore “ripple effects,” so that you can analyze things without them. Then you can introduce ripple effects, cet. par., and analyze the consequences of ripple effects. That’s how economics reason, and it’s how all science proceeds. You deal with complicated things by making them not complicated! Then, once you understand one thing, you can add more and more.

    This is also why “orthodox” economists often accuse heterodox economists of strawmanning. Do you think we don’t know about volatile asset prices, increasing returns to scale, etc? What tools do you think we use to analyze these things? And who makes progress on these fronts? Mainstream economists, while heterodox economists sit around calling us unrealistic.

    Of course the inferiority of all alternatives matter! No scientist, in any branch of any science, has a perfect model. They are all flawed. And they are used anyway, because the alternatives are worse!

    David Orrell isn’t an economist, which I suppose raises his authority in the eyes of heterodox economists. And Steve Keen simply makes bad, lazy arguments that violate the laws of economics. Go find a few mainstream economists at your local university who work on subjects similar Keen’s, present his arguments to them, and watch him get shredded.

    • #10 by Unlearningecon on January 9, 2012 - 10:59 am

      If it helps you, I was taught economics by a pack of wolves and am only able to communicate it verbally by howling.

      Stop trying to pull rank on me, OK? I will ignore your assertions that there are economic ‘laws’ that apparently cannot be violated by logic or empirical evidence, and also your repeated bile-spitting at various non economists on the grounds that they are, well, non-economists. Also, say it with me: neoclassical theory. Neoclassical theory. That’s what you mean when you say ‘economics’.

      Now let’s just discuss the issues.

      ‘Ok, I have no idea what you’re talking about. What does “dynamic” mean as you use it, and why the hell would it invalidate CA?’

      CA is a static snapshot of the productive capacity of a country in different industries. It suggests that everyone should allocate their own time most efficiently, rather than worrying about what others are doing, which leads to the most efficient production overall.

      ‘doesn’t change the fact that CA explains all trade everywhere at all times, and furthermore that free trade is the optimal policy for all nations.’

      Yes, it does, because if tariffs affect the long-run productivity of an industry then it may be sensible over the long term to enact protective measures. I wrote about this in more detail here, offering a hypothetical example. Also note that almost EVERY developed country used tariffs when they started out, which supports my argument.

      ‘Obviously while a tariff increase the productivity of one industry, it does so at the expense of other industries, reducing overall economic efficiency, and furthermore, political incentives imply that tariffs will eventually reduce the protected industry’s productivity as well–look at the auto industry.’

      In the short term, a tariff will indeed affect other industries in other countries by increasing their prices. However, it is a question of whether the long term productivity gains outweigh this short term loss. Evidence suggests that, in developing countries, they do.

      ‘No. Geez. Your argument fails because it violates CP. You “proved” CP does not hold by not holding it! It’s circular. CP implies that you ignore “ripple effects,” so that you can analyze things without them.’

      No, I proved that a movement of one curve affects the other curve and creates a feedback loop which the diagrams, as static snapshots, cannot capture. I provided a specific example, linked to a more general example on Robert Vienneau’s website, and now am offering you this one, too (not S & D but the same principle).

      ‘Then you can introduce ripple effects, cet. par., and analyze the consequences of ripple effects. That’s how economics reason, and it’s how all science proceeds. You deal with complicated things by making them not complicated! Then, once you understand one thing, you can add more and more.’

      No. The point is that you can’t hold everything constant because the economy is too interlinked. You can’t say ‘this happens, which creates ripple effects, but we’ll ignore them and then introduce them when everything else holds constant, never mind that they in turn create their own ripple effects’. You simply cannot model a dynamic system with a static snapshot, it makes no sense.

      ‘Of course the inferiority of all alternatives matter! No scientist, in any branch of any science, has a perfect model. They are all flawed. And they are used anyway, because the alternatives are worse!’

      There’s a difference between a model which is the best approximation and one which bears no resemblance to reality and contradicts itself internally. You don’t use a bad model just because there’s nothing else.

      ‘Go find a few mainstream economists at your local university who work on subjects similar Keen’s, present his arguments to them, and watch him get shredded.’

      Lol, I love this. They’ll just come out with the same crap you do – straw man, ignorant blah blah. The problem is that after 2008, they can’t hide behind their models. Keen predicted and can model the crisis perfectly, whilst neoclassical economics simply cannot. The only ‘critiques’ I’ve read of Keen have just been predictable and few actually engage him fully.

      I was, unfortunately, working under the assumption that you had read a few of my earlier posts, but you’ve just come here and repeated the party line for mainstream economists. Please read my FAQ and some of my earlier posts before you do it again.

    • #11 by Sergei on January 23, 2012 - 7:19 am

      “Do you think we don’t know about volatile asset prices, increasing returns to scale, etc?”

      You do, but if the general model requires additional qualifications to remain valid why is it still rolled out as a general model? The real general model of S&D is that in response to increasing/decreasing supply/demand prices can fall, rise or stay the same depending on many other factors.

      When classical mechanics is rolled out it is NOT claimed to explain everything. When quantum mechanics is rolled to it IS claimed to explain everything but because it is too complicated for most of our practical experiences we can resort to classical mechanics for those matters. Never ever have I heard or read anything similar about S&D models. They are just true by construction.

  1. Does it Matter if Early Models are Flawed? « Unlearning Economics
  2. An FAQ for Mainstream/Neoclassical Economists « Unlearning Economics
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