Economics Superbus I

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superbus: proud (Latin)

During the past week I have been in Frankfurt, where I participated in a Strüngmann Forum Complexity and Evolution: A New Synthesis for Economics. The basic premise that motivated the discussions among the 40 scientists at the Forum was that the field of economics is mired in two deeply flawed paradigms: rational agents and a focus on equilibrium.

The core models that inform economic theory (and the advice economists give to policy makers) assume that people are rational agents, who only care about maximizing their ‘utility function’ (using the jargon of economists). In plain language it means that humans only care about getting material rewards and avoiding punishments. Considerations such as morality, honor, and concern for the welfare of others do not affect the choices people make.

homo_econ

The focus on equilibrium means that economists typically ignore the dynamics. Although the economy is constantly in flux, mathematical economists imagine what would happen if the conditions were constant for a sufficiently long time. This assumption allows them to generate powerful mathematical insights about such things as price formation, adjustment of production to demand, and so on. The problem with this assumption is not only that no economy is ever in equilibrium, but that the economic theory tends to ignore such intrinsically dynamic events, like, for example, the Great Recession of 2007­-8.

So our charge from the organizers (disclosure: I was on the advisory committee that helped to plan the meeting) was to brainstorm about ways that insights from evolutionary theory (which has a lot to say about what really motivates people, apart from desire for gain) and complexity theory (which has a lot to say about complex dynamics, such as cycles, chaos, and sudden collapses) can be incorporated into the thinking of economists.

At this point, hopefully, those readers of my blog who are professional economists (and those non-economists, who, like me, have been following how economics has been transforming itself in the last couple of decades) are boiling with frustration. Of course, everything I said in the beginning paragraphs of this blog is a caricature. There are many economists who have been using evolution or complexity science (or both) in their research. One of the most significant developments in Economics recently (in the last two-three decades) is the rise to prominence of the field of Behavioral Economics. Many economists have been looking to evolution for insights for quite a time (for example, Friedrich Hayek).

Economists who attended the Forum (where they were a minority outnumbered by psychologists, anthropologists, political scientists, and biologists) repeatedly complained against being mischaracterized in this fashion. In fact, the economists who were at the Forum all use evolution and complexity in some fashion (which is why, of course, they were invited).

Indeed, economics is evolving, and there are many economists who don’t need to be preached to about the shortcomings of the homo economicus model or the need to embrace the complexity theory. Yet, any good caricature, while being a gross exaggeration, carries a seed of truth in it.

First, some of the economists who push the envelope are considered to be ‘heterodox’ by the majority of their colleagues, who continue to churn out equilibrium models of homines economici interacting in idealized free markets.

Second, and more important, the policy advice that economists give has hardly changed as a result of new economic thinking that embraces complexity and evolution. In fact, I find it difficult to discern any appreciation for evolution or complexity in what the economists tell policy makers or newspaper reporters. It’s the same litany that markets must be opened, governments’ role reduced, taxes cut, government provision of public goods cut, and social norms substituted with monetary incentives.

That this is bad advice is one of the major insights we get from evolutionary and complexity theories-informed research, both theoretical and empirical. And it often leads to disasters.

Remember that rare moment of self-doubt in the economic profession following the financial debacle of 2007? No mainstream economist predicted it. Worse, the advice they gave in the years before the crisis contributed to creating the crisis.

economist_cover

Similarly, the advice that economists gave to the Russian government during the 1990s massively contributed to the collapse of the GDP in Russia by half and a deep immiseration of the majority of the population. (It did, however, enrich a few oligarchs and, interestingly enough, quite a few of the economic advisers). More recently, a large dollop of blame for the mess in which Iraq currently finds itself is due to the disastrous decision of the Bremer vice-regency to throw untrammeled markets on the fragile Iraqi economy.

I know that economists will tell me that they perfectly well understand the limitations of homo economicus and equilibrium approaches. In fact, three of them did during the private interactions at the Forum. (One was so emphatic in denying the charge that he characterized it as “bullshit.”)

Yet I stand by the following formulation of what is wrong with economics: the policy advice that economists give 99 percent of time is based on the core theory that is almost entirely ignores the new developments in behavioral and evolutionary economics, as well as new non-equilibrium economic theories.

[to be continued]

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Gene Anderson

Indeed, forward-thinking economists know this, but you’d never guess that from the commentaries on economics in the media. Advisors, newscasters, and so on still believe in the Rational Economic Man (sic) who has perfect information, in the Free Market, and so on. It’s a religion, and thus hard to fight by reasonable arguments.

Peter Turchin

Right on. It’s ideology, not science

Luigi Forlai

The problem that you mention is really related to the possibility to make a mathematical model of the economic system and therefore make comparisons of predictions.

When you get out of a) maximizing and b) static equilibrium, the mathematical models are more difficult to manage a give less insight.

The point (at least in macroeconomics) is to get beyond rational and static but starting from it

For ex I discovered your work through Paul Krugman mentioning you in a NYT post. He’s capable to go beyond rational behavior and static equilibrium but nevertheless start from there.

Peter Turchin

Indeed, with more realistic assumptions about human behavior, models become more complex, and analytical solutions become impossible. So you have to shift to numerical solutions and computer simulations. This also allows you to follow the dynamics, rather than solve for the equilibrium. We have methods for resolving these issues.

pseudoerasmus

One word : DSGE (http://en.wikipedia.org/wiki/Dynamic_stochastic_general_equilibrium)

Did you think central bankers just did comparative statics on the chalk board ?

pseudoerasmus

Also see noahpinionblog.blogspot.com/2013/10/rationality-issue-is-not-issue.html

Chris Kavanagh

Isn’t part of the problem the soundbite nature of commenting on the media? I can think of lots of statements from informed psychologists and anthropologists, which are equally misleading and mired in outdated theories. I also think its a bit of a red herring to focus on failed cases as demonstrating that a particular economic approach is invalid as proponents can just as easily focus on successful cases and point to various mitigating factors.

Peter Turchin

So what are the successful cases?

Chris Kavanagh

Well that’s the issue really… any example cited, say Botswana or Mongolia, could also be explained as succeeding due to other factors, in those cases- resource abundance. Personally, my limited understanding of the development literature leads me to a similar conclusion about the usefulness of the ‘one size fits all’ economic ideology underpinning things like the WB’s Structural Adjustment Programs, but at the same time I am also well aware that there are endless debates about the relative ‘success’ of such programs and how far they can be explained by compliance with conditions and so on. There are lots of WB and IMF reports, as well as independent papers, highlighting the success of specific interventions and lots of papers criticising such claims.

My point then is that if we blame economists for the failures of national and global economies, should we equally credit them for economic boons? I tend to see much more of the former than the latter and while I’m not advocating some extreme relativist claim that economists and the advice they supply being irrelevant to national/global fortunes, I do think we need to be careful to avoid cherry picking examples that support our personal position.

Peter Turchin

Chris, when civil engineers build a bridge, we expect it to stand and not collapse. And 99% of them are fine. When one collapses (exceptionally rarely) we find out who to blame and how to prevent a similar occurrence in the future.

Now imagine that when half of the bridges have collapsed, somebody says – but we should credit the civil engineers for those bridges that did not collapse. This is the argument you are making.

Chris Kavanagh

Building a non-collapsing bridge is a rather different endeavour than managing an economy. It’s complicated but engineers are dealing with inorganic material structures with predictable properties, this seems to be a rather different circumstance than what economists are dealing with. Again though, I’m not saying we shouldn’t criticise certain economic policies, especially when there are clear negative outcomes, I’m just saying that pointing out failed cases to prove that an approach is misguided is only persuasive if it can be shown that the examples aren’t cherry picked to support a particular viewpoint. The many papers that have attempted to do so have not (as far as I’ve seen) produced any definitive consensus and tend to fall predictably in line with the author’s political persuasions.

Lorenzo from Oz

There was a vast range in outcomes in the transition from command economies to mixed economies, something there had been very little experience in. I agree that some poor advice was given in the case of Russia: but having a central bank essentially deliberately sabotaging the transition was much more important in the economic crunch.

“More recently, a large dollop of blame for the mess in which Iraq currently finds itself is due to the disastrous decision of the Bremer vice-regency to throw untrammeled markets on the fragile Iraqi economy.” Much more important was immediately de-mobilising the army (lots of unemployed soldiers–see Ku Klux Klan, Freikorps etc for how disastrous that can be) and having no clue how to deal with a tribalised society or the Sunni/Shia/Kurd dynamics. The Iraqi economy actually had significant economic growth before the non-economic failures caught up, which Kurdistan continued to experience.

If you want an example of successful advice from economists, Australia provides an excellent example of successful public policy reform based on economic advice. Of course, our political culture is a lot more utilitarian/Benthamite than the US’s, or Russia.

Peter Turchin

See my comment above about civil engineers and bridge building

Lorenzo from Oz

Engineers do not deal with agents who can react to what they do. You are preaching the value of complexity and you really think comparing economic advice (which may or may not be followed and, even if it is, deals with reacting agents) to engineering is a legitimate response?

Lorenzo from Oz

Please name the engineering equivalent of Goodhart’s Law:
http://en.wikipedia.org/wiki/Goodhart's_law

Lorenzo from Oz

Of course, our federal political structures more or less force governments to conciliate a range of opinion, so force broader information sources in policy development. I suspect the ability to ignore folk has much more to do with hamfisted policy than economists.

hgintis

I was one of the economists at the Frankfurt conference, and I can attest to the accuracy of Peter’s comments. Some points:
1. If you want to get good applications of standard economic theory, read The Economist. They almost always get it right.
2. Most critics of economic policy are misguided leftists who don’t understand how markets work, and misguided rightists who don’t understand the nature of market regulation.
3. Complexity and evolution are very important for economic policy, but this has been available to us since Hayek’s pioneering work 70 years ago. The enemy of good policy is the absence of the (a) institutional structure and (b) moral standards that foster healthy economic dynamics and growth.
4. I stressed this in my book, The Bounds of Reason (Princeton 2009), which really avoided issues of complexity and evolution altogether.

Peter Turchin

Thanks, Herb. Yet, I hope you will forgive me for pointing out that you and Sam Bowles are not typical traditional economists, by far.

What do you think of Part II? http://socialevolutionforum.com/2015/02/09/economics-superbus-ii/

J. E. Lane

I’m glad to see that Hayek was mentioned. There was a series of lectures last year given at Oxford (sponsored by their Hayek Society). I was glad to have been invited to give a lecture on what can be learned by applying evolutionary theory to economic theories. However, it seems that not only are ideological commitments in the way, people are unwilling to admit some of the morally dissonant aspects of applying evolution to understanding how individuals should react in terms of competition… I would love to see what comes of the Frankfurt conference in regards to actual, actionable decisions that are both theoretically sound as well as realistic in that they might be implemented in the future.

Peter Turchin

There will be a volume published by the MIT Press, which will probably come out in early 2016. Most of the articles for it are still being written or revised, though. My colleague David Sloan Wilson, who was the main moving force behind this Forum, will probably blog about it soon.

pseudoerasmus

In fact, I find it difficult to discern any appreciation for evolution or complexity in what the economists tell policy makers or newspaper reporters. It’s the same litany that markets must be opened, governments’ role reduced, taxes cut, government provision of public goods cut, and social norms substituted with monetary incentives

I’m curious, what would be an instance of evolution- and complexity-informed policy advice on taxes, provision of public goods, regulation, monetary policy, etc. ?

But I see much more heterogeneity in economic advice than you do. After all, in the US-Euro context, you have large camps of both pro- and anti-austerity people, and those divided by according to whether the instrument of adjustment should be fiscal or monetary or both.

Peter Turchin

As an example, on tax policy: we should increase taxes on the rich, because humans hold strong inequity aversion values.

pseudoerasmus

That argument already exists without any reference to evolution and complexity.

Radek

Going back to 19th century crude Utiliarianism even (though there the argument for progressive taxation relies on diminishing marginal utility of income rather than inequity aversion)

I’m also not so sure that economists argue that government provision of public goods should be cut. The argument for public provision of these goes back to Jules Dupuit, a French engineer, who was the first one to derive a demand curve from “utility”. Now, some economists do tend to over-invoke the Coase Theorem (if negotiation costs are low, the problem solves itself), without actually thinking through the implications, but these are probably a very small but perhaps vocal minority. In other instances you might get economists pointing out that certain goods that are provided by the government don’t really meet the criteria for a “public good” (what’s non-rival and non-excludable about mail delivery?) but that’s actually a valid argument.

pseudoerasmus

This movement will almost certainly fail, in the sense that rational agents and equilibrium will never be dislodged from centre stage. If some heterdox ideas turn out to be useful, those will be stolen and then get cleverly derived from models using the standard assumptions.

Also, the “crisis within economics” is really confined to macroeconomics, which is always fighting a theological war. And unless someone can predict business cycles, no macroeconomist will ever listen to the evolution-and-complexity people. And macroeconomists rule the central banks, the treasury departments, and the international financial institutions.

Radek

“Fluctuations” macro really is in a bad state though.

pseudoerasmus

Personally, my limited understanding of the development literature leads me to a similar conclusion about the usefulness of the ‘one size fits all’ economic ideology underpinning things like the WB’s Structural Adjustment Programs, but at the same time I am also well aware that there are endless debates about the relative ‘success’ of such programs and how far they can be explained by compliance with conditions and so on.”

This misses the point. IMF-style structural adjustment programmes are not just about economic ideology, but also creditor interests. Most countries which resort to IMF loans are insolvent (can no longer afford to finance their external deficits), and in the absence of external charity, they would be forced to undertake drastic austerity anyway. The IMF extends them loans in exchange for certain reforms. Some of that advice may be misguided, but the IMF does not make those recommendations purely out of doctrine. It also represents creditor interests. Many of Germany’s demands on Greece are unreasonable, but it’s not necessarily economic doctrine driving them. Greece’s creditors want their money back without a haircut, and they don’t necessarily care that forcing Greece to run a large primary surplus exacts a severe toll on the population.

There was a vast range in outcomes in the transition from command economies to mixed economies, something there had been very little experience in. I agree that some poor advice was given in the case of Russia…

Not to mention that Russians actually played a role in the transition. They were not compelled by Sachs or Shleifer to undertake those policies.

Chris Kavanagh

My comment about a ‘one size fits all’ economic ideology referred to the economic rationale attached to the conditions related to SAPs or ‘advice’ if you like. I wasn’t commenting on what motivates the desire to try and insure a return on investment. As far as I am aware there is now a widespread recognition that the original conditions for a lot of the SAPs provided in the 80s and 90s were misguided and failed to take account of various factors related to local contexts. Isn’t this part of the reason for the development and growing popularity of the POST-Washington consensus?

Your comments about the competing interests related to economic policies also further highlights the argument I am making. Whether economic policies are deemed to be a success or failure often depends on who you are asking and what timeframe you are using. Which is why I questioned whether Peter’s choices can really prove that neoliberal policies are misguided.

pseudoerasmus

You are missing the point. The IMF is not in the business of economic development. The IMF is in the business of temporarily maintaining the solvency of insolvent countries, and its conditions are intended to eliminate the short-run causes of that insolvency. In that sense, there is actually only 1 recipe: austerity. That is often counterproductive (because the economy contracts and there is even less revenue), but the only alternative to austerity is for generous international benefactors to finance a more gradual, less drastic adjustment, and usually such benefactors don’t exist.

I’m not defending the IMF, but it seems to me, the real behavioural issue is not with the prescriptions of the IMF. The real issue is why so many countries have financially irresponsible behaviours in the first place. When commodities boom, these countries tend to spend that extra revenue, and often run budget deficits to spend even more, and since they can’t get financing, they tend to print money. When the boom stops, then they are insolvent. There are many behavioural issues to be explored here: time preference & impulsiveness, fiscal populism & weak institutions, population heterogeneity & low provision of public goods, etc. etc.

Chris Kavanagh

I’m not sure which point I am missing? I don’t disagree with pretty much any of your description about the purposes of the IMF, although I would dispute that ‘temporarily maintaining the solvency of insolvent countries’ is nothing to do with development- but that’s semantic quibbling. That, in your judgement, the SAP policies are (relatively) sound, or at least necessary, and that the main issues lie with the financial irresponsibility of recipient countries again serves to highlight that there is no overall consensus on where to proportion blame when there is an economic failure. In all likelihood there is at least some blame that could be levelled at both the economists at the international monetary foundation (and other such organisations) and the various internal actors and special interests of recipient countries (including internal economists). My limited engagement with developmental economics leads me to have greater sympathy with the critics of neoliberal interventions (like Peter) but my whole point was that there are many who would disagree and the evidence is not clear cut.

To answer one point though: The common criticisms regarding the IMFs SAPs and other neoliberal programs was not simply that they promote austerity but that the manner in which they do so was inflexible and in many cases exacerbated problems (in turn decreasing the likelihood that the loans will ever be repaid). As I mentioned above, I think there is a general consensus now that the previous template for SAPs (and other similar interventions) was too rigid, hence the so-called Post-Washington consensus. Am I wrong in this assumption?

hgintis

Blaming insolvency on the insolvent country ignores one simple point: most country leaders are only around for a short time, so they don’t much care about insolvency that occurs ten years down the line—unless they borrow now, they won’t be around even one year down the line.
I fully believe this is a structural problem that the IMF should address, but doesn’t have the authority to do so.

Dan Hoyer

Great post Peter — I’m really interested to see what specific approaches, or even policy recommendations, come out of the discussions from this conference.

I agree that, from my limited experience with recent work in development economics and ec. theory, there seems to be an increasing body of experts concerned with problematizing the old economic assumptions and embracing more chaotic, complex, and multidirectional approaches to economic growth and stability. This is encouraging, but obviously there is still much to be done. Particularly problematic I think, as some of the other comments bring up, is the level issue – I think its somewhat more apparent how complexity models and evolutionary theory can inform macro-level economic analysis, but the micro-level may be a tougher sell. Perhaps this is where the interaction between economic agents at different levels, MLS, etc. need to be stressed?

I also feel duty-bound as a Classicist to point out that the semantic range for the latin ‘superbus’ goes from proud to arrogant/tyrannical (hence the Etruscan King Tarquinius Superbus was considered the paragon of the evil despot by most Roman authors). As you say Peter, “the policy advice that economists give has hardly changed as a result of new economic thinking that embraces complexity and evolution” – some of this, I think, can be attributed to the arrogance of a small but influential group of economists and advisors over the years. Hopefully, the increasing influence of evolutionary theory can help push the meaning of Economicus Superbus away from ‘the arrogant economist’ and closer to ‘the proud’!

pseudoerasmus

Behavioural economics already dominates development economics (not the “old” development economics, but the economics of development assistance and poverty alleviation).

I think its somewhat more apparent how complexity models and evolutionary theory can inform macro-level economic analysis, but the micro-level may be a tougher sell.

It’s the other way around !

Peter Turchin

Could you provide some references that behavioral economics has any impact on development economics?? It’s news to me, although I admit that I am not steeped in the development economics literature.

Dan Hoyer

I know too that ‘neuroeconomics’ is a popular sub-field in Psychology and cognition departments these days, which focuses on behavioral modes as well as some of the neurochemical inputs to behavior and decision-making.

Peter Turchin

“the semantic range for the latin ‘superbus’ goes from proud to arrogant/tyrannical”
Aha! Note the translation in Part II. (I am playing a little game here.)

I like Economicus Superbus, and now wish that I titled this post so! But now I am stuck with the old title.

Concom

From my experience with economists, I have impression that they are not generally assume that human behaviour is rational (as homo economicus concept insists), but instead they suggest that humans can be forced to behave rationally. The same is true for equilibrium; they do not suggest that the economy is always persisting around equilibrium, but rather that the economy could be forced to behave in such way.

It seems that economists are not interested in bringing additional complexity to their model; on the contrary they are looking for mechanisms (evolutionary, neuropsychological, political, etc.) that could reduce complex human behaviour to the level of homo economicus.
In fact, this is the classic approach founded by Bentham and Adam Smith, who pointed two necessary conditions for the “invisible hand” operating: (1) A strong state which enforces laws for all citizens, and (2) A strong (Protestant) morality, which prevents cheating at the community level. From this perspective, there is no mystery in the fundamental causes of the current fail in free market economy: (1) the state is unable to enforce the law on “big corporations”, and (2) Protestant morality virtually disappeared without replacement, moreover cheating has become omnipresent and unpunished.

Perhaps, the real challenge is not in the changing of economics models but rather in the changing of human behaviour:
Сan the evolutionary science to become a new moral basis for society?
Does evolutionary science ready to become a new “scientific” substitute for religion?

Peter Turchin

Well, if humans are successfully forced to behave rationally, that would be a disaster of the first magnitude. Essentially, human societies will cease to exist.

Concom

However, if humans are not forced to behave rationally, it may also lead to collapse of modern society. Where is the path between the Scylla and Charybdis?

James Walsh

For those interested, the World Bank’s recently released the World Development Report 2015: Mind, Society, and Behavior, which examined the need to introduce a more realistic understanding of the human actor into development economics. Here is the link to a pdf of the Report:

http://www.worldbank.org/content/dam/Worldbank/Publications/WDR/WDR%202015/WDR-2015-Full-Report.pdf

Peter Turchin

I looked through the table of contents, and it looks very promising, indeed. Look forward to read it at my leisure. Thanks for the pointer.

hgintis

I was an advisor to the World Bank on the World Development Report 2015. It is thoroughly behavioral and quite interesting. It received rave reviews by David Brooks in the NYTimes and by The Economist (which has been skeptical of behavioral economics—especially nudge-type policies).

pseudoerasmus

In plain language [utility maximisation] means that humans only care about getting material rewards and avoiding punishments. Considerations such as morality, honor, and concern for the welfare of others do not affect the choices people make.

Actually these sentences are completely false. I’m surprised Herb Gintis did not point this out.

O.Voron

‘Would it make sense for medical students to study unrealistic models of the human body for their training in anatomy?’

Peter Turchin

Several commenters essentially pointed that my Russia example is anecdotal, because there are so many other possible explanations. Well, I don’t have time to chase the reference down, but some years ago there was a statistical analysis of African countries that followed IMF recipes and their GDP growth was substantially lower than those that did not. If memory serves, the study accounted for obvious counter-explanations (e.g., that only countries that were already in crisis followed IMF programs).

hgintis

The IMF has always been an arm of the world’s big banks, and its leaders have been free market crazies. See this talk by Joe Stiglitz:
https://clg.portalxm.com/library/keytext.cfm?keytext_id=33.

Peter Turchin

Thank you all for the wonderful comments! I am leaving for another workshop, and will be gone the rest of the week, so my responses may be slow. Also, there is a lot of food for thought – lots of good links to investigate.

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