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</head><body bgcolor="#FFFFFF" text="#000000"><div>This is an excellently written piece in several ways, which should be extended. From this stand point, a progressively more functional economics can be defined. A side point is that communication is fully a multiple process. and that the person (s) attempting to convey shares responsibility in having a "text" or body(unit) of knowledge be understood. Academic economists have as a profile been well insulated from that responsibility, which abandons the process to dys-information and persuasion/threats. An interesting side note is that where the smell of economics and testosterone is strong, there are also several domains which have been largely abandoned, monetary economics and economic history being two examples. This is on top of the near black (worse than just dismal) out on institutional economics/macroeconomics as anything other than the fiction extrapolated from Milton Friedman's "positive" micro economics. Georgist economics (cf Henry George 19th century commons focused), Thorstein Veblen, and others being outside of that conformity.</div><div><br></div><div>as we go, Tadit</div><div><br></div><div><br></div><div><br></div><div><br></div><div><br></div><div><a name="2" style="font-family:Arial, Helvetica,
sans-serif;font-size:18px;" href="http://feedproxy.google.com/%7Er/NakedCapitalism/%7E3/EHmhwfPhbZg/economics-debunked-chapter-two-for-sixth-graders.html?utm_source=feedburner&utm_medium=email">Economics
Debunked: Chapter Two for Sixth Graders</a>
</div><p style="font-size:13px;color:#555;margin:9px 0 3px
0;font-family:Georgia,Helvetica,Arial,Sans-Serif;line-height:140%;font-size:13px;"><span>Posted:</span>
22 Sep 2011 01:35 AM PDT</p>
<p>Readers gave high marks to A<a href="http://www.nakedcapitalism.com/2011/09/the-very-important-and-of-course-blacklisted-bis-paper-about-the-crisis.html">ndrew
Dittmer’s summary of a dense but very important paper by Claudio
Borio and Piti Disyatat of the BIS</a> and asked if he could
produce more of the same. </p>
<p>While Andrew, a recent PhD in mathematics, has assigned himself
some truly unpleasant tasks, like reading every bank lobbying
document he could get his hands on to see what their defenses of
their privileged role amounted to, he has yet to produce any
output from these endeavors that are ready for public consumption.</p>
<p>However, I thought readers might enjoy one of Andrew’s older
works. He e-mailed me right after I started working on ECONNED.
Our conversation went something like this:</p>
<blockquote>
<p>Andrew: I am a Ph.D. student in mathematics at Harvard. I have
found your blog to be terribly interesting while trying to make
sense of the way in which the global economic architecture is
evolving, or devolving as the case may be.</p>
<p> I should finish my doctorate in a month, assuming nothing goes
terribly wrong. I would be very happy to help you with your book
in whatever ways are useful for you. In particular, I would
definitely be able to review and comment in a fairly minute and
exacting way on chapters of your book.</p>
<p>Me: That is a very kind offer, thanks! What is your
dissertation on, BTW? And are you doing theoretical or applied
math?</p>
<p>Andrew: Theoretical math </p>
<p>Me: [inwardly] <em>Holy shit, this is one of the smartest
people in the country!</em></p>
</blockquote>
<p>It turns out that Andrew did indeed provide detailed commentary
on the logic of all the chapters, as well as the thread of the
argument across the book after it was drafted (something few
editors do). Chapter 2 was the most daunting chapter, in that it
is a fundamental critique of economics from a methodological
standpoint. Every time I though I had a draft nailed, I’d get
extensive feedback from Steve Waldman and Andrew, with the net
result that I’d go back and start from close to scratch. This
happened eight times and I was clearly losing patience.</p>
<p>Andrew, recognizing that I was starting to lose it (writing an
ambitious book in six months was rather deranged, and all the
revisions were adding a lot of added pressure) suggested how to
restructure the chapter in the form of a lesson guide for sixth
graders (as mentioned earlier, Andrew taught six and seventh
graders math in the Cambridge public schools on the side). It was
useful and also provided some badly needed comic relief.</p>
<p>Those of you who have read ECONNED may recognize the parallels (I
adopted his outline in large measure). I am confident readers who
have not read the book will still enjoy his rendition.</p>
<p>* * * * * (HISTORY)</p>
<p> Once upon a time, about a hundred years ago, economics was
different from how it is today. Many famous people had thought
about economics, including Adam Smith, Ricardo, Marx, and others.
Economics was not a perfect science, and lots of people who
thought about economics disagreed. But in the last century,
economists started to agree about two things: economics should
become as mathematical as it possibly could, and politicians
should listen to economists.</p>
<p> Economics at the time was not a very mathematical science, at
least compared to the way it is today. Economists used to write
articles with very few equations, or even without any equations at
all. When did economists start to use math more? The beginnings
might have been toward the end of the 1800′s, with some economists
named Jevons, Menger, and Walras. But a person who was
particularly important was Paul Samuelson. He comes into the story
later.</p>
<p> In the 1920′s and 1930′s, there lived a great economist named
John Maynard Keynes who came up with new ideas about economics.
Many people thought that they made a lot of sense because they
seemed to explain how governments had managed to get their
countries out of the Great Depression. Politicians began to listen
to economists more and more.</p>
<p> Someone named Lorie Tarshis went to Keynes’ classes, took notes,
and made a book out of it. The name of the book was “Elements of
Economics.” It was published in 1947. Back then, there were people
who thought that communist spies were everywhere. Some of these
people, including William F. Buckley, decided that Tarshis’ book
was also part of a communist plot, and started saying so very
loudly to as many people as they could find. Many colleges became
afraid to use “Elements of Economics” as a textbook.</p>
<p> Meanwhile, Paul Samuelson was writing his dissertation, and he
saw how angry the people had gotten with Tarshis. He decided to
make it so his dissertation could not be attacked in the same way.
So he did three things, writing very “carefully and lawyer like.”
First, he changed Keynes’ ideas a little bit so that in
Samuelson’s version of them, they said that corporations in the
capitalist system would always give everybody a job as long as the
government and labor unions didn’t bother the corporations. That
made corporations happy with him, so that they didn’t think people
should call him a communist. Second, he called his ideas
“neoclassical synthesis Keynesianism.” That made other economists
think that he wasn’t changing their ideas very much, so they were
more happy to support him. Third, he wrote all of his arguments up
in mathematical form. Now why would he want to write up his ideas
as mathematical arguments?</p>
<p> Well, for one thing, a lot of people don’t understand
complicated math, so he could automatically win arguments with
someone who didn’t understand math. Even the people who went
around calling people communists couldn’t call him a communist if
they didn’t understand the math he was doing. There was another
reason, too. Samuelson could turn problems that economists used to
argue about into equations. Then he would solve the equations and
the argument would be over. [Lucas quote]</p>
<p> Samuelson’s book was called “Foundations of Economic Analysis.”
It was published in 1947, and it became a big success. Nobody told
Samuelson that he was a communist. Other economists started to use
mathematical models more. </p>
<p> Later on, in the 1950′s, two economists named Arrow and Debreu
made a simplified mathematical model of the economy, and proved
that in their model, there would never be a time when people
wanted to buy something and nobody would sell it to them.
Economists thought that this was very exciting. Now they used math
even more.</p>
<p> Nowadays, most papers on economics have equations in them. All
economists have to be able to talk about their ideas using
mathematical models and statistics, or other economists won’t
respect them. This is part of what is called being able to “think
like an economist.” It is a special ability that you can only
learn by going to graduate school in economics. A professor named
David Colander surveyed economics graduate students to find out
which of seven factors were most important in order for them to
succeed in graduate school. The top three factors all had to do
with being good at math. The least important factor was having “a
thorough knowledge of the economy.”</p>
<p>So learning how to “think like an economist” is very important,
because if you don’t do it, then no matter how well you understand
the actual economy, economists still won’t take your arguments
seriously.</p>
<p> Have these changes made economics a better science, or a worse
science?</p>
<p>* * * * * (CRITICISM OF AXIOMATIC MODELS)</p>
<p> Samuelson, by using mathematics, was able to win arguments and
make sure people liked him, especially the more important people.
Other economists followed his example. How did Samuelson use
mathematics to become successful? The first thing he did, if you
remember, was that he made sure that his economics would say that
corporations would make sure people had jobs, and so corporations
were good. So his first technique was to make sure that his
economics said things that people would like. But that doesn’t
seem to make sense. Isn’t the point of mathematics that in math,
things are either right or wrong?</p>
<p> Actually, the way that things work in math is that first, you
make ASSUMPTIONS, and then you figure out from the assumptions
whether things are right or wrong. So the way that you use a
mathematical argument to say things that people will like is that
you change the assumptions until they make it so the answers are
answers that people like.</p>
<p>[At this point the kids become angry. "That's stupid, " they say.
"It sounds like they're going in circles." The responsible teacher
at this point tries to avoid being too political with his or her
young audience, and tries to make vague excuses for the
economists. However, the teacher can't help recognizing that the
students sort of have a point.]</p>
<p> Even though economists were supposed to be using mathematics so
that they wouldn’t have to argue any more, it doesn’t seem to help
much if they can still get any answer they want by just changing
their assumptions around. For example, [insert McCloskey quote
about the A'/C'-theorem].</p>
<p> That means one way to figure out whether mainstream economics
makes sense is to see what the assumptions are, and to try to
decide whether those assumptions make sense. For example, what
were Samuelson’s assumptions? What were Arrow and Debreu’s
assumptions?</p>
<p> Samuelson had one big assumption, that economists call <em><strong>ergodicity</strong></em>.</p>
<p>[Teacher pauses to give kids time to stumble over the word.]</p>
<p> When they say ergodicity, they mean that no matter what happens
in the world, in the end, everything will reach a point whether
things stop changing. That point is called the “equilibrium.” At
the equilibrium, everyone will end up with a certain amount of
money. The amount of money that everybody gets at the equilibrium
depends on how talented they are, and not on anything that
happened before. So if you rob a bank, it won’t matter because
when you get to the equilibrium, if you’re stupid, you will still
have the same amount of money you would have had if you didn’t rob
the bank.</p>
<p>[A kid with disciplinary issues mutters, "This is bullshit. Why
do we have to learn this?" Other kids ignore him and try to take
notes.]</p>
<p> What’s more, at the equilibrium point, everyone will have a job,
everyone will have lots of stuff, and no one will feel like there
is any way that America could be a better country.</p>
<p>[Eyes glaze over.]</p>
<p> Actually, what’s kind of funny is that in physics, if there are
three stars or planets and gravity pulls them around, what do you
think happens? They end up going into orbits around each other.
But their orbits will be different if they start out in different
places. So it would be kind of weird if an economy with millions
of people doing all sorts of complicated things always ended up in
the same way, if three planets can end up in all sorts of
different ways depending on where they start moving from. But who
knows? Maybe the economists are right about ergodicity.</p>
<p> It’s actually even weirder than that. Because in physics,
Poincaré figured out one hundred years ago that even if you know
where the planets start out, if you’re wrong about how far apart
two planets are by even an inch, then as time goes on, the orbits
that you think the planets will go on will start to get more and
more wrong, until there comes a point when the orbits you thought
the planets were going to settle on are totally different from the
way that the planets are actually traveling. So it’s really hard
to predict what will happen even to three planets, if you try to
look far enough into the future. But who knows? Maybe economists
are right about ergodicity, and in an economy if you measure
things carefully enough and are clever enough, you can figure out
exactly what will happen to the economy for the next one hundred
years.</p>
<p> Then there were Arrow and Debreu, who proved that in their model
people who wanted to buy something would always be able to find
someone who would sell it to them. They had assumptions, too. They
assumed ergodicity, like Samuelson, but they also assumed other
things. They assumed that everybody in the world knows everything
about everything that is being sold all over the world. Also that
you know the odds of whether it will rain on a Tuesday in a
thousand years. This is called “perfect information.”</p>
<p> Some people who don’t think like economists have made fun of
economists for making unrealistic assumptions like these. Those
people seem to think that if economics is based on assumptions
like these, that maybe aren’t true, then economics must not be a
useful science. But these people don’t know that in 1953, Milton
Friedman destroyed all of their arguments with a magical
“get-out-of-reality-free card.” When you play this card, it makes
it so you’re not allowed to make fun of economists for basing
their theories on assumptions that aren’t true.</p>
<p> Friedman said that if you could use a theory to describe the
world correctly, it didn’t matter if your assumptions weren’t
true. Actually, it was even better if they weren’t true, because
that would mean that your theory was very, very clever!</p>
<p> That means to decide if standard economics makes sense, we need
to see whether it says things that are true, and we shouldn’t pay
attention to whether or not the assumptions are true. For example,
economists say it’s bad to pay the people with the worst jobs more
money</p>
<p>[Kids snap out of their stupor. "What?" a kid asks, dazed.]</p>
<p>because if you do, then the people who give the poor people jobs
will fire some of them. A couple of economists named Card and
Krueger tried to test the theory and they announced that the
theory was wrong, and you could pay poor people more money and
have it be a good thing. Other economists saw that if Card and
Krueger were right, then standard economics had to be wrong, and
they went into shock. They were sure that Card and Krueger had to
be wrong somehow. </p>
<p>[One kid asks, "But wait. I thought that Friedman said that the
assumptions of the theory weren't important, just whether it was
true in real life. If it wasn't true in real life, then it was a
bad theory, right?" Teacher tells the kid to wait, there isn't
much time left in class and there are a lot of other things left
to discuss.]</p>
<p>Some of them tested what happened when you gave poor people more
money and said that no, the theory was right after all. Other ones
tested it too and said that Card and Krueger were right and the
other economists were wrong. So even though Friedman’s magic
get-out-of-reality-free card sounds like a cool thing, it’s
actually really hard for economists to use it in real life.</p>
<p> But even though the card might not really work, mostly people
don’t argue with economists and so they still use their theories
and “think like economists.” “Thinking like economists” is kind of
like looking at the world with 3-D glasses. When you’re watching a
3-D movie, it makes it so that you see really neat things. When
you’re not watching a 3-D movie, then everything looks red and
blue and kind of weird. But economists still like wearing their
3-D glasses.</p>
<p> When economists look at the world through their 3-D glasses,
they see it as having “ergodicity.” Remember what that means? It
means that if you just leave corporations alone and help them to
do what they want faster, the world will, all by itself, become a
happy place. You don’t need to stop them from doing anything they
want to do, or try to make them wear seatbelts. Just help them to
drive as fast as possible. It also means that economists can
figure out what the economy is going to do, and you can trust
them.</p>
<p> For example, economists have invented computer programs called
“DSGE models” that they use to predict the future. Because of
ergodicity, the DSGE models say that nothing bad will happen to
the economy unless something crazy happens, like the people in the
Middle East not wanting to sell us any more oil or Martians
attacking the earth.</p>
<p> Another example is that some of the big banks invented really
complicated things that were sort of like money, but sort of not
like money. Those things are called “derivatives.” The big banks
liked the derivatives because they were sure they could make a lot
of real money from them. Some other people who weren’t economists
thought that derivatives might be dangerous. Those people thought
that if things in the economy went faster, they might also break
more easily. But because of ergodicity, economists were sure that
since derivatives helped corporations do things that they want to
do faster, the derivatives would be good. So the economists made
it so nobody paid attention to the people who said derivatives
were dangerous, and the big banks got to make all of the
derivatives they wanted to.</p>
<p> Later, the derivatives helped to make trouble in the economy.
That’s why some of your parents lost their jobs. The big banks who
made all the money from the derivatives had trouble too and were
almost destroyed, but the government gave them more money so that
nothing bad would happen to them. Meanwhile, the government won’t
let people find out what it did with the money it gave to the
banks. It says that the details need to be kept secret by a group
of bankers and economists called the Federal Reserve. The people
on the Federal Reserve think like economists and so it’s okay for
them to know the secret.</p>
<p>* * * * * (OTHER APPROACHES TO ECONOMICS)</p>
<p> There have been some people who don’t like the economics that
starts with assumptions and then tries to do math with the
assumptions. [you could cite Blaug here] Some of these people have
tried to make other kinds of economics.</p>
<p> Some people tried to make a kind of economics that is called
“systems dynamics.” In this economics, you pretend like the
economy is a really big machine, and sometimes parts of it can go
crazy or break. Some people liked this kind of economics,
including some of the people who said that derivatives were
dangerous. But economists mostly don’t like this kind of
economics, so they don’t use it.</p>
<p> <b>One day, some economists noticed that if you’re playing
cards, if you peek at someone else’s hand, then you’ll probably
win more than someone who doesn’t peek. That’s because you know
your cards and their cards and they only know their own cards.
The economists who noticed this called it “asymmetric
information.” Since economists before that assumed “perfect
information,” so everybody playing cards knows everybody else’s
cards, they were amazed at how smart these economists were and
gave them Nobel Prizes.</b></p>
<p> Another day, some economists noticed that sometimes people are
stupid and do things that waste money. They made a theory about
this called “behavioral economics.” Since economists before that
assumed “perfect information,” [and rational expectations] or in
other words, people know everything that is happening everywhere
in the world and always do whatever makes the most money, they
were amazed at how smart these economists were and gave them Nobel
Prizes.</p>
<p> There were also some economists who noticed that if you give
another kid your lunch and tell him to hold it for you until
lunch, he might eat your chocolate bar and then tell you that
someone stole it. Their theory is called the “principal/agent
dilemma.” This theory also seemed very new and exciting to other
economists.</p>
<p> <b>When people started making fun of economics because
economists hadn’t realized that there was going to be an
economic crisis, some economists like Eichengreen and Rodrik
told those people that they were wrong and economists could have
been able to know that there was going to be a crisis.
Eichengreen and Rodrik said that the only problem was that
economists hadn’t used the new theories like asymmetric
information, behavioral economics, and principal/agent theory,
but economists would remember and use them next time.</b></p>
<p> But since all of the new theories are different from the old
economics, what usually happens is that economists use only one of
them at a time. If they got rid of the old economics completely,
then other economists who like the old economics would be angry at
them or not pay attention to them. So they use the old economics
and then add on a little bit of the new economics and hope that it
works. An economist named Peter Dorman said that if the old
economics is like a big giant, then each thing that is wrong about
the old economics is like a wound that blood is pouring out of.
Each new kind of economics is like a band-aid that economists try
to put on one of the wounds, but they can’t put band-aids on all
of the wounds at the same time. So the giant lumbers forward,
blood spurts out of him all over the place, and nothing changes.
Gruesome, huh?</p>
<p> Some economists have tried to use a lot less theories and mostly
just figure out what is actually going on in the world. This kind
of economics is called “empirical research.” For example, when
Card and Krueger tried to figure out what would happen if you paid
more money to people with crappy jobs, that was empirical
research.</p>
<p> But when they did it, a whole lot of people got angry with them
and disagreed. So it can end up being pretty hard to tell what is
going on in the world.</p>
<p> There are a few reasons why this is true. For one thing, the way
economists usually try to find out what is going on is by looking
at some numbers or graphs and trying to find a pattern. But the
numbers might not be right. And what happens if someone wants to
study something and they can’t find any numbers to study it with?
For example, some economics students decided they wanted to find
out if the trouble with the economy had to do with making it so
companies that try to get people to buy houses didn’t have to
follow as many rules. But those companies wouldn’t give them any
of the numbers they needed to find out if their idea was right. So
the economics students gave up. They didn’t have to give up – they
could have talked to people who bought houses and interviewed them
and things like that. But it would have been more work and other
economists might have thought that they were weird to use
interviews instead of numbers. So instead they gave up. </p>
<p>This is kind of like the story about a drunk guy who loses his
keys and walks over to the street light and looks under it.
Somebody asks him why he’s looking under the light when he
probably lost them some other place. He says that it’s dark in the
other places so it’s hard to look there. Do you see the connection
with the economics students who wanted to study houses? They
couldn’t find the numbers that made it easy to look at their
problem, so they stopped looking.</p>
<p>[In fact, the connection between the joke and the problems with
the mortgage lender deregulation research is the one idea here
that is abstract enough that it would be tricky to explain to
sixth graders.]</p>
<p> Another problem is that if you look at enough graphs, you’ll
eventually find one with a pattern just by chance. This is bad,
because it might not be a real pattern. It might just be an
accident. If you take a fake pattern and make people think that
it’s a real pattern, that’s called “overfitting the data.” It’s
kind of like cheating.</p>
<p> If you don’t want to cheat and overfit, there are some ways to
make it more likely that you’re finding a real pattern and not a
fake pattern. If you find a pattern one year, you can look at
another year, or another place, and see if there is the same
pattern. This is called “cross-validation.” </p>
<p> Even though it’s a good idea to do cross-validation, a lot of
economists don’t do it. A couple of people named Gerber and
Malhotra did detective work on economics papers, and they found
out that lots of economists were probably overfitting. They
couldn’t tell who was doing it, just that a lot of people were
doing it. If you’re an economist, you want to have a good job, and
to get a good job, it helps to find patterns and write papers
describing the patterns to other people. So some economists maybe
wanted to get a better job and so they overfitted so they could
find more patterns.</p>
<p>* * * * * (STATUS AND FUTURE OF ECONOMICS)</p>
<p> Economics seems to be in a lot of trouble right now. The old
economics has problems, and the new kinds of economics have
problems too. Some economists have even given up studying the
economy and now study things like speed-dating and violence in
movies.</p>
<p> A guy named Thomas Kuhn said that when people make a science,
they keep using it as long as they can. Sometimes they can tell
the science isn’t working very well. This is called the
“late-paradigm” stage. It sort of means that the old science has
become sick. Even then, people will only stop using the old
science when someone invents a new better science AND when all of
the professors who liked the old science get old and die. </p>
<p> It looks like economics is in a “late-paradigm” stage. But
people don’t have a new better economics, so people still keep
using the old economics. What are some things that should happen?</p>
<blockquote>
<p>(1) Economists should be honest about when they don’t know what
will happen in the future so that people don’t rely on them in
ways that they shouldn’t.<br>
(2) Economists should admit that in economies some people want
some things to happen and other people want other things to
happen. They should be honest about what kind of world they want
to live in, and not pretend like they know how to find a world
in which everybody will be overjoyed.<br>
(3) Economists should work less at trying to find reasons not to
listen to people, and try harder to learn about the economy,
even from theories that they don’t like, methods like interviews
that don’t involve numbers, and from the ideas of people who are
not economists.
</p>
</blockquote>
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