Defending Economics: Has Rodrik Got it Right?

Dani Rodrik geldt binnen het economenwereldje als een van de meest progressieve, vooral door zijn kritiek op de Washington Consensus. Zijn boek Economics Rules laat echter zien dat hij weinig kritisch is over de neoklassieke economie, volgens hem ‘the only sensible way of thinking about economic affairs’. Wat hebben we dan eigenlijk aan zijn stelling dat de economische wetenschap op zich niet heeft gefaald toen de financiele crisis onverwachts uitbrak, en het probleem louter was gelegen in ‘placing too much faith in the wrong models at the wrong time’?

by Dirk Damsma

On Friday, November 3rd, Professor Rodrik was in Room for Discussion to talk about Trade and Globalization. He has discussed this topic at length in The Globalization Paradox (2011). I appreciate that Rodrik is highly self-critical and openly admits that he was overoptimistic in the run-up to the financial crisis. As he puts it: ‘Along with the rest of the economics profession I too was ready to believe that prudential regulations and central bank policies had erected sufficiently strong barriers against financial panics and meltdowns in the advanced economies, and that the remaining problem was to bring similar arrangements to developing countries. My subplots may have been somewhat different, but I was following the same grand narrative’ (2011: xii). According to Rodrik, however, the dismal failure of this grand narrative is not necessarily a sign of economics failing as a science. It merely shows we were placing too much faith in the wrong models at the wrong time. The problem thus lies in model selection, rather than being caused by flaws in these models themselves.

Critical versus non-critical assumptions

He elaborates on his position in his later book Economics Rules (2015). He argues that we need to distinguish between critical and non-critical assumptions. In his view ‘an assumption is critical if its modification in an arguably more realistic direction would produce a substantive difference in the conclusion produced by the model’ (2015: 27). These critical assumptions have to correspond to reality, while the non-critical ones need not (and may well appear absurd to non-economists). The critical assumptions also guide our selection of models. Imagine being confronted with some empirical problem, like – say – disappointing growth figures in a particular country. According to Rodrik, a good economist would then set out to examine the many possible impediments to growth (such as lack of trade, training, infrastructure , property rights enforcement and what not). Next s/he would bring out the models that map out the consequences of these assumptions and check whether the growth barrier assumed in a specific model corresponds to that country’s reality. To verify that this is the right model to use, one can further check whether the model’s many (direct and incidental) implications are also borne out in reality. If so, we can use the model to see what it predicts will happen if that growth barrier is removed. If the results conform to the goal that the politicians in that country have set, we can safely advise them to go on and start working on removing the barrier in question. Models thus are best viewed as diagnostic tools, and as such they can be properly or improperly used, but cannot themselves be right or wrong.

Now this sounds like a prudent way of applying models to reality. The problem is that many assumptions that are critical in Rodrik’s sense cannot actually be modified ‘in an arguably more realistic direction’ at all. Doing so, would invalidate a whole class of models. If households are not identical for instance, models invoking individual rationality cannot generate (predict) a unique market outcome at all, and would thus be useless as diagnostic tools. (If you follow my earlier columns, you may be getting a bit weary with me talking about the SMD conditions by now, but its implications are so pervasive and so often downplayed, that I feel they can never be overexposed.)

People like Minsky (1992) and Keen (e.g. 2017) have shown that when the idea of loanable funds is replaced by the much more realistic idea that investment and concomitant money creation is a function of prospective profits, the dynamics of the system change completely. Yet growth diagnostics (a field that Rodrik proudly hails as being a prime example of the correct use of models) almost always hinges crucially on this doubtful idea of loanable funds.

Does neoclassical economics provide the only sensible way?

Despite this, Rodrik is crystal clear that economic models must be neoclassical. As he puts it: ‘At the core of neoclassical economics lies the following methodological predisposition: social phenomena can best be understood by considering them to be an aggregation of purposeful behavior by individuals—in their roles as consumer, producer, investor, politician, and so on—interacting with each other and acting under the constraints that their environment imposes. This I find to be not just a powerful discipline for organizing our thoughts on economic affairs, but the only sensible way of thinking about them’ (2007: 3).

However, models can only function as diagnostic tools if the entities and transmission mechanisms critical to getting the diagnosis right are stable while diagnosing. They must also correspond to real world stability. It just so happens, that individual predispositions and actions are much more volatile than aggregate ones. Apparently, social phenomena are stabilized more by social conditions than by stable, predictable individual inclinations. Durkheim (1979 [1897]) showed, for instance, that soldiers have higher suicide rates than civilians. So if civilians become soldiers, the overall suicide rate rises. Similarly, consumption of certain positional goods (goods that showcase your status) probably depends more on the relative size of high status groups, than on individual inclinations (cf. Bourdieu 2010 [1984], Ilmonen 2011, Miles 1998). But this implies that in many cases ‘purposeful behavior by individuals’ is a far less powerful discipline for organizing our thoughts on economic affairs than are ‘social pressures emanating from social groups’.

So Rodrik’s defense of economics fails, because his predisposition towards neoclassical economics precludes him from modifying many critical assumptions in a more realistic direction. His idea is OK, but we need to take it a few steps further and expand economists’ model library with models of different stripes. Once Marxist, Keynesian, Developmentalist, Evolutionary, Institutional and other models are all considered equals, Rodrik’s approach might well work.

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1 Reactie

  1. “we need to take it a few steps further and expand economists’ model library with models of different stripes. Once Marxist, Keynesian, Developmentalist, Evolutionary, Institutional”

    Mag ik dan aan het rijtje de economische theorie van Rudolf Steiner toevoegen want geld is een bedenksel van de mens. Dhr. P. Steenstra doet een aardige inleiding voor het ontstaan van deze diverse bedenksels/ onze huidige geldsystemen op de site van de driegeleding- (een essay dat al in 2002, dus voor de financiële crisis is geschreven):

    https://www.driegeleding.org/essays/2002-03-003.html

    Het huidige geldstelsel is aan herziening toe. De antroposoof Rudolf Steiner deed in 1919~1922 voorstellen en introduceerde 3 aparte geldstelsels voor de Economische-, Geestelijke- en het Rechts-leven (de 3 geledingen). Geld moest apart gecreëerd worden als respectievelijk KOOP-geld, GEEF-geld en LEEN-geld.

    Dus iedere geleding kreeg het aparte recht om geld te creëren en geld dat niet gebruikt werd zou uit roulatie genomen worden om onnodige de- en/of inflatie te voorkomen.

    Door diverse roerige politieke gebeurtenissen rond 1920 (o.a. opkomst communisme, nazisme, fascisme etc etc) heeft het aanvankelijke enthousiaste onthaal van Steiner’s ideeën niet door kunnen zetten.

    We hebben nu met onze digitale technieken weer een kans om geld niet op één hoop te gooien maar geld laten ontstaan in de aparte geledingen (economie, geestelijk/ cultuur en rechtsleven), geld met digitale tags (dus traceerbaar) en blockchain technieken.

     

     

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