In Praise of Theory

Econophile's picture

This originally appeared in The Daily Capitalist.

This is an article I did for a local newspaper for which I write a regular column on economics. Size limitations required the article to be very concise, thus a philosophical treatise on theory, epistemology, and intellectual trends was not possible. But I think it came out well. What do you think?

*  * * * *

Why is the economy a mess? Why can’t our leaders fix it? Why can’t we get good people to go to Washington to fix things? Why can’t we just pick the “best” ideas from all sides and get this thing fixed? I get asked these questions frequently.

I have an answer but it is not what you may be expecting.

The answer is not that we don’t have good, smart people trying to solve our problems. Obama’s staff is stocked with capable, bright people including Secretary of the Treasury Tim Geithner, and Austan Goolsbee, the new chief economic adviser. Fed Chairman Ben Bernanke, a Republican, is one of the smartest people you would ever meet. He received his Ph.D from MIT. He was a professor of economics at Princeton. He is a great admirer of Milton Friedman, the revered founder of Monetarist economic theory and a fierce defender of free markets.

The recently departed chief economic adviser to the Obama Administration, Larry Summers, has a Ph.D in economics from Harvard. He is the son of two well known economics professors and his uncles are Nobel laureates, Kenneth Arrow and the late Paul Samuelson.

Say what you will, but they are the cream of mainstream economics, they all have the best of intentions, and they very much want to solve our economic problems. After all, their boss’s job depends on it.

The answer to the above questions is this: the economic theories of the cream of mainstream economists are wrong.

If real world results can be used to measure cause and effect, then we have proof in the sad state of our economy that they are wrong. Their solutions are wrong because their ideas are wrong and their ideas are wrong because their economic philosophy is wrong.

This is where I really hope to capture your attention even though I am getting into things philosophical. Most “practical” people dismiss “theory” as just the musings of ivory tower types. They eschew theory for “common sense.” This attitude is wrong for it is the academic theoreticians who have captured the commanding heights of ideas, especially in economics. They have changed the world, and that is real power.

You can only refute bad theory with good theory. Good theory can be counter-intuitive to what seems “common sense” or “pragmatic.” I don’t mean to be dismissive of common sense, but Einstein referred to it as just a bunch of prejudices we have formed by the age of 18.

Economic theory is a complex topic, but bear with me for a moment, I have a point.

The theory or philosophical foundations behind mainstream economics is the belief that (i) studying aggregates of data (like GDP) reveals truths and can predict economic behavior, (ii) people act rationally thus you can design mathematical formulas to determine the best policies to affect such behavior, and (iii) the government can effectively carry out these policies.

All of their principles, solutions, proposals, studies, and policies are founded on these rocks. I have greatly simplified a complex topic, but I do so to make a point.

It may seem to you that these theories are fine so what is the big deal? It is a big deal because the solutions these theories have spawned have failed in the real world and the economy is in trouble.

Mainstream economics ignores human nature. They think they can effectively direct collective human behavior because we are “economic units” and by studying masses of data they can devise mathematical formulas to “correct” our actions. This is called the “science” of econometrics. It is not that the study of data itself is bad, but the idea that it is predictive is false. I can look at the output of certain data and get an idea of what auto production is, but I can’t tell you what auto you will buy tomorrow. Econometrics is the farthest thing from a hard “science.” Free market economists Mises and Hayek called it a fake science. (See Hayek’s Nobel Prize lecture.)

A number of free market economist-philosophers, such as Mises and Hayek, have come up with a completely different view of the economic world. Instead of treating us as aggregate economic units, they examine our behavior as individuals. After all, the “economy” is just the result of hundreds of millions of individual choices made every day.

These free market economists believe the proper basis of economics is to study how individuals make decisions and interact in an imperfect world. They don’t believe it is possible to predict human behavior by studying aggregates because aggregates don’t make choices, only people do, and those choices are based on personal values, emotions, and feelings, things that are subjective and immeasurable. It takes into account that we don’t always act rationally and that markets aren’t perfect.

It gets very complicated from here so I will stop with the philosophy. If you want proof, then know that free market capitalistic countries have been the most successful in the world.

If you accept the fact that mainstream economists failed to see the obvious coming, that they have failed miserably to revive the economy yet they continue to use the same failed policies, then wouldn’t you agree we need change?

We can only change the direction of our country by challenging the foundations of mainstream economics. And that is why theory is so important.

Very, very few mainstream economists have bothered to study the intellectual foundations of economics. They have been spoon-fed this mechanistic econometric view and do not have the intellectual training to contradict it. The fact is that much of academia is a closed society hostile to ideas that contradict conventional wisdom. That too is human nature.

How can we effect change? By respecting and praising theory. By respecting the work of academic theoreticians. By working to bring free market theories to light. By donating money to institutions which support free markets. By supporting the publication of books by free market theoreticians. By supporting free market educational programs. By educating ourselves about the richness of philosophy. By not taking the easy way out by looking for expedient solutions. By voting for politicians who respect ideas and the power of freedom.

And that is why I write.

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FreedomGuy's picture

Wow, Econophile! We are blood brothers in economics. I just posted this under another ZH article on attending a Krugman lecture and the ensuing reader comments. I hope your article is published. I wrote:

What is interesting to me is the basic arguments of what government ought to do are never addressed. One of the reasons I prefer the Austrian school of economics is not simply because I think they are right, but because it dovetails with the ideas implied in the U.S. Constitution. I challenge anyone to find in the Constitution enumerated duties of the Federal government to  enact social justice (income redistribution), establish national retirement plans, ensure universal health treatment, establish preferred treatment for favored industries (agriculture, housing, etc.), and in essence run the economy. I cannot remember but it seemed that our government was instituted to protect our rights as we pursue life, liberty and happiness.

To put it simply, it is up to us in an economy to negotiate the terms of private interations from the price of labor to the real value of any good. All are forms of contract. Where the modern political conservative and liberal err in my mind is that both agree government ought to run an economy which is to say that it can. I submit that first a government, any government cannot run an economy and second that it ought not to do so. Krugman like any keynsian or central planner lives by the conceit that they can control the commanding heights or levers of incredibly complex economic systems which consists of tens of billions of decisions every day in every single part of the globe.

Ben Bernanke's monetary policies reinforced by Krugman et al's economic theories are all THEORETICAL exercises wherein the final result cannot be calculated. We are all forced against our will to be part of these grand social experiments.  

What I like about libertarian political philosophy paired with Austrian economics is that you let all people, hence an economy go withersoever it will. People (who are free) will preferentially trade real money (not reserve notes), establish systems and learn from the failure (and successes) of others. In essence, they will innovate and adapt every hour of every day. No one is forced to be part of anyone else's social-economic experiment. This prevents complete system failure (like hyperinflation) while improving the lot of mankind.

michigan independant's picture

No matter what we do someone will think it is a fetish defined as the pursuit of economic growth in politics and economic theory as a universal cure for all society's problems. The first thing Mises and Hayek firmly conveyed is you cannot save anyone from themselves and amplitude of effect of credit abuse. Until we focus on what is helpless and what is not we have created mindsets that do not produce. As long as percentages take percentages any Company's will not tolerate it any more since it is value added service or you are gone. Many Corporation are Lean and Mean for a reason. To many people may assume what makers of products will or will not tolerate. We understand that the Consumers decides who lives or dies to produce another day. I have found it to be true that to many thing work is something the Government does for them as they expect it. History convey's the consequences of attitudes that the term experts ignore. If Uncle Sam decides that the rate is 10 and it is double that why worry about the people since Capitalism has rules that these educated ignore since as they say they have no skin in the game. Nobody has issue with the helpless.

As for the "It is all about economic cycles--forget philosophy" I rest my case on that conveyance and will see how your interview goes going forward with the other 10 percent  attitude, but I am sure I am missing your context. I will be painfully blount. They do not care at all what you think since there are layers to insulate why they do not care. Many still work Corporate and if you have to ask what is going on the Bus already ran you over.

doolittlegeorge's picture

They've taken "God" out of economics.  Can't have one without the other.  I put the word in quotes because no matter the math ultimately all ecnomic theory devolves into a belief system.  Not telling you what to do but I see nothing wrong with going to church on Sunday, realizing "we really have no control over this" and most importantly "giving it a rest."  Simply put this so called "money machine" refuses to give unto God what is God's and needless to say "they're over the top when it comes to giving unto Caeser" in the form of Washington DC, the Fed and "Congress."  Well--some call 'em recessions, I call 'em "God." This happens to be "Caeser's recession"--the Democrats should have stopped asking for our money--instead they passed a trillion dollar health care "entitlement"--more to the point "they aren't getting anymore money, anyways."   The result?  To start with "i ain't votin' for you, phucker."

geno-econ's picture

Nothing wrong with economic theory , but a lot is wrong in practice and is in the eye of the beholder. If you accept the global econmic model then the US is in decline for many reasons dealing with deficits, stagnant military adventures, decline in resourses  and social values. However economists and polititians do a great white wash by saying it is not our fault---economic theory is being impeded by others whether it be China, lack of education,corruption, level playing field etc.  Often the discussion drifts to religion and philosophy ----afterall the US personifies democracy , free enterprise, free thought ,ingenuity, creativity and certainly we should be the winners in the global market place. This hubris is misleading , and the sooner we wake up the better. It is all about economic cycles--forget philosophy

ChanceIs's picture

Smart people ALWAYS question the underlying work of their predecessors.  Witness Galileo and Copernicus.  Geithner, Summers, and Bernanke still think that the world is flat and the center of the universe.  I give them second rate intelligence marks.  They recognized the economic game as one wherin one does just enough academic work spouting back to vain economists professors their bullshit theories in order to get high marks on tests and advance to the prestgious name graduate economic schools.  The process repeats there (further reinforcing itself).  They then get great paying jobs in federal institutions and go back to their mother academic ivory towers when the term is over for even greater SALARIES.  Emphasis on SALARIES.  Any of those three ever make a payrooll?

LongSoupLine's picture

You lost me in the article when you stated the "smart people" have "the best intentions"

wrong.  This about power, hubris and greed. period.

RockyRacoon's picture

I'll go with you on the power, hubris, and greed part.  Only if you'll agree that it is not primarily in the halls of academia.  It is within the financial sector and the governmental area.  The economists are the cultivated tools of same.  Our educational system and our mechanics of social advancement are constructed in such a way as to benefit those most likely to follow the thrust of those who benefit the most.  There is no academician who is paid nearly the same as any major CEO.  The economic theorists are given a taste of the pie now and then by being hired as figureheads and show-pieces, but they still don't get to join the inner circles.

snowball777's picture

Academicians? No.

Coaches? Probably (they get a slice of the ad revenue and huge bonuses for getting into and/or winning bowl games).

steve from virginia's picture

Just a shill for the austrian punishment- fags who don' know nuttin' either.

The actions of hundreds of millions even billions is determined by advertising. Anyone with a TV knows that!

Change the economy throw away the televsion.

snowball777's picture

I'll grant you that Rand's perm is a little fruity, but it's Kentucky where people with names like Gaylord complain about fags with a straight face.

Could not the TV be used for good as well?

Throw away the media!

Species8472's picture

"Say what you will, but they are the cream of mainstream economics, they all have the best of intentions, and they very much want to solve our economic problems. After all, their boss’s job depends on it."

I don't think that is true. People rise to the top not only because they are smart, in this case that means testing well, but because they have a personality that drives them toward the achievement of power and position. They know how to work with people and game the system to achieve that end. And the institutions that they are associated with tend to promote that behavior because of the social networks that form around them. I do not think they really are the cream.

And do they really want to solve our economic problems, or do they want to continue in power, and promote the reelection of the politicians that support them and their organizations?

Another thing to consider is that they are really in over their heads and don't know what to do, and to stay in power they must do something, when in fact nothing is probably the best way forward.

The fact that their is so much controversy among economists over the correct course of action should be enough to demonstrate that economists don't know much about how the world works. If you put a bunch of physicist and engineers in a room and give them data such as the velocity and environment of a projectile, there will be very little disagreement about where the projectile will land. Most of the discussion will be about how accurate an answer is necessary (which will determine how involved the calculation need be). The engineers might discuss efficiency but we can be certain that all the answers and methods propose will be essentially the right ones, the projectile will land where they say it will. Compare that to economics. They really don't know anything that maters.


IQ 145's picture

 I couldn't agree  more. "The cream" tends to be more widely curious; asks more questions, seeks out other texts; argues with the professors; gets squeezed out of Phd. programs, or quits in disgust; or learns to keep a low profile and gets a job teaching at a small but excellent college. These "great ones" are all egomaniacs.

IQ 145's picture

 I couldn't agree  more. "The cream" tends to be more widely curious; asks more questions, seeks out other texts; argues with the professors; gets squeezed out of Phd. programs, or quits in disgust; or learns to keep a low profile and gets a job teaching at a small but excellent college. These "great ones" are all egomaniacs.

Tic tock's picture

..if we can imagine a better economy, it can be achieved.

RockyRacoon's picture

I guess the Fed just suffers from a failure of imagination.  Maybe they should get some writers of fiction and some theoretical physicists on the board.

snowball777's picture

Here's my idea: convince people there's a lottery and that for a small fee, they could win a huge prize, but instead of using mathematics to tax people with poor skills, this time we'll tilt the game in favor of those playing so that everyone who signs up wins slightly more than they gambled.

We'll save a ton on helicopter fuel costs.

cowdiddly's picture

Ummmm you mentioned intellectual trends and economics in the opening paragraph. A contradiction in terms. I stopped reading there.

RockyRacoon's picture

You started your comment with, "Ummmm".   I stopped reading there.

 "There is a principle which is a bar against all information, which is proof against all arguments and which can not fail to keep a man in everlasting ignorance-that principle is contempt prior to investigation."

Charley's picture

Let us consider one example: the imposition of the debased federal reserve note on society resulted not from government edict, but from the monopoly of gold in a few hands. This monopoly over money was broken by the introduction of a currency that was not based on gold. But, it was engineered by the very people who had the monopoly on gold in the first place -- the banking cartel. In repsonse to the dearth of money created by their own monopoly they said to society: "Here is your money: use this worthless piece of paper as money."

RockyRacoon's picture

You can edit your own posts as long as they have not received a reply.

Charley's picture

Nice piece ... I liked it, but I think you lose it once you turn to the idea of free markets.

"Free markets" is itself a conceptual aggregation. What is free in this free market? Are individuals acting within an unbounded space, or are their choices bounded by consequences for themselves and for others? If individual choices are bounded, how then does the aggregate of these choices become free of bounds? How does the individual freely act? What are the bounds, if any, on freedom of action.

I think you need to take this back and rethink the concept of free markets. Once you critique the concept, the entire writings of Hayek and Mises will collapse...

Charley's picture

For what it is worth, "free market" is a historically limited concept which is fairly meaningless outside a society where, in fact, human action is as bounded as any fuedal empire. Which is to say: We call it a free market precisely because it is not.

snowball777's picture

They believe themselves to be referring to "free" as in freedom, but when it gets down to brass tacks (tax?) they're really only about "free" as in beer.

nmewn's picture

"If you accept the fact that mainstream economists failed to see the obvious coming, that they have failed miserably to revive the economy yet they continue to use the same failed policies, then wouldn’t you agree we need change?"

The nub of it. I like it.

For the layman it points out that there are other ways of looking at (processing) what economies are.

It also points to the peril of group think, which is at the heart of what I believe you are trying to get across.

Cut/print...five stars ;-)

RockyRacoon's picture

I copied the same text:

If you accept the fact that mainstream economists failed to see the obvious coming, that they have failed miserably to revive the economy yet they continue to use the same failed policies, then wouldn’t you agree we need change?

I'll just add that the entire topic should be moot in the sense that it is folly to expect any government to "control" an economy.   If the blasted politicians and the war machine were unable to fix rates, regulate money, and supposedly be responsible for employment, we might not be in this fix.  The proper role should simply be the prevention of fraud, adjudication of contracts, etc.  The problems stem from excessive governmental fiddling.

On an associated topic, if QE2 is not going to be effective on the "markets" and employment, then removing it won't be either -- right? 

nmewn's picture

"The proper role should simply be the prevention of fraud, adjudication of contracts, etc.  The problems stem from excessive governmental fiddling."

Exactly Rocky.

"On an associated topic, if QE2 is not going to be effective on the "markets" and employment, then removing it won't be either -- right?"

Making everyone poorer (by killing the dollar) to make the government "debt free" is the definition of insanity.

Tic tock's picture

The economy is how mankind interacts with the material world.

snowball777's picture

Then why doesn't economics ever seem to put a price on the externalities it effects on the material world?


blunderdog's picture

Well, I'd say the article sucks, because you seem to think you're challenging the conventional ideas, but you rely on use of the word "economy" as if you know what it means.

There's not really such a thing as "the economy" in the abstract sense in which is commonly believed to be understood.  "The economy" is nothing but a word we hang on a set of relationships which NO ONE FUCKING SEES OR KNOWS.

The worst part about it is that people say things like, "the economy is doing well" as if they have any idea at all what "the economy" is in the first place. 

They don't have any idea what "the economy" is.  They have a set of statistics and figures about a tiny number of relationships in a very large and complex system, and PRETEND that this tiny amount of data is sufficient to describe the entire system.

A doctor who looked only at red-blood cell count when determining the health of a patient would not be doing the best work.  If a physicist says "the universe is an orderly system," is he telling the truth or lying?  Does it even make sense to ask such a question?

"The economy" is not a mess.  The specific set of data-points which people claimed to have understood is no longer behaving in the manner they desired.  That's a very different problem--not a problem with "the economy" at all, but a problem with the (fictional) intellectual models we use to talk about it.

"The economy" is going to do just fine, even if 50% of the global population is starving and the other 50% can't generate a profit.

"Nothing's fucked, Dude."

Walter_Sobchak's picture

nothing's fucked here dude, you're being very un-dude dude.

aarskever's picture

Not to ruin your party, but why talk about "free" market theories? "Free" Market Theorizing is exactly what caused this mess -- because it brought with it all sorts of stupid assumptions such as the idea that egoistic behavior automatically results in the best outcomes (have these people even heard of prisoner's dilemma games?), the idea that information distributes to everyone immediately, that information tells the same thing to every different person -- especially because it is frequently used by lobbyists to argue that they should really not be regulated (resulting in monopolies which are horrible for innovation and competition, and entry to a market, etc. etc.). Growing first in one place (the west) and then, when that place is fully built, another (asia) means that the first place will have to go back to the uncultivated state again before something new can be built there, and this is the problem facing the US today. Yet the capitalists living in the US don't give a fuck that their countrymen are dying from hunger because they went and invested elsewhere because they wanted to have more money and could no longer invest in the US in such a way that they got their 30% YoY ROI (which was entirely reasonable).

Isn't the first order of business to understand how markets work, and how they crash, and why they can organize themselves in to ways that bring about their own collapse, whereas in other times they do not?

Anyway, "The fact is that much of academia is a closed society hostile to ideas that contradict conventional wisdom" is claptrap. The reason academic economics is like that is because lots of macroeconomists have turned themselves into weathermen, earning money by pretending to advise companies and becoming millionaires by sitting on boards of directors (Looking at you, Larry), which in turn happened because of the idiotic US mantra that "clever people should be rich", etc.. Sure, they are unwilling to change the game in such a way that they're no longer doing 'healthy growth DSGE modelling', because that would deprive them of their lucrative weathermen positions, but that hardly means that 'much of academia is hostile to "conventional wisdom"', because the conventional wisdom is very much dependent on the crappy Econ 101 education everyone who does business school learns.

Macroeconomists looking only at the possibility for growth, and how this can happen are as silly as doctors who are only willing to understand how healthy people function while refusing to consider how certain behaviors can lead to sickness, arguing that taking steroids is fine because you get more muscles, even while your testicles atrophy, and then being surprised that you are no longer fertile. Far too many symptoms are seen as 'deviant' (and therefore undesirable, and therefore, for some entirely unscientific reason, unworthy of their understanding) rather than as effects of the same "growth" policies, so that the bust that follows a boom is understood as something that must be delayed (through credit extension and whatever) -- as though that mitigates, rather than increases, the problems associated with the end of a business cycle, where the means of production have to be rearranged to fit with current demand.

11b40's picture

Since my "formal" knowledge of economics is tiny, maybe I should just be quiet, but though I agree with your basic premise  aarskever, it does seem that many of our immediate problems are related to throwing out some basic principals I vaguely recall from Econ 101.

One of those was 'guns OR butter'.  I was told that no nation in history had been able to long sustain a policy of 'guns AND butter'; that a choice had to be made between one or the other direction.  Electing to fight what have become this nations longest wars on 2 fronts, while keeping the cost off the books and being told to go shopping, seems to me to be sheer stupidity.  Oh, and I almost forgot to mention that we got tax cuts, too!  Is this a great country or what?  No shared sacrifice needed, no pain.  Wow.

Then, there is this little supply & demand thingy.  The very first time I heard the term supply-side economics, I got the same little visceral response I get when I hear someone say "trust me".  Same with trickle-down economics.  Open wide and swallow this nice dose of snake oil.  Maybe my 'common sense' is showing, but I do believe the demand side of the equation is the stronger one.  Supply is immaterial if there is no demand, and when there IS demand, supply has this amazing way of showing up.  A couple of macro examples are prostitution and the doomed war on drugs.

Usually, knowing what is right is relatively easy to figure out.  It's doing what is right that is hard.  Same with economics.  Econ 101 is OK.  Econ 102 & beyond is where the manipulation starts & we get in trouble.

...but, like I said, my knowledge is limited.

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Nihilarian's picture

Here's a list of assumptions PhD's should work with:

(i) studying aggregate data does nothing to predict the future

(ii) people are not rational

(iii) thus, central planning does not work


indeed, I agree with your premise of free markets. And I find the need to draw a distinction: free in a sense that market participants engage in free trade and that government is only involved in protecting participants from each other (enforcing contracts, criminalizing fraud). And not what it has been doing in our society: actively participating in the economy, favoring some participants over others, changing the rules, not enforcing the rules, or breaking the rules themselves.

Dollar Bill Hiccup's picture

How about a running ZH thread or column covering all of the above?

1) Is anything predictive of the future considering economics? If so, under what parameters?

2) If people are not Rational and the notion of a Raional Agent underlies modern economic assumptions, then three questions :

a) What is a Rational Agent exactly supposed to be, and how?

b) What is a Non Rational Agent, if we discard the notion of the Rational Agent?

c) What is an Agent period, rational or non rational? A subject, a moment of history, a mechanistic causality, a consumer etc.

3) What kind of planning does work? If mathematics is the substructure of rational planning, does a shift to fractals maintain the same rational substructure in a different guise? How do narrative structures affect, enable or disable supposed rational substructures? How do self reflexive structures affect supposed rational substructures?

Dr_Dazed's picture

Starting assumptions, propositions or pre-conceived conclusions?  I didn't understand the goal of data grounded modeling to be "predicting the future" when I took econometrics.  The real problem with econometrics as I see it is the focus on equilibrium solutions.  Strong rationality assumptions are part of the equilibrium state model - not necessarily applied across the spectrum of economic studies and certainly not part of the basis for behavioral economics as currently practiced.


As for "(iii) thus..." - the word "thus" implies a necessary logical conclusion which you have failed to achieve.

There's plentiful reason to bash economics.  One perhaps found in the religion the is commonly referred to as "free market efficiency" which is often an excuse to fail to really look at how markets fail in practice.

Ripped Chunk's picture

"The real problem with econometrics as I see it is the focus on equilibrium solutions"

Exactly. Like trying to immobilize a drop of mercury with a butter knife. Equilibrium continues to move about.

i-dog's picture


Great article and great response. It's all far simpler than economists try to make it!

Complex systems, by definition, cannot be centrally planned. They fractally evolve -- with unforseen and unpredictable emergent properties -- from the self-interest of each component. From water molecules in clouds, to cells in living organisms, to each actor in the economy, this always holds true.