Guest Post: The Pseudoscience Of Economics

Tyler Durden's picture

Submitted by Azizonomics

The Pseudoscience of Economics

Modern economics is obsessed with modelling. An overwhelming majority of academic papers on the subject work like so: they take data, and use data to construct formal mathematical models of economic processes. Models mostly describe a situation, and describe how that situation would be changed by a given set of events; a very simple example is that as the supply of a good diminishes, its price will increase. Another is that deficit spending increases the national income. A mathematical model is a predictive tool created to demonstrate the outcome of events in a massively simplified alternate universe.

As someone who rather enjoys voyages of the imagination, the use of mathematical models in economics is intriguing. The pretension that through using formal mathematical techniques and process  we can not only accurately understand, but accurately predict the result of changes in the economy is highly seductive. After all, we can accurately predict the future, right?

Wrong. The wonderful and terrible and confounding thing about our world is that it is a deeply unpredictable place, at least in the economic sphere where each number (for instance “aggregate demand” or “aggregate supply”) in an equation may loosely refer to millions of huge, complex and dynamic events. When you’re using huge simplifications to describe reality, those simplifications may miss the important details, and your projections may go askew.

Not all modelling is equal. Newton’s model of gravitation (since superseded by Einstein’s relativity) makes relatively accurate predictions about how gravitation works, and what would happen to an object dropped 500 metres above the Earth. NASA used Newton’s equations to fly to the Moon. Of course, even in physics there are occasionally divergences and oddities (which is why there are quite often unrepeatable or anomalous experimental results, for instance the recent experiment that seemed to show neutrinos travelling faster than the speed of light). So economics — with its fixation on creating models of situations, and using these models to attempt to predict the future, mimics physics, chemistry and biology, where data is collected, and used to produce theories of physical processes which allow a modestly accurate representation of the future.

The key qualitative difference, though, is that mathematical economic theories don’t accurately predict the future. Ben Bernanke — the chairman of the Federal Reserve, and one of the most-cited academic economists in the world told the world that subprime housing was contained. That is the economic equivalent of Stephen Hawking telling the world that a meteorite is going to miss the Earth, when it is really going to hit. Physicists can very accurately model the trajectories of rocks in space. But economists cannot accurately model the trajectories of prices, employment and interest rates down on the rocky ground.

The thing that I believe modern economists are most useful for is pointing out the glaring flaws in everyone else’s theories. Steve Keen has made a public name for himself by publishing a book entitled debunking economics, in which he explains the glaring and various flaws in modern economic modelling (DSGE, New Classical, etc).

Economics is a complex and multi-faceted subjects. Economists must be in some measure, philosophers, historians, linguists, mathematicians, statisticians, political scientists, sociologists and psychologists, and many other things. The trouble is that at some stage in the last century the multi-faceted multi-dimensional economics (like that Xenophon) was hijacked by mathematicians who tried to turn this huge and delicate subject into an equation. Yet economics — and economic decisions, from the macro to the micro level — is a human subject. It is subtle and psychological and sporadic. A human subject requires human language, human emotion, human intuition.

The grand theoretical-mathematical approach to economics is fundamentally flawed. Trying to smudge the human reality of economics and politics into cold mathematical shackles is degenerative.

So what to do if you want to understand the economy?

Follow the data, consider the history (similarities and differences between the past and the present) and explain your conclusions simply, as you would to a child. Consider philosophical definitions: what is money? What is demand? What is supply? What is value? How does demand affect supply? What are the global patterns of trade? Why have they emerged this way and not an alternative way? Consider possibilities. Admit the limitations of your knowledge and explore the boundaries. Stop forcing the construction of absolutes, grand frameworks, grand theories. No theory will ever be robust to everything nature will throw at it, but simple microeconomic heuristics (opportunity cost, cost-benefit analysis) combined with data-focussed historical analysis may be more robust than cold, dead mathematics.

As Heraclitus noted:

No man ever steps in the same river twice

No two situations are identical. And in this universe even tiny differences can have huge effects on the outcome of a situation. This is the butterfly effect, a term coined by Edward Lorenz, and derived from the theoretical example of a hurricane’s formation being contingent on whether or not a distant butterfly had flapped its wings several weeks before.

The pseudo-scientific school of mathematical economics hungers and craves for a perfect world, where each river is the same, where there is no butterfly effect, where human preferences are expressed in equation form, where there is no subtlety or ambiguity or uncertainty.

It is a dreamworld constructed by and for people with Asperger’s Syndrome.

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Cognitive Dissonance's picture

Long time Zero Hedge readers might remember my four part series which discussed the money meme in some length.

"Perception, Inception and the Trojan Horse Money Meme"

Mr Lennon Hendrix's picture

Yeah we have been discussing this topic everyday for years. 

PS, what happened to chat?

Cognitive Dissonance's picture

LM

I just don't have the time to devote to ZH's chat at this time so I have been avoiding it completely. Once I am done with the extensive renovations to our Plan "B" retreat that I have mentioned a few times here on ZH I'll be able to spend more time (again) on ZH.

In fact, we will be leaving for Plan "B" in a few hours and we will not be back until Sunday evening. That's the way it has been every (extra long) weekend for the last 3 months.

NotApplicable's picture

Not only is it all pseudoscience, it's all they know. All other theories have been presented to them as a historical artifact, if at all.

Robert Wenzel discusses his speech at the Fed, and how it was quite the eye-opening experience.

http://www.economicpolicyjournal.com/2012/04/my-fed-speech-details.html

CIABS's picture

It's a waste of energy to focus on the "wrongheadedness" of most economic discourse.  If that's what it really is, then the economists doing it are useful idiots.  The discipline of economics is assiduously steered away from the truth by those in a position to do so, because there is so much at stake.  This is true of all of the so-called social sciences, for the same reason.  Widespread understanding of society would bring up the irresistible urge to change it, with regard to the maldistribution of power and wealth.  The most dangerous of the social sciences is the study of history.  All the others have been made intentionally ahistorical, in order that they be neutered.  Most of economics, like most social-scientific discourse, is pure brainwash.

vast-dom's picture

i modelled the shit out of SP and continually arrived at 800 for last year. So I'm first to admit my science is pseudo at best....until it isn't.....my timing, that's another pseudo issue....

 

the fed, that's not psuedo since benny has wrecked my modeling...so pseudo QE or pseudo QE results medium term?

sunaJ's picture

What you did is model the shit out of a shit model of another shit model based upon political and power considerations you probably are not aware of.  The rules will change to meet unrealistic expectations.  It is economic oligarchy perched on the cliff of anarchy.  You will be lucky before you are accurate, but good luck.

NotApplicable's picture

Now why did you have to go and ruin a perfectly good post by mischaracterizing anarchy?

The word you're looking for is chaos (a resultant feature of an oligarchy's inability to maintain control).

Zola's picture

The reason why Central Banks, central planning and current economics is so incompetent ? They would have to discover this : 

http://en.wikipedia.org/wiki/Psychohistory_(fictional)

 

Bernanke is 1000 years too early...

Dr. Acula's picture

>The reason why Central Banks, central planning ... is so incompetent

Because they don't have to be competent.

If they incur financial losses, they don't face liquidation. They just counterfeit and steal more.

 

CrashisOptimistic's picture

"Follow the data, consider the history (similarities and differences between the past and the present) and explain your conclusions simply, as you would to a child."

 

Okay.  I'll do that.

None of this matters.  There is no history of a civilization running out of air. 

Only oil matters.  Only oil matters.  7 billion can't live without oil.  

Oil is air.

A child could understand that.

AnAnonymous's picture

Billions live without oil but hey who cares?

AlaricBalth's picture

The arrogance of those who believe they can model risk is astounding. David Li's huge miscalculation with his Gaussian Copula Function, which was supposed to measure and mitigate risk in the CDO markets, proved that risk modelling is an inexact science because you cannot consistently measure the behavior of people during extreme circumstances. Li's formula caused trillions of dollars in losses, reported and unreported and brought the world to the brink of the abyss.

insanelysane's picture

The problem is that the people that say, "well the mathematical models show X", are the same people that are saying, "this time is different."  That is insanity.

Dane Bramage's picture

Algorithms for predicting popular delusions - get 'em while they're hot!    Also available: fashion functions & madness modeling.

Downtoolong's picture

Look, if  you’re goal is to rob hundreds of millions of people of  trillions of dollars, don’t you have to come up with some elaborate diversion to distract them and draw their attention away from what you’re doing? How else  are you going to get away with it?

Econophile's picture

This is an old discussion, mainly between empiricists and the Austrians going back a couple hundred years. Why the author failed to discuss this is surprising. It is what Hayek called "scientism", the attempt to make economics like the physical sciences. Human behavior just ain't that easy. Menger, Mises, and Hayek wrote many books on this topic. Further, I didn't see any reference to Taleb, the latest along this line,  who ridiculed the failed Gaussian models of Modern Portfolio theory, efficient market theory, CAPM, etc. It's a fair topic to discuss, but it's nothing new.

Dr. Acula's picture

>Menger, Mises, and Hayek wrote many books on this topic. Further, I didn't see any reference to Taleb, the latest along this line

FYI, Taleb is not an economist like the others. According to http://en.wikipedia.org/wiki/Nassim_Nicholas_Taleb, he is an "essayist... a practitioner of mathematical finance,[10]a hedge fund manager,[11][12][13] a Wall Street trader,["

Also, as an economist, Hayek is clearly not in the same class as Mises.

I would add Hans-Hermann Hoppe to your list of anti-empiricists.

 

trembo slice's picture

+ Rothbard... but meantioning the Austrians is sufficient.

Cassandra Syndrome's picture

Imo, Rothbard is the greatest. Even better than Mises. The Austrian perspective is about the only means of interpreting the economy in the dynamic form as the interactions of the multitudes of people. 

Mathematics is only useful Post Factum, it cannot be used to forecast. Cause and effect logic and A Priori reasoning is what works best with economic forecasts. 

trembo slice's picture

Rothbard is my favorite intellectual as well.

jpmrwb's picture

I agree but I would also add Rothbard. Why didn't the author just say there are "no constants" in economics. That's why the models don't work.

mikesswimn's picture

"The trouble is that at some stage in the last century the multi-faceted multi-dimensional economics (like that Xenophon) was hijacked by mathematicians who tried to turn this huge and delicate subject into an equation."

Don't confuse a mathematician with a foolish economist mathematically competent enough to construct a lagrangian.

barliman's picture

 

Brinng!, Brinng!

"Hello. Yes. Yes. I see your point. Don't worry, I'll tell them."

The Amalgamated Secret Societies of Wiccans, Intelligentsia, Pundits, Evangelists & Shibboleths  (ASSWIPES) called and wanted their objection to the use of the term pseudoscience made public.  They say they have spent an enormous amount of time and effort getting their various undertakings recognized as pseudosciences and feel ZeroHedge's careless use of the term with regard to Economics undercuts the value they have gradually been able to associate with the word.

barliman

Ignatius's picture

Maybe Steve Keen just got lucky.

Downtoolong's picture

I suspect economist’s frustration may be a leading cause of their penchant for centralization. They’re all desperate to make a correct prediction, just once. But the only way that can happen is if they can force the outcome to happen no matter what.

Problem Is's picture

"They’re all desperate to make a correct prediction..."

Being wrong 100% of the time never bothered Alan "Crazy Chester" Greenspan...

ebworthen's picture

Excellent.

Economics is like weather prediction or climate modeling; walls of super computers churning data and models 24/7 and they still can't give you a good forecast.

Add to the rivers of varying data, collection techniques, and validity measures - the unknowable dynamic of individual human choices - and modern economics approaches alchemy requiring faith.

Stuck on Zero's picture

There is excellent science behind weather forecasting and economics.  There is poor predictability because the science is stochastic.  Don't confuse the real masters of the science with the paid shills who will say anything for a buck.

 

mickeyman's picture

The purpose of economic theory is to cover political objectives with impenetrable bafflegab.

The decisions are made, and pointy-heads in ivory towers concur. Who are you to say they are wrong.

The same is true for geopolitics.

http://worldcomplex.blogspot.ca/2011/05/geopolitics-and-economics-cloaking-evil.html

sunaJ's picture

It is not just people with Asperger's Syndrome that find such a mathmatically-modeled world appealing.  The desire to fortell risk runs deep within the human conscience.  It is part of what drives religion, economics and politics.  With fear-driven parts of life, we seem to choose willful deafness than face the music.  It is part of the human condition.  When the contorl over the recognition of our own ignorance is wrested from the psychopaths, perhaps then we can pursue a paradigm based on robustness and healthy self-governance.

Dragline's picture

It's worse than a pseudo-science.  Economics is a pseudo-religion that is used to support political theories like the divine right of kings in another age.  All political thought based on economics is doo-doo and should be rejected out of hand.

And since most politicians never read Debunking Economics or another history of the subject, they don't even know what they believe in and why its essentially counter-factual.  For example, historically the deregulation of markets and innovation in technologies has led to the concentration of wealth in the hands of a few.  No economist has ever explained why this is so.

A real attempt at a "science" of economics would throw out the equlibrium based models and start with the mathematics of Benoit Mandelbrot (like Taleb does) and the research of human behavior by  Kahneman & Tversky.  The whole thing needs to be thrown out and reinvented like the "earth-centered universe" once was.

Thunderlips's picture

Damn Straight.  Econ textbooks still assert that barter predated currency economies as the main method of transaction, and there's absolutely no evidence barter was the primary method of transactions in a society. 

 

Pre currency economies were either command, reciprocity, or credit.  Credit actually predates currency in some early civilizations.  Barter onlyhappens in societies that are used to coinage, but for reason it's unavailable (shortage of coin and paper, inside prisons, etc.)

Mycenae doled out goods centrally, as did early Egypt.  Iroquis women divided the harvest according to need.  NW'ern Indians wined and dined each other as a form of competition.

This was a guess made by economists in the 18th century, and it still is handed down to successive generations of economists without ever being checked against Archeology or Anthropology.

Macrocompassion's picture

Pseduo-science is what Nobel Laurate and physicist Richard Friedman called economics and he was right! This is because so many of that "arts" kind  of academics somehow do not have sufficient imagination nor breadth of vision to appreciate that like gas molecules, the average properties of parts of our society can be modelled and to obey very exact laws.

Ths is the basis behind the model that I presented in Google Images DiagFuncMacroSyst.pdf  which is a complete representation of a country's social system of macroeconomic functioning. 6 entities support 19 different kinds of mutual flows of money versus goods, services and valuable documents. That is all that is needed but it is a more comprehensive model that the kinds that followed from the 2-sector one by F.Knight in 1933. yet the Keynesians still use slight variations on this antiquated model to show how our social system can be "cured". Shame on them and on all psedu-scientists! Today we have far better ways.

 

QuietCorday's picture

I have always found this aspect of economics to be really odd. It takes no notice of other confounding cultural and personal quirks that play into people's economic behaviour.

As a tiny example, the number of people I have come across that never sell shares because they were inherited from parents or grandparents is quite astonishing. The number of people who retain economic understandings that derive from the mid 80s or mid 50s, understandings still influence their behaviour today, is remarkable.

All this creates "irrational" behaviour that economists simply cannot model. I remember being flummoxed at how unrealistic so much of the content on my partner's economics MA actually was -- it really was "how many angels can dance on the head of a pin" kinda stuff, when  ... errr... "angels" would have far better things to do than dance on pins.

The best economic forecasts and commentary, in my experience, have always come from people with some sort of social science or humanities background: politics-bods, anthropologists, historians ... people who have studied "people" and how they behave.  

i_call_you_my_base's picture

In my time spent modeling and being around others who model, two things became apparent: 1) a greater understanding of a system often gives an individual a false sense of control, and 2) people believe that greater complexity in the model results in a more "correct" prediction ("if I could just account for this one thing..."). Obviously, both of these are fatal errors. I often found myself saying things like, "it's better to acknowledge an unknown than to convince yourself you have accounted for it." People didn't listen because they didn't want to acknowledge the unknown. In their mind it opened the model to criticism. To them, having the unknown meant the entire thing was an unsolved problem and reflected badly on them.

SoNH80's picture

Agree 100%.  Their unwillingness to acknowledge unknowns-- integrate a range of outcomes-- actually undercuts their credibility.

LoneCapitalist's picture

Are you talking about KNOWN unknowns or UNKNOWN unknowns. sarc.

SoNH80's picture

MICROeconomics is pretty damn near a science.  Marginal cost, how to minimize waste in producing X widgets for Y inputs, price elasticity, etc.  Command economies can have macro success at first, but their lack of microeconomic discipline and principles kill them over time.  My basic micro course in college was a hell of a lot of fun, and has remained a reference point for me since.

Mainstream MACROeconomics?  They're very good at predicting last quarter.

Diet Coke and Floozies's picture

Fully agree. See my comment below....

BobPaulson's picture

Thank you. The complete lack of empiricism in Economics is very very troubling. The fact that they had to buy a Nobel Prize to get some credibility speaks volumes.

For those not in the know, the so called Nobel Prize in Economics is a sham. Take a look at its origin.

CommonSense89's picture

There is NO lack of empiricism in mainstream economics. That is precisely the problem. neoclassical and neo-keynsian economists rely completely on empiricism. It doesnt work (when both schools rely completely on incorrect assumptions, theories, etc. Shit, they actually teach kids the IS LM model in level 2 macro courses. They of course fail to mention that the inventor, Hicks, denounced such models as being mere teaching gadgets). Other heterodox schools either use less empiricism or outright reject it, like Austrians

Bunga Bunga's picture

Where is Dr. Paul Krugman?

ebworthen's picture

Modeling his next book deal and emailing Obama about being his economic advisor for second term.

TheFourthStooge-ing's picture

...and breaking a few windows.

 

Problem Is's picture

"Where is Dr. Paul Krugman?"

Trying to pull his head out of his own ass hole using his feet for leverage...