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Sunday, June 19, 2016

Book Review - Economics Rules

The book Economics Rules: The Rights and Wrongs of the Dismal Science by Dani Rodrik is aimed at a wide audience, and explains how economists look at the world. What works, and what does not. For non-economists, the discussion is at an understandable level, and hard to argue with. However, the book can be viewed as an apology for the state of mainstream economics, and this aspect is probably much less convincing for advanced readers.

Book Description

The book was published in 2015 by W.W. Norton & Company, and is 215 pages (excluding front and back matter). The book contains an index and references.

Dani Rodrik is the Ford Foundation Professor of International Political Economy at Harvard's John F. Kennedy School of Government. In addition to his academic work, he authored The Globalization Paradox.

Book Chapters

  • The Use and Misuse of Economic Ideas
  • What Models Do
  • The Science of Economic Modeling
  • Navigating among Models
  • Models and Theories
  • When Economists Go Wrong
  • Economics and Its Critics
  • The Twenty Commandments

Reasonable Introduction For Non-Economists

As the chapter titles listed above indicate, Rodrik argues that economics consists of choosing among different mathematical models. There is no one true model; rather each captures some aspect of reality. The key is recognising which model to choose.

The book outlines some of the broad debates within the field, and how various models were used and abused historically. He criticises how the field has developed, although he reserves his greatest criticisms for fields that he is not directly implicated with.

For someone who knows very little about economics, but would like to understand better its well-publicised problems, Economics Rules is a perfectly reasonable place to start. It is well-written, easily understood, and it is hard to argue with the basic ideas presented.

Less Satisfying From An Advanced Perspective

Although Rodrik criticises mainstream economics, he does so in a very guarded way. Fundamentally, the field is supposedly in good shape, its just that a few bad apples applied models badly. Although he recognises that economists have made strong criticisms of mainstream economics, he stops well short of the diagnosis of the heterodox community.

Correspondingly, the book is open to strong criticism on theoretical grounds. Professor Lars P. Syll reviewed the book, discussing its theoretical limitations. An extremely brief summary is that Syll notes that although Rodrik is willing to discuss some changes to mainstream macro models. he stops far short of touching the theoretical core. As a result, all that can be done is some window dressing.

I have sympathies with Professor's Syll's criticisms. However, one could argue that his criticisms could not be understood by the real target audience of the book -- people who do not know a lot about economic theory. You need to understand both mainstream economics, as well as the post-Keynesian literature, to understand the post-Keynesian critique. If Professor Rodrik had attempted to cover the theoretical objections raised by Syll, the book may have been unintelligible for most readers. 

An example of the limitations of the discussion, Rodrik has a potted history of the Keynesian-Real Business Cycle debate in the section "The Theory of Business Cycles and Unemployment" in Chapter 4. He runs through the mainstream debate, and how it tied into real-world developments. However, he ignores the criticisms of the theory used by both sides in the debate by the heterodox literature. By not acknowledging the existence of this criticism, he creates a false dichotomy between the two sides. However, I recognise that adding in such a discussion would have made that section of the book much larger, and harder to read.

Defence Of Economics Seems Fairly Lame

Even if we grant that the theoretical debates were toned down in order to simplify the text, his defence of economics seems unsatisfying.

One of the breakthroughs economists have supposedly provided us with is congestion pricing. The observation that people might drive down town less often if they are charged for it is treated as a deep insight into society. The breakthrough in congestion pricing was not the idea of charging people, it was the ability of electrical engineers to develop systems that allowed for levying tolls in an efficient manner.

Another breakthrough is in the area of auction design. Although some of the auction designs used in the sale of spectrum was clever, is cleverness alone a justification for making a topic worthy of study in a university? Video game designers routinely develop far more clever algorithms, but it is hard to justify viewing video games as being a serious social science.

He also gives examples of how development economics is now much more empirical than it was in the past (development economics is one field he has worked in). However, saying that development economics has improved in recent decades is not saying a lot. Pretty well every country that listened to development economists in the 1960s and 1970s was economically crushed; practically anything would be an improvement. Furthermore, it is unclear whether small field experiments is going to do anything other than put a band-aid on problems. The economic advances after the Great Depression were the result of macro changes to the economy, put in place by a broad political coalition. Without a similar coalition, there is no reason to expect a country to pursue fundamental reforms.

Economists And Math

One of Rodrik's arguments is that the use of mathematics makes argumentation more clear. I have to agree with that sentiment. Unfortunately, he provides an example of the danger of verbal translations of mathematical statements. He writes on pages 47-48:
There is no way to improve on this outcome, in the sense that no reshuffling of resources could possibly leave someone better off without making some others worse off. Note that this definition of efficiency --Pareto efficiency, named after the Italian polymath Vilfredo Pareto--pays no attention to equity or other possible social values; a market outcome in which one person receives 99 percent of total income would be "efficient" as long as his losses from any reshuffle exceeded the gains that would accrue to the rest of society.
Although he is correct in his first statement about reshuffling of resources, the second version is incorrect. There is no notion of "society" in Pareto optimisation, and so we do not compare the gains of the rest of society to an individual's losses. Although this is a fairly minor slip up, it is somewhat revealing. Pareto optimality is a fairly trivial condition, and tells us very little. It is so trivial that it is difficult to explain verbally. The only reason we care about it is that economists have fairly consistently oversold its importance, using misleading terminology to explain what it implies. (UPDATE: An abusive commenter with poor reading abilities objected to my statement "There is no notion of 'society' in Pareto optimisation..." This phrasing was an obscure call back to the "There is no such thing as society" phrase that still makes a lot of people angry. However, it does not completely explain the boring details of why the characterisation of Pareto Optimality in the book is wrong; I leave that as an exercise to the reader. The comments were deleted as they were highly abusive, and frankly stupid.) 

The use of mathematics for clarity is a reasonable goal. However, mainstream economics mainly appears to use fancy-looking mathematics to obscure the general weakness of the modelling techniques. One recent example I noted was the use of event studied to "prove" that Quantitative Easing lowered interest rates, when it is trivially obvious that event studies cannot be used in such a fashion. The entire Dynamic Stochastic General Equilibrium (DSGE) literature relies on random logical leaps at key points within "proofs." The fact that there is a debate (the "neo-Ricardian controversy") about how interest rates work in monetary policy models tells us that at least some of the producers of DSGE papers have no idea how the mathematical systems they are studying actually behave.

Which Models To Choose?

Rodrik is correctly ambivalent about our ability to choose a model that properly fits a given situation. However, if we cannot make such a determination, model building is a waste of time. Saying that a policy could either cause the economy to expand or contract is not a big help.

However, he also argues (page 199):
Pluralism with respect to conclusions is one thing; pluralism with respect to methods is something else. No academic discipline is permissive of approaches that diverge too much from prevailing practices. [...]
To be counted as an insider, as someone whose work should be taken seriously, you have to operate within these rules. If my work has been accepted within economics, it is because I've followed the rules. 
These two principles contradict each other. If the accepted methodologies imply the use of models sharing a common defect, we only get to choose amongst incorrect models.

If we look at mainstream macro, the methodologies are built around core assumptions that cannot even be tested against empirical data. (One of the running themes of Interest Rate Cycles was that the unmeasured variables that mainstream macro is based on are estimated in a fashion that ensures that they can "explain" any historical data set.) If we stick to existing methodologies, it will be almost impossible for any theoretical advances to be made. It is not entirely accidental that official agencies have been warning Japan about the need to switch to "sustainable" fiscal policy for decades; mainstream analysis of government debt is a hopeless muddle, and all of the models stink.

Admittedly, economics is a large field, and the rest of it may not be as dysfunctional as mainstream macro. However, it is unclear whether those areas are of as much interest to most readers. The complaints about economics as field revolved around the failures that were highlighted by the financial crisis; very few people are concerned whether the design of spectrum auctions was optimal.

Concluding Remarks

Although what Dani Rodrik writes is directionally correct, he pulls his punches when discussing the state of mainstream macro. For readers that are less familiar with the field, this may not matter. However, for people with a greater knowledge of the state of macroeconomics, the skirting around of difficult topics makes the book less satisfying.

 (c) 2016 Brian Romanchuk

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