PKT message, A Future Economics

Dear Gang:

I just posted the following on the NKS (New Kind of Science) Forum.

Gunnar

As follow-up to Fiona Maclachlan?s thoughtful contribution, I thought I should give a bird?s-eye view of the conclusions of my own work over three decades in the field of the epistemology of science in general and of economics in particular insofar as they relate to certain key issues addressed by her.

1. Computational Systems.

First, as one who has spent a long time puzzling over questions of methodology in economics, I agree that NKS does have something "essentially new" to say with its distinction between computationally reducible and irreducible systems, and I'm excited about the prospect of witnessing the debate in economics moving forward in the right direction as NKS ideas gain acceptance.

Comment:

At first glance ? for an NKS-neophyte such as myself ? the distinction between ?computationally reducible and irreducible systems? appears analogous to that between ?closed? and ?open? systems as exemplified in theoretical economics by Walrasian General Equilibrium Systems (closed) and non-Walrasian Systems (open).

In theoretical physics, the Laplacian construction of Newtonian Mechanics as applied to the Universe exemplifies a closed system ? if a single photon could be added to or subtracted from its energy-mass, the Universe would exemplify an open system.

2. Analytical Economics and Common Sense

I?d argue, however, that the relevant debate in economics is not between theory and history, or between theory and application. Rather the issue is of the type of theory that is appropriate. Von Mises, for instance, takes the side of the theoretician against the Prussian Historical School, but he was also against those who wished to import methods directly from the physical sciences.

Where I would draw the distinction in economics is between the modern view that economic theory must take the form of an axiomatic-deductive model that generates falsifiable predictions, and the older approach exemplified in the work of most leading economists from Adam Smith through J.M. Keynes.

In the brief history of models of markets in the notes to the NKS book (1015R) this older view is labeled common sense, which is probably as good a term as any.

Comment:

In my view, the seemingly intractable nature of perennial methodological issues in the field is rooted in failure to recognize that Economics comprises both Closed- and Open-System features as reflected in what Bentham termed the Science and Art of Economics, respectively ? what I call its Analytical and Common Sense aspects.

The most egregious example of such failure remains the construction of the Closed-System Say?s Law of Markets as an Open-System proposition, whereby a strictly axiomatic or Analytical conclusion is incongruously held to have been ?refuted? by Common Sense appeal to the Empirical phenomenon of non-clearing markets.

3. Models and Prediction

I recall Stephen Wolfram being quoted in the press saying that he runs his business using ?common sense.? Certainly, there?s an overlap between arriving at business decisions and traditional economic analysis-- the determination of the profit maximizing price of Mathematica 5, for example, is a case of both.

The common sense approach does entail an element of rough prediction, so it extends beyond historical description. It can also make use of formal models as a check on the logical consistency of one?s conclusions. The decision to charge existing users of Mathematica less for an upgrade than what is paid by a new user may seem intuitively obvious, but the economist?s toolkit has the formal model of price discrimination to show exactly under what circumstances it is, in fact, the profit maximizing strategy. In the traditional approach formal models are used as tools to leverage and refine one?s economic intuition and judgment.

In the modern approach, on the other hand, the formal model is all there is to theory.

A typical case for the modern view can be found in the introductory chapter of Von Neumann and Morgenstern's Theory of Games and Economic Behavior (3rd ed. 1953 7-8). They argue that economists must start with the ?very simplest facts of economic life and try to establish theories which explain them and which really conform to rigorous scientific standards.? They continue:

This preliminary stage is necessarily heuristic, i.e. the phase of transition from unmathematical plausibility considerations to the formal procedure of mathematics. The theory finally obtained must be mathematically rigorous and conceptually general. ? Beyond this lies the field of real success: genuine prediction by theory. It is well known that all mathematized sciences have gone through these successive phases.

Comment:

The von Neumann-Morgenstern thesis is predicated on a fundamental misconception of the relationship in physics between ?fact? and ?theory?, on the one hand, and ?theory? and ?prediction?, on the other hand, compounded by failure to distinguish between the Closed- and Open-System aspects of Economics addressed above.

With respect to the latter, it is self-evident that data culled from a computationally irreducible system cannot in principle be transformed into a computationally reducible system for purposes of predicting the parent system?s dynamic behavior.

As for the former, the ?facts? of solar system orbital mechanics are a function of ?theory? as fashioned by Newton and Einstein, respectively, whereby Closed-System observational data was translated into two distinct mathematical ?models?. In turn, successful use thereof for prediction attests to the Closed System?s structural stability irrespective of whatever causal interpretation may have come to be associated with either ?model?.*

[*As emphasized by Newton up front in ?Principia?, the variables of the gravitational equations presented therein for the Earth-Moon System were NOT to be construed as explanatory in any manner, shape, or form with respect to whatever physical factors might account for the observational data which served as input for his ?model?.]

4. Economics: A Branch of Logic AND Common Sense

Against this view consider Keynes? remarks on methodology contained in his correspondence with Roy Harrod regarding Harrod?s paper ?Scope and Method in Economics?:

It seems to me that economics is a branch of logic, a way of thinking; and that you do not repel sufficiently firmly attempts ? to turn it into a pseudo-natural-science. ? I also want to emphasize strongly the point about economics being a moral science. ? It is as though the fall of the apple to the ground depended on the apple?s motives, on whether it is worth while falling to the ground, and whether the ground wanted the apple to fall, and on mistaken calculations on the part of the apple as to how far it was from the centre of the earth. (Keynes, Collected Writings, 14:296-300)

Also revealing is a footnote in Keynes? biographical essay on Alfred Marshall:

Professor Planck, of Berlin, the famous originator of the Quantum Theory, once remarked to me that in early life he had thought of studying economics, but had found it too difficult! Professor Planck could easily master the whole corpus of mathematical economics in a few days. He did not mean that! But the amalgam of logic and intuition and the wide knowledge of facts, most of which are not precise, which is required for economic interpretation in its highest form is, quite truly, overwhelmingly difficult for those whose gift mainly consists in the power to imagine and pursue to their furthest points the implications and prior conditions of comparatively simple facts which are known with a high degree of precision.(Keynes, Essays in Biography 1951 158n)

Comment:

?The economist has consoled himself for his barren results with the thought that he was forging tools which would eventually yield fruit,? Paul Samuelson wrote in ?Foundations of Economic Analysis? (1942). ?The promise is always in the future; we are like highly trained athletes who never run a race, and in consequence grow stale. It is still too early to determine whether the innovations in thought of the last decade [the 1930s ? insert] will have stemmed the unmistakable signs of decadence which were clearly present in economic thought prior to 1930.?

Now, some sixty years later, the continued ?attempt [by mainstream and monetarist scholars] to turn [economics] into a pseudo-natural-science? remains the single most telling indicator of intellectual decadence within the economics profession ? an attempt which has been doomed to failure since its beginning upon the advent of neo-classical economics after mid-19th century for reasons indicated above.

On the basis of my own research during the past thirty years, I am persuaded that a veritable renaissance of Economics is within reach, provided only that young scholars (a) grasp the distinction between computationally reducible and irreducible systems, and (b) draw the appropriate conclusions therefrom insofar as the respective places of Logic and Common Sense in a Future Economics are concerned.

5. A Future Economics

I would argue that the difference between Keynes and those who espouse the modern view is that Keynes had an intuitive sense of the computational irreducibility of economic phenomena and of the problems it poses for economic analysis. His comments about the apple, especially, suggest the recognition of an inherent complexity of human decision that renders the traditional methods of the physical sciences ineffective.

Many observers of contemporary economics share Keynes? intuitive sense and have raised protests from time to time. (See www.paecon.net for an example of a well-organized protest launched by students in France in 2000.)

In the past, the response to the protests has been a plea for patience. The assumption has been that if economists soldier on along the path of mathematically rigorous theory, eventually they will reach the Promised Land imagined by Von Neumann and Morgenstern, that is, ?the field of real success: genuine prediction by theory.? The weight of authority of those issuing the pleas for patience has, in the past, successfully marginalized the critics.

The role of NKS in all this is its potential to cause a significant shift in the debate. If one accepts that the fundamental unit of analysis in economics is human decision and if one accepts that human decision is computationally irreducible, then it follows from NKS that the modern approach of formulating axiomatic-deductive models to generate falsifiable predictions is incorrect. Honest observers of contemporary economics have reason to move from a mere skepticism about its direction to a provisional conviction that it is indeed on the wrong track

Or, to switch metaphors, NKS identifies which branches of inquiry will never reach fruition. It provides the basis for a provisional conviction of something that has long been only a suspicion: that the reason for the lack of progress within in the discipline is that for the past fifty years, economists have been pruning off the wrong branches!

Comment:

What are the appropriate places of Logic and Common Sense in a Future Economics?

The brief answer, I submit, is that Monetary Economics must be reconstructed from the ground up to reflect the Logic of the monetary aspects of cooperative productive activity viewed as the pooling and conversion of the individual Factor Endowments of A, B, and C into Final Output in which A, B, and C will share as agreed up front and formalized through Credit arrangements whereby A, B, and C all acquire claims to Final Output which are commensurate with their Factor Contributions thereto.*

[* THIS IS SAY'S LAW, although Jean Baptiste Say never put it this way ? and, without going into details, the underlying concept of cooperative productive activity is readily shown to accord with the concept of ?income? set forth by Keynes in ?A Treatise on Money? (Ch. 9):

"Income. - We propose to mean identically the same thing by the three
expressions:

(1) the community's money income;

(2) the earnings of the factors of production; and

(3) the cost of production;

and we reserve the term _profits_ for the difference between the cost of production of the current output and its actual sale-proceeds, so that profits are NOT part of the community's income as thus defined."

Finally, "...now, at greater distance,? John Hicks wrote in 1973, ?we find (I believe) that the 'General Theory' loses stature, while the 'Treatise', in spite of its eccentricities, grows. The 'General Theory' is a brilliant squeezing of dynamic economics into static habits of thoughts. The 'Treatise' is more genuinely dynamic, and therefore more human."]

Everything else is Common Sense.

Gunnar