Friday, June 14, 2013

Flexibility and Neoclassical Economics

A common complaint from some of those learning economics, and from some economists themselves, is that the formal study of economics is straitjacket that limits analysis and constrains policy conclusions--in particular that it leads to an overappreciation of market forces and an underappreciation of the usefulness of government interventions. This belief seems misguided to me. John Maynard Keynes, who said so many things so well, once wrote (in his introduction to Cambridge Economic Handbooks: "[Economics] is a method rather than a doctrine, an apparatus of the mind, a technique of thinking which helps its possessor to draw correct conclusions."

Dani Rodrik spells out very nicely how neoclassical economics has proved no hindrance to his work that has often questioning what was at the time mainstream economic wisdom in an interview published in the April 2013 issue of the World Economics Association Newsletter. Here are a few of Rodrik's comments. 

On the usefulness of the economics toolkit

"I have never thought of neoclassical economics as a hindrance to an understanding of social and economic problems. To the contrary, I think there are certain habits of mind that come with thinking about the world in mainstream economic terms that are quite useful: you need to state your ideas clearly, you need to ensure they are internally consistent, with clear assumptions and causal links, and you need to be rigorous in your use of empirical evidence. Now, this does not mean that neoclassical economics has all the answers or that it is all we need. Too often, people who work with mainstream economic tools lack the ambition to ask broad questions and the imagination to go outside the box they are used to working in. But that is true of all “normal science.” Truly great economists use neoclassical methods for leverage, to reach new heights of understanding, not to dumb down our understanding. Economists such as George Akerlof, Paul Krugman, and Joe Stiglitz are some of the names that come to mind who exemplify this tradition. Each of them has questioned conventional wisdom, but from within rather than from outside. ...

"The criticism of methodological uniformity in Economics can also be taken too far. Surely, the use of mathematical and statistical techniques is not a problem per se. Such techniques simply ensure our arguments are conceptually and empirically coherent. Yes, excessive focus on these techniques, or the use of math just for its own sake, are a problem–but a problem against which there is already a counter-movement from within. In the top journals of the profession, I would say most math-heavy papers are driven by substantive questions rather than methods-driven concerns. "

On the level of policy disagreement that exists among those using similar mainstream methods

"Pluralism on policy is already a reality, even within the boundaries of the existing methods, as I indicated. There are healthy debates in the profession today on the minimum wage, fiscal policy, financial regulation, and many other areas too. I think many critics of the economics profession overlook these differences, or view them as the exception rather than the rule. And there are certainly some areas, for example international trade,where economists’ views are much less diverse than public opinion in general. But economics today is not a discipline that is characterized by a whole lot of unanimity."

 On the critique that many economists are narrow in their outlook.
"There are powerful forces having to do with the sociology of the profession and the socialization process that tend to push economists to think alike. Most economists start graduate school not having spent much time thinking about social problems or having studied much else besides math and economics. The incentive and hierarchy systems tend to reward those with the technical skills rather than interesting questions or research agendas. An in-group versus out-group mentality develops rather early on that pits economists against other social scientists. All economists tend to imbue a set of values that tends to glorify the market and demonize public action. What probably stands out with mainstream economists is their awe of the power of markets and their belief that the market logic will eventually vanquish whatever obstacle is placed on its path."
 Here's one example of Rodrik using standard economic analysis as a tool for challenging conventional wisdom--in this case, the conventional wisdom that the benefits of globalization clearly outweigh the redistributive effects.
"Take for example the relationship between the gains from trade and the distributive implications of trade. To this day, there is a tendency in the profession to overstate the first while minimizing the second. This makes globalization look a lot better: it’s all net gains and very little distributional costs. Yet look at the basic models of trade theory and comparative advantage we teach in the classroom and you can see that the net gains and themagnitudes of redistribution are directly linked in most of these models. The larger the net gains, the larger the redistribution. After all, the gains in productive efficiency derive from structural change, which is a process that inherently creates gainers (expanding sectors and the factors employed therein) and losers (contracting sectors and the factors employed therein). It is nonsensical to argue that the gains are large while the amount of redistribution is small--at least in the context of the standard models. Moreover, as trade becomes freer, the ratio of redistribution to net gains rises. Ultimately, trying to reap the last few dollars of efficiency gain comes at the “cost” of significant redistribution of income. Again, standard economics. Saying all this doesn’t necessarily make you very popular right away."
On the flexibility of economic modeling in reaching pre-desired conclusions

"I love an old quote from Carlos Diaz-Alejandro who once said something along the lines of “by now any graduate student can come up with any policy conclusion he desires by building appropriate assumptions into his model.” And that was some thirty years ago! We have plenty more models that generate unorthodox conclusions now."

For noneconomists, I guess the obvious question is: "If economics doesn't give a correct and clear answer most of of the time, what good is it?" I sometimes argue that the main version of economics,  at its best, is that  it is a disciplined way of thinking and arguing that makes clear where people disagree. If two economists disagree, they can unpack each other's arguments. Do they disagree in their underlying assumptions? In their model of how those assumptions fit together? In their arguments over cause and effect? In their beliefs about what data to use? In the statistical methods they use? Even when economist end up disagreeing, they should be able to pinpoint the sources of their disagreement--and thus to agree on what issues need to be further researched and resolved. From this process, provisional truths (and is there really any other kind?) do emerge.