388. A methodological sleight of hand

Mainstream economics is based on the following three basic assumptions: economic agents are autonomous, have given preferences, and make rational, optimal choices between alternative ways of spending scarce resources.

This is not an ontological claim: good economists readily admit that these agents do not exist. In fact agents are limitedly rational, and routinely do not make optimal choices. The assumption is fictional, according to a methodology of instrumentalism: they serve as instruments for parsimonious, rigorous deduction of explanations of phenomena. It saves the enormous, complicated effort of explaining processes of decision making of individuals, which is the field of psychology, between individuals, which is the field of sociology.

Instrumentalism is not nonsense. In seeing the world one cannot see everything at the same time. Every view is conditioned, enabled and at the same time constrained by a perspective, a way of looking. The justification of counter-factual assumptions ‘as if’ is that they should lead to predictions that can be tested empirically.

The scientific scandal of economics is that this can hardly be done. The reason is twofold. First, predictions affect the choices that produce outcomes, and this can be self-fulfilling or self-defeating.

Second, in an economy there is little opportunity for controlled experiments, where one controls the factors that affect outcomes, next to the factors adduced from the theory. Society cannot be handled as a laboratory. As a result, predictions turn into retrodictions, tested after the fact, in retrospect, on the basis of statistics, in econometrics, where control of other factors, not part of the theory, is exercised with data on them. Great ingenuity has been exercised to develop ever more sophisticated tools for this. However, there still is the problem concerning the ceteris paribus assumption that factors other than those included in the process ‘remain the same’, as well as the causal structure, the logic of explanation. One cannot be sure of that, and when predictions fail one can claim that it is because conditions were not the same.

Also, many relevant variables have not been and sometimes cannot be measured. Measurement being methodologically sacrosanct, research proceeds with what can be measured. This yields the cliché of the joke of the drunk man leaning against the lamppost at night: ‘Why are you standing there, at the lamppost?’ ‘I am looking for my car keys’. ‘Did you lose them here?’ ‘No, but this is where the light is’.

A deeper problem, discussed in the philosophy of science, is that facts are ‘theory laden’: the terms and conditions of observation and measurement are formed according to the forms of understanding: the basic, often tacit, taken for granted, assumptions and meanings, of the theory. That, however, is a problem for all sciences.

Next, and here lies the scandal, economists conduct a methodological sleight of hand. They begin with the admission that their assumptions are not realistic, they cannot perform strong empirical testing, and then, as if the assumptions have nevertheless been proven justified, they deduce recommendations of policies from them as if they are scientific and can be taken for granted.

For that they employ the following, logic, as the core of economics. Going back to Adam Smith, the idea is that of the invisible hand of the market. Each consumer seeks to satisfy its own preferences, this creates demand for products, and when supply cannot cover it, prices rise, which draws producers to that product, until supply and demand are in equilibrium, and thereby scarce resources are directed automatically to where they have the most utility, in satisfying demand.

This is so appealing that, regardless of any lack of empirical tests, policy is invariably slanted in favour of the market. And so the market expands in all directions.          

Another rationale that has been used for the instrumental assumption of rational agents making optimal choices is illustrated by the following metaphor. From Chicago (the crucible of market economics), cars randomly move out in all directions. There are gasoline stations only along a few of the roads. After a large number of kilometres there are cars moving only along the roads with gas stations. It is as if those drivers rationally chose the roads with gas stations. 

The idea is that since markets select out inefficient firms, we observe only efficient outcomes, as if the agents made the optimal choices, so that is how we can proceed, explain phenomena as if choices were optimal.

The response to this has been[i] that if the argument is in fact one of selection, as in evolution, one should conduct the study in that way: model markets as eco-systems. This gave rise to the birth of evolutionary economics. One should see, and model, how efficient markets are in fact, in selecting out suboptimal choices.

However, that becomes complicated, since it requires the modelling of a process, which depends on many subsidiary assumptions, and thereby economics loses its crystalline clarity and rigour that is its pride, the pride of a myth of equilibria of outcomes without an account of how they may or may not be achieved. 

i] I think the first was Sidney Winter, in his PhD study.