Tuesday, October 29, 2013

Immanuel Kant, Crank

One intellectually bankrupt technique to rationalize non-engagement with an argument is to complain that the ones putting forth the argument compare themselves to Nicolaus Copernicus or Galileo:

"So the central laws of the movements of the heavenly bodies established the truth of that which Copernicus, first, assumed only as a hypothesis, and, at the same time, brought to light that invisible force (Newtonian attraction) which holds the universe together. The latter would have remained forever undiscovered, if Copernicus had not ventured on the experiment-contrary to the senses but still just-of looking for the observed movements not in the heavenly bodies, but in the spectator. In this Preface I treat the new metaphysical method as a hypothesis with the view of rendering apparent the first attempts at such a change of method, which are always hypothetical...

This attempt to introduce a complete revolution in the procedure of metaphysics, after the example of the geometricians and natural philosophers, constitutes the aim of the Critique of Pure Speculative Reason." -- Immanuel Kant, Critique of Pure Reason, Preface to Second Edition.

As I understand it, Kant's revolution was not to look for what must humans be to understand an external, given, phenomenal reality. Rather, he asked, what must the phenomena be such that we could observe it, given the properties of our understanding. But I have never read far in this particular book. Nor, given non-Euclidean geometry and other readings in philosophy, do I expect to agree with it.

Saturday, October 26, 2013

An Alternative Economics

Who are the greatest economists of, say, the last fifty years? I suggest the shortlist for many academic economists would include Kenneth Arrow, Milton Friedman, and Paul A. Samuelson. Imagine1 a world in which the typical academic economist would be inclined to name the following as exemplars:

  • Fernand Braudel
  • John Kenneth Galbraith
  • Albert Hirschman
  • Gunnar Myrdal
  • Karl Polanyi.

These economists did not insist on using closed, formal, mathematical models2 everywhere3. They tended to present their findings in detailed historical and qualitative accounts4.

  1. Maybe the history of political economy is overdetermined, in some sense. So I am not sure what this counterfactual would entail.
  2. They did use or, at least, comment on small mathematical models, where appropriate. For example, both Hirshman and Myrdal had cautions about the Harrod-Domar model.
  3. I have been reading a little of Tony Lawson.
  4. As far as I am concerned, these are accounts of empirical research.

Friday, October 25, 2013

Raj Chetty Needs Your Help

I have argued before that whether or not economics is a science is an uninteresting question. Rather, one should be concerned with the quality of arguments economists put forth, how they engage one another, and how they respond to empirical evidence. As regard to the quality of arguments, Raj Chetty's performance contradicts his thesis. (I realize I am talking about an article meant for the general public, not a journal article meant for other members of his profession). Chetty writes:

"...At first blush, Mr. Shiller's thinking about the role of 'irrational exuberance' in stock markets and housing markets appears to contradict Mr. Fama's work showing that such markets efficiently incorporate news into prices.

What kind of science, people wondered, bestows its most distinguished honor on scholars with opposing ideas? 'They should make these politically balanced awards in physics, chemistry and medicine, too,' the Duke sociologist Kieran Healy wrote sardonically on Twitter.

But the headline-grabbing differences between the findings of these Nobel laureates are less significant than the profound agreement in their scientific approach to economic questions, which is characterized by formulating and testing precise hypotheses. I'm troubled by the sense among skeptics that disagreements about the answers to certain questions suggest that economics is a confused discipline, a fake science whose findings cannot be a useful basis for making policy decisions.

That view is unfair and uninformed. It makes demands on economics that are not made of other empirical disciplines, like medicine, and it ignores an emerging body of work, building on the scientific approach of last week's winners, that is transforming economics into a field firmly grounded in fact.

It is true that the answers to many 'big picture' macroeconomic questions — like the causes of recessions or the determinants of growth — remain elusive. But in this respect, the challenges faced by economists are no different from those encountered in medicine and public health. Health researchers have worked for more than a century to understand the 'big picture' questions of how diet and lifestyle affect health and aging, yet they still do not have a full scientific understanding of these connections. Some studies tell us to consume more coffee, wine and chocolate; others recommend the opposite. But few people would argue that medicine should not be approached as a science or that doctors should not make decisions based on the best available evidence..." -- Raj Chetty, Yes, Economics Is a Science, New York Times, 21 October 2013: p. A21.

Chetty's argument is chalk and cheese, apples and oranges. Chetty brings up the existence of open questions in medicine. (I find it easy to decide which studies about health to believe; I pick the ones that tell me to do what I want to do anyways.) But the complaint about this year's Nobel is not about the existence of open questions in economics. It is rather wonder at the simultaneous award of the top prize to two, namely Eugene Fama and Robert Shiller, for apparently making opposite statements about how markets work. (I am ignoring Lars Peter Hansen in this post.) As I understand it, you do not usually get a Nobel in Physics, Chemistry, or Medicine without empirical evidence for your claims. Later empirical findings might overturn Nobel work, but, if so, the prize would not be shared in the same year for both establishing and overturning a theory. So Chetty's argument is a blatant non-sequitur.

What is needed is an argument why the specific work of the researchers sharing the award is complementary, not contradictory. You can find some such arguments on the Internet, but Chetty skates right by this need at too high a level of abstraction to be useful. (Readers should feel free to offer other links in the comments for such arguments.) I do not think this analogy works in the details, but imagine a prize at the relevant time simultaneously honoring Tycho Brahe and Johannes Kepler. Tycho had a mistaken halfway, sort of heliocentric model of solar system, and Kepler had a correct, geocentric model with the planets having elliptic orbits. But Tycho would not be being honored for his mistaken model. Rather, as I understand it, he collected more useful and precise observations of the planets than had been done by anybody before him. And Kepler used these observations to develop and verify his theory. If Tycho's work was not available, Kepler would not have succeeded.

(Note that work by economists with Randomized Control Trials (RCTs), natural experiments, and Instrumental Variables (IVs) is irrelevant to any points I have made above.)

Off topic aside: I want to note this post from Unlearning Economics, the Post-Crash Economics Society at the University of Manchester, an article about this society in The Guardian, and an organization called Rethinking Economics.

Saturday, October 19, 2013

Some Aspects Of A Theory Of Finance

I consider this post to be a complement to some recent comments by Lars Syll on this year's Nobel prize. I here outline an (unoriginal) theory to contrast with the Efficient Market Hypothesis.

Keynes described the prices of bonds, shares, and other financial instruments as, at any time, reflecting a balance of Bulls and Bears. As G. L. S. Shackle points out, if this is an equilibrium, it is an "inherently restless" equilibrium. If a price continues unchanged, Bulls, who expect the price to rise, will eventually be disappointed. Likewise, a symmetrical condition is true for Bears. Furthermore, news from outside the stock market will be changing market expectations, causing some Bulls to become Bears and vice versa.

For this account to make sense, it seems to me, the market must be populated with decision makers who have vastly different ontological and epistemological beliefs. It is not a case of all agents having one model, with different parameter estimates being updated in light of experience. Shackle, in modeling such decision makers, introduces the concept of focal points. If profits exceed the upper focus point at some time, the decision maker will realize that more profit can be gained than is accounted for in his theory. And so he will adopt some other theory, in some sense. Likewise, losses or too little profit will, outside of some range, lead to another change of mind, with consequent changes in plans and actions.

Stock prices are numbers. One might initially think they could be described by probability distributions. One could think of the price of a stock at a given time as a random variable. And, in this special case, perhaps Shackle's model of decision-making reduces to the theory of sequential statistical hypothesis testing.

A random variable is a function from a sample space to the real numbers, where a sample space is a set of all possible outcomes of a random experiment. An event is a (measurable) subset of the sample space. So a stock price is not an event in the sample space. For example, the recent brouhaha in the United States over the debt limit is presumably an aspect of an event that has had some impact on stock prices. Can one assume that all possible events are known beforehand? That all agents who might bet on stock prices know all events? If not, how does it make sense to model stock prices as coming from a probability distribution? Paul Davidson suggests extending the concept of non-ergodicity to cover these cases where the complete sample space is not known, and the mere possibility of some future events are capable of surprising someone:

"In expected utility theory, according to Sugden..., 'A prospect is defined as a list of consequences with an associated list of probabilities, one for each consequence, such that these probabilities sum to unity. Consequences are to be understood to be mutually exclusive possibilities: thus a prospect comprises an exhaustive list of the possible consequences of a particular course of action... An individual's preferences are defined over the set of all conceivable prospects.' Using these definitions, an environment of true uncertainty (that is, one which is nonergodic) occurs whenever an individual cannot specify and/or order a complete set of prospects regarding the future, because the decision maker either cannot conceive of a complete list of consequences that will occur in the future; or cannot assign probabilities to all consequences because 'the evidence is insufficient to establish a probability' so that possible consequences 'are not even orderable' (Hicks)... Hicks associates a violation of the ordering axiom of expected utility theory with 'Keynesian liquidity' ..., since, for Hicks..., 'liquidity is freedom' to delay action that commits claims on real resources whenever the decision maker is ignorant regarding future consequences." -- Paul Davidson (1991, p. 134)

In the above quote, Davidson is contrasting what he calls the True Uncertainty Environment with the Subjective Probability Environment. Davidson argues that my favorite definition of ergodicity, as applying to stochastic processes in which time averages converges to ensemble averages, characterizes the Objective Probability Environment.

One might argue that a more mainstream approach to finance is more empirically applicable than the Post Keynesian approach outlined above. It seems to me that if one wants to argue this, one needs to establish some reason why a diversity of agent views could not persist. I am unaware of any such argument, and I think the literature on noise trading should lean economists to think otherwise.

Traders in stock and bonds constitute one audience for theories of finance. I suppose they prefer mathematical theories that they can use to price financial instruments. I am not sure that the above theory can be cast into mathematics further than Davidson and Shackle have already accomplished. I will note that when Dutch Shell found themselves wrong-footed in the 1970s by the formation of OPEC and the oil crisis, they set up a group to do scenario planning. These are the sort of events whose existence in the sample space might not have been long foreseen. As I understand it - I forget why, some members of that group explicitly took inspiration from Shackle's work.

  • Davidson, Paul (1991). Is Probability Theory Relevant for Uncertainty? A Post Keynesian Perspective, Journal of Economic Perspectives, V. 5, No. 1: pp. 129-143.
  • DeLong, J. Bradford, Andrei Shleifer, Lawrence H. Summers, and Robert Waldmann (1990). Noise Trader Risk in Financial Markets, Journal of Political Economy, V. 98, Iss. 4: pp. 703-738.
  • Hogg, Robert V. and Allen T. Craig (1978). Introduction to Mathematical Statistics, Fourth edition, Macmillan.
  • Shackle, G. L. S. (1940). The Nature of the Inducement to Invest, Review of Economic Studies, V. 8, N. 1: pp. 44-48.
  • Shackle, G. L. S. (1988). Treatise, Theory, and Time, in Business, Time and Thought: Selected Papers of G. L. S. Shackle, New York University Press.
  • Shackle, G. L. S. (1988). On the Nature of Profit, in Business, Time and Thought: Selected Papers of G. L. S. Shackle, New York University Press.

Friday, October 04, 2013

Thou Shall Listen To Economists: The Number One Principle Advocated By Economists

Alex Tabarrok, as I understand it, is an economist in the economics department at George Mason University. Brad DeLong has been famously feuding with David Graeber, an anthropologist and anarchist (also known as - to those who speak english - a libertarian), but not an economist. Would it be more or less to DeLong's credit for that background to explain this agreement with Tabarrok's incompetent stupidity? I am not going to link to any of my multiple demonstrations that there is no such thing as a marginal productivity theory of distribution. Not only do I have mathematical proofs, I am in agreement with what good neoclassical economists, from Leon Walras to Christopher Bliss, have explicitly stated.

I am not sure what I think of this article, by Peter Frase, in Jacobin. I am in agreement with the conclusion. I am also in agreement that, in practice, actually existing capitalism contains lots of markets that are not competitive1, in some sense. But I wish more would note that even if markets were competitive, the conclusions of the market fundamentalists would not follow2. It is a major error of contemporary mainstream economics to think that everything would be great if only markets were competitive3.

  1. At least two theories of competitive markets exist: (1) The classical theory, in which competitive markets exhibit no barriers to entry, and a tendency exists, across and within industries, towards a uniform rate of profits. (2) The neoclassical theory, in which firms take market prices as given and, perhaps, do not suffer from any problems connected with limits to information, computation, etc.
  2. For example, Piero Sraffa can be read as putting forth a model, in his 1960 book, in which markets are competitive and in which exogenous political forces set the functional distribution of income.
  3. Different schools argue over how important, in practice, deviations from competition are and whether governments can correct these deviations.