Wednesday, February 18, 2009

Challenge: Formulate your issue in one sentence

When I see criticism of economic theories they often seem to go on and on, use lots of “ism” words (positivism, pluralism, autism and worse), and be very vague and abstract and wordy. Which is why I have the following challenge: Take your criticism and formulate the main point in one sentence free from overly abstract and philosophical/methodological jargon.

Here’s my attempt:

  1. Against some types of welfare theory: If you have no empirical evidence concerning what people actually care about and what choice alternatives they actually face, then you do not have sufficient information to establish that they are welfare maximizing.
  2. Against some types of “explanatory theories”: If you claim to explain why something is the case, then all sorts of empirical information are relevant in assessing your driving assumptions and proposed mechanism– not just market data.

I don’t feel these two claims should be controversial. They seem rather obvious to me – yet these two “principles” (if accepted) are sufficient to kill off (I believe) much of the weirder (but accepted) theories in economics. My Ph. D. work on Rational Addiction theory was (in retrospect) basically the attempt to make these two claims and show why they were sufficient to discard many of the claims made in top 5 journals concerning the validity and implications of rational addiction theories:

  • Welfare: As long as you merely observe market choices and develop a “choice model” to accurately reproduce/fit patterns in the market data (whether “stylized facts” or econometrically through structural models) – this does not prove/establish/support the claim that the consumers in question are maximizing their long term welfare. All you’ve proved is that they are acting “as if” they are maximizing some utility function (which you have not shown to be related to their actual welfare) given some choice set (that you have not shown to be the one they are facing). No matter how insanely and self-destructively you act – it will be possible to develop some model that rationalizes this as optimal behavior for some set of preferences and constraints.
  • Explanation: Merely observing economic data and developing a “model” to accurately reproduce/fit patterns in this, is insufficient to establish that your proposed causal mechanism is actually at work in the real world. If your theory, e.g.,  asserts that people have information that does not exist, are solving problems that we know they are not facing, or influencing the world through relationships that we have no reason to believe in – then these are good reasons to discard your proposed mechanism as an explanation.

Is there some non-obvious flaw in my claims that rescues the weirder economic theories? I’m open to that possibility - please let me know.

Also interested in other attempts to formulate one-sentence summaries of

Monday, February 16, 2009

Have you taken into consideration how your opponent has taken into consideration that you have taken into consideration how they… damn… where was I?

Interesting blogpost on “cognitive hierarchy theory”, which basically seems to involve the empirical examination of how many such steps people use in their actual reasoning when making decisions.

Big surprise: They don’t take it to infinity.

"The cognitive hierarchy theory finds that people only do a few steps of this kind of iterated thinking," [Caltech’s Colin Camerer, Professor of Behavioral Economics] explains. "Usually, it's just one step: I act as if others are unpredictable. But sometimes it's two steps: I act as if others think *I* am unpredictable. You can think of the number of steps a person takes as their strategic IQ. A higher strategic IQ means you are outthinking a lot of other people."

Most of us have a pretty low strategic IQ, but that's to be expected, Camerer notes. To reach a truly high strategic IQ requires either special experience with a particular type of game (such as poker), training, or, in rare cases, special gifts.

Perhaps more interesting to us economists are the implications. The prof says: "We think it means you can fool some of the people some of the time"

That would seem to have “interesting implications” for welfare analysis…. ;-)

On a related note – when I encounter comedy based on this theme I always wonder whether the scriptwriter has studied economics. From the mediocre Ben Stiller comedy “mystery men”:

And the sitcom Friends had this as a central gag to the episode where the friends find out that Monica and Chandler have an affair. You can even get t-shirts with the line “They don't know that we know they know we know.”

Wednesday, February 4, 2009

Criticizing economics – uhm, how really?

Ole writes about the pitfalls when criticizing economics. Take it one step back – how to do it? Soap is sticky compared to any economic model.

Take simplification: In first place, you cannot attack a model for being unrealistic in any particular aspect because of its need to be simple. I buy that.

But what does one mean by keeping it simple? “Stripping it from everything that is irrelevant for the question at hand” one might answer. Aha. But when undressing reality, how do I know when to stop? And how do I make sure that I can leave out something; that it doesn’t interact in any important way with what I mean to describe (To stay in the dressing room: taking off the belt might mean the trousers are on the floor)?

But it is not only that. If you point out that it is not only a simplification but also rests on wrong assumptions you are told that they are not wrong but heroic: needed to get at the very essence of what you are interested in. But, hello, are there any rules for those Hercules assumptions? I haven't seen them. Nobody seems to care about justifying assumptions. Rather, anything goes it seems as long as rationality is in place, assuring mathematics are on board. I see the point of using maths but I want to make sure that what I end up with is not to economic reality what the board game “Monopoly” is to real estate agents.

Take the pet I am supposed to keep watch over these days, the Cournot model; describing imperfect competition by few sellers that have some given capacity and decide on quantities to be put on the market. There is an itch, telling me that reality and Cournot do not always get along well. But how do I scratch it?

Do all other firm decisions not interact or interfere with the choice of quantity? Who am I to judge? Does it matter? And is it a mere simplification? Nope. One example: The model is requiring all the sellers to be perfectly informed and I don't think I need to make a case here arguing that production costs are business secrets. So it's not only simplifying, it is making assumptions that one knows are wrong. How to argue then that it still captures the essence of imperfect competition?

I don’t know, but it is argued. But if it is okay and necessary to have wrong/heroic assumptions, where does that leave the one wanting to criticize the model?

Imperfect competition means higher prices and less supply compared to the perfect competition case. The Cournot model says it is by restricting quantity taking the other suppliers' quantities into account that that happens, giving, at least theoretically (there are tons of info requirements on the researcher too) an idea of by how much the magnitudes change. Is the Cournot model just a straw man for "higher prices"? Does it not make any claim to be a description of how those prices are achieved?

My point is that 1) even with an MPhil in Economics (got that on paper) models are still mysterious monsters to me and 2) they don't tell me what type of monster they are, making it hard for me to decide whether to take the sword or the garlic to attack them.

Tuesday, February 3, 2009

Non-economist comes across rational addiction theory

Andrew Gelman is a professor of statistics and political science at the Columbia University. In a recent blogpost in the blog “statistical modeling, causal inference, and social science” he comments in passing on rational addiction theory – one of the examples used in a discussion on econometrics that he gives his perspetive on:

the study of smoking seems pretty wacky to me. First there is a discussion of "rational addiction." Huh?? Then Ziliak and McCloskey say "cigarette smoking may be addictive." Umm, maybe. I guess the jury is still out on that one . . . .

OK, regarding "rational addiction," I'm sure some economists will bite my head off for mocking the concept, so let me just say that presumably different people are addicted in different ways. Some people are definitely addicted in the real sense that they want to quit but they can't, perhaps others are addicted rationally (whatever that means). I could imagine fitting some sort of mixture model or varying-parameter model. I could imagine some sort of rational addiction model as a null hypothesis or straw man. I can't imagine it as a serious model of smoking behavior.

In response to a comment from an economist who explains briefly that Rational Addiction comes from a seminal paper and has proved influential in health economics, he responds:

My reply to this: Yeah, I figured as much. It's probably a great theory. But, ya know what? If Becker and Murphy want to get credit for being bold, transgressive, counterintuitive, etc etc., the flip side is that they have to expect outsiders like me to think their theory is pretty silly. As I noted in my previous entry, there's certainly rationality within the context of addiction (e.g., wanting to get a good price on cigarettes), but "rational addiction" seems to miss the point. Hey, I'm sure I'm missing the key issue here, but, again, it's my privilege as a "civilian" to take what seems a more commonsensical position here and leave the counterintuitive pyrotechnics to the professional economists.