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Every Model is Wrong

July 8, 2014 52 comments

We have been discussing Austrians and their relationship to “mainstream” economics here lately and that topic raises a lot of issues.  I want to go into some of those issues in depth but I want to address them in a very broad way that isn’t really about Austrian economics.  I want to address some deep philosophical questions surrounding the nature of models and their role in economics and the mindset of many people in various “heterodox” schools including Austrians but also Marxists, post-Keynesians and so on.

Models

In general, models serve one or both of two purposes.  They can be explanatory and exploratory.  By the former I mean that a model can be used to explain some concept that the creator has in mind in a (relatively) simple way to someone who does not necessarily fully see or understand it to begin with.  By the latter I mean that it can be used to explore a question which the creator of the model does not know the answer to.  Now clearly, a model which is originally exploratory, typically becomes an explanatory tool once it has answered the questions it is designed to answer and the function of explanation works in essentially the same way in the mind of the “student,” which is to say that it walks them through a series of logical steps which take them from a set of premises that they already “knew” to a set of conclusions which they previously did not know.  So every model is in some sense explanatory and exploratory, the distinction is in the mind of the beholder.

But the important thing to consider is the mindset of the person developing/working with the model.  Are they designing the model in order to explore some questions that they don’t know or to explain some concept that (they at least think) they know?  In my view, either one is fine.  Probably, the best models are created for the purpose of explaining a concept that is already, at least partially, understood by their creators.  However, what I think is imperative is that, when developing and working with a model, the modeler remain at all times an explorer.  By this I mean that he must be open to the possibility that the model will reveal something he had not previously understood.

This is the line between a scientist and a rhetorician.  It is also analogous to the (easier to understand) process of observation.  If a rhetorician thinks that an increase in X leads to an increase in Y, their goal is to convince you of that and they select data that reinforces their argument and try to ignore, downplay or obfuscate information that contradicts it.  (For an example of this turn on any cable news network at any time.)  If a scientist thinks that an increase in X leads to an increase in Y, they go through a careful process of gathering and analyzing data that can either confirm or refute that hypothesis and if the data refutes it, they acknowledge that outcome.

In modeling, we have a similar situation.  You can try to make a model that shows that an increase in X leads to an increase in Y but if you get in there and suddenly discover that this is not the case in your model, do you say “surprisingly, the relationship between X and Y in this model is not that which I previously speculated,” or do you say “this model isn’t working” and tweak it to get what you want or throw it out all together?  (For the record, it’s not necessarily bad to tweak it but you should notice that you have to do that because something didn’t work exactly the way you thought and this should increase your understanding.) Read more…

Holy Marxism Batman!

June 10, 2014 2 comments

Well my intellectual odyssey regarding the nature of fiat money has taken a dramatic and hilarious turn.  Thanks to Nick Edmonds, after months (years?) of shouting crazy theories about money and debt into the internet, I have finally come across the right words to type into Google that lead to other people who have been saying this type of thing for  a while now.  Those words are “monetary circuit theory.”  Go ahead give it a try.  Doesn’t sound hilarious so far?  Well I haven’t gotten to the punch-line.  It turns out these people are pretty much all Marxists.

Man, didn’t see that one coming.  So the bad news is, I have to admit that Marxists (some Marxists) got something right.  But the good news is that, being Marxists and all, they seem to have a lot of issues to work out that I can probably help them with.  Of course, they may not want my help but that’s beside the point.

For instance take Steve Keen who appears to be the main circuit theory guy out there right now.  I still don’t know a whole lot about him but I’ve been working through his lectures on endogenous money on youtube and I don’t know if he would call himself a Marxist but it’s pretty clear that he has a lot of gripes with “neoclassical economics” (which is what I would call “economics”).  He also has a lot of nice things to say about Marx, including that we should all read Marx and he has a lot of not-so-nice things to say about Adam Smith and David Ricardo.  Also, by the end of the second lecture he clearly establishes that he is on the wrong side of the fundamental divide between Marxists and “mainstream” (or “neoclassical”) economists.  I will get to that in a bit.  Also, he is being paid by George Soros.

Here are the lectures I have watched so far.

Lecture 07 part 1

Lecture 07 part 2

Lecture 08 part 1

Lecture 08 part 2

I tried to start with lecture 01 but about fifteen minutes in he started telling me how the normal consumer choice model is nonsense by pointing out how many bundles a consumer would have to keep track of in order for the completeness assumption to hold.  At that point I decided to skip to the part about endogenous money which kicks in at number 7 in order to keep so much blood from shooting out of my eyes that I could no longer maintain consciousness. (I am resisting the urge to go off on a tangent about how that is a silly argument) In these lectures there is some really great stuff and some not-so-great stuff and I will delve into these issues in the near future.

Steve’s main point seems to be that the problem with economists is that they aren’t equipped with the analytical tools that engineers use.  I would say this is partly a valid point although there are a lot of truly dynamic mainstream models so I think he is exaggerating the ignorance of the profession to some degree.  But in trying to make economics more like engineering, he basically strips all the economics out.  What I mean by economics is any sentient being making a choice between different alternatives.  This is not totally surprising considering the reckless abandon with which he began tearing down the established principles for modeling such choice at the very beginning.  It’s a lot easier to make superficial criticisms of the assumptions other people have to make to get a model to work.  It is a lot more difficult to come up with an alternate way of modeling it without making those assumptions (or others that would be vulnerable to similar criticisms).  So just take that out and make a model of flows where you just say how the flows depend on variables and it’s totally arbitrary.

And yet, like I said, there is some great stuff in there.  We just have to take the great stuff and try to work it into mainstream economics.  I think it can be done.  Probably not by Marxists but luckily I’m on the job now.  So we’ll see how that goes.  For right now let me tackle an issue from the last lecture linked above (08 part 2, about 15 minutes in) which is just too egregious to let stand.

The issue is a quip about climate change.  But let me say up front that if you read the following and find yourself arguing with me about climate change you are missing the point.  This is about models, economics, and intellectual integrity.

Physicists learned as a fundamental law of reality, what’s known as the second law of thermodynamics.  And that’s a true law.  Economists have all these crazy laws like the law of one price saying that a good costs the same all over the planet–garbage.  It is violated all the damn time.  You cannot violate the second law of thermodynamics.  And that basically says that the amount of disorder in the world increases over time.  Entropy being a measure of disorder.  And production involves going in the opposite direction, you take raw materials and you transform them into something as elaborate as a computer which is obviously getting more order over time.  Now for that to occur and still live within the second law of thermodynamics, there MUST be a greater offsetting increase in disorder.  And that’s where pollution comes from, pollution, waste energy and so on.  So necessarily, to get that local increase in complexity and a decrease in disorder, an increase in order, there has to be overall increase in entropy.  And that’s our link between what we do in production economics and what’s happening in the biosphere.  It’s necessarily, unavoidably true, which is one of the reasons I find the climate skeptics a bit on the silly side.

Now I don’t know much about thermodynamics but I happen to know quite a bit about the law of one price and the law of one price does not say that the price of a good should be the same all over the world.  It says that it should be the same in a given market.  Exactly what a given market means is somewhat open to interpretation.  This is a law derived within a particular model.  And the assumptions of that model are that there are no transaction costs, imperfect information or other frictions involved in trading.  These are not assumptions because they are true, they are assumptions because assuming them allows for the creation of a model which yields some results that are helpful when thinking about how things work.

Even a clumsy interpretation of the law of one price would hold that the same good in different places can have different prices (which I am assuming is what he mans by “cost”).  A careful interpretation would hold that if we observe the same good selling for different prices, we must be observing one or more of the assumptions of the model being violated.  So Keen is two degrees removed from a proper characterization of the law.  But surely this is just because economic laws are all garbage, not like the “true laws” of the hard sciences.  It must be that Keen is so used to dealing with “true laws” that he can’t wrap his mind around the significance of these crazy economic laws that are always violated because they only hold under a set of assumptions that are almost never strictly in effect.

Now I’m no physicist but it seems to me like we have observed things getting more complex here on the blue marble.  Even if you take humans, with all of our productive activity, out of the mix, what about all this life I’m looking at?  Isn’t a duckbilled platypus a higher level of order than rocks and water and primordial ooze?  So I kind of felt like this second law of thermodynamics was being violated all over the damn place.  And (rather than just declaring the law garbage) I figured he might be mischaracterizing it.  After all, he had just demonstrated a propensity to do this.  So I did a (very) little research on the topic.  Turns out Wikipedia can sort this out in about two minutes.

Naturally, I started at the “second law of thermodynamics” page.  You only need to read the first sentence.

The second law of thermodynamics states that the entropy of an isolated system never decreases, because isolated systems always evolve toward thermodynamic equilibrium, a state with maximum entropy.

When I saw that, I was pretty sure I could see the problem already.  I wasted a couple minutes trying to figure out exactly what entropy means (I still don’t know) and then I clicked on “isolated system.”  Again, read the first sentence.

In physical science, an isolated system is a thermodynamic system which is completely enclosed by walls through which can pass neither matter nor energy, though they can move around inside it. Or it is a physical system so far removed from others that it does not interact with them, though it is subject to its own gravity.

Does that sound like the Earth to you?  If it does, you probably haven’t noticed that big orange ball in the sky which is constantly blasting in energy (not to mention having a gravitational influence).  So wait, doesn’t that mean that the second law of thermodynamics is dependent on a set of assumptions that don’t apply to the case under consideration?  Yes, but at least he is being consistent.  And in fact, if you read down a couple of paragraphs, you find this little gem.

Because of the requirement of enclosure, and the near ubiquity of gravity, strictly isolated systems do not occur in nature. They are thus hypothetical concepts only. Sometimes people speculate about “isolation” for the universe as a whole, but the meaning of such speculation is doubtful.

. . .

The concept of an isolated system can serve as a useful model approximating many real-world situations. It is an acceptable idealization used in constructing mathematical models of certain natural phenomena; e.g., the planets in our solar system, and the proton and electron in a hydrogen atom are often treated as isolated systems. But from time to time, a hydrogen atom will interact with electromagnetic radiation and go to an excited state.

So really this law is a conclusion reached under a set of assumptions that never actually hold, in order to illustrate some interesting point that helps us understand how actual systems work and therefore, in practice, if you try to just go around applying the conclusion to everything without paying attention to the assumptions and what the model (and therefore the law) actually means, you can’t help but find that it is violated all over the damn place.  Or in Keen’s words, the law is “garbage.”

So he is being consistent in the sense that he is mischaracterizing the meaning of these laws as they relate to the real world.  But he is being inconsistent in the sense that with the law of one price, he fails to observe what he incorrectly says the law implies and concludes that the law is garbage.  In the case of the second law of thermodynamics we fail to observe what he incorrectly says the law implies and he chooses to not believe the observation but rather to simply assume that there must be some other unobserved consequence which is more significant (somehow measured) than the observed increase in order.  It is not necessary to actually observe this because, after all, it’s a law!  And of course, I mean a real law, not like one of those garbage economics laws with all their false assumptions…

And this, is the fundamental divide between Marxists and “neoclassical” economists.  We assume that production and exchange are (or at least have the potential to be) constructive in the sense that everyone can benefit.  Or you might say, it increases order (though these are not really the same issue, they are somewhat analogous).  This comes from the concept of subjective value which implies that people can value goods in one form more than another (production) or one person can value certain goods more than another (exchange).  There is a lot of reasoning behind that framework but ultimately, every model has to start with some set of assumptions and in this case they are related to this notion of subjective value.

On the other hand Marxists assume that this trade and production is redistributive at best and often that it is actually destructive.  This is an assumption (just like the opposite view which I hold) and there are different ways of characterizing it.  Originally, it was based on the labor theory of value which holds that there is an objective value of everything that is based on the amount of labor it takes to produce it and this is attached to the item, not to individuals who want the item.  This means that it is the same for everyone which means that there are no possible benefits from trade.  And that single fact changes everything about the way Marxists see the world. 

In this case, we have an example of an entirely different approach where Keen is literally just assuming that everything is inherently destructive citing (erroneously) the second law of thermodynamics and taking any notion of value (economics) entirely out of the equation.  But the effect is the same, you reach the “conclusion” that improvement is impossible, only degradation and this paradigm undermines the entire foundation of mainstream economics.

So what needs to be done here is becoming pretty clear to me.  We need to rescue the good parts of monetary circuit theory from this Marxist quagmire and try to include some actual economics where there are some people making rational decisions and there is the potential for real gains from trade.  Stay tuned for that.

Utilitarianism is a Stupid Idea

May 8, 2014 7 comments

I don’t know what it is about utility but I just can’t seem to read anything about it, with the exception of my boring old “mainstream” economics textbooks, without getting supremely disturbed.  I have spent a lot of effort trying to explain to Austrians how they don’t understand the concept as it is used in mainstream economics.  But whenever I read something by Sumner on the subject I find myself much more sympathetic to their (still misguided) complaints.  To be fair to Sumner, he might be the best monetary economist in the blogosphere and he is about as “conservative” a one as you will find anywhere.  So I agree with much of what he says on most subjects but he frequently disrupts my adoration by reminding me of his utilitarian ways.  Though he often claims to be a libertarian (and in many ways he is), in my opinion utilitarianism in its most common applications is inherently incompatible with individual liberty.

First, let me say that the standard economic definition of utility has nothing to do with utilitarianism.  In a strict economic sense, utility is meant only to represent a rank ordering of a person’s preferences across different bundles of goods or states of nature.  In this context it is nonsensical to compare one person’s utility (or marginal utility) to another’s nor does it matter if marginal utility is diminishing as the same ordinal preferences can be represented by many utility functions with either increasing, decreasing or constant marginal utility in any particular good.  This is all explained in any decent text and I am sure Sumner would not dispute this (I’m not accusing him of not understand the concept).

However, what utilitarians have in mind is something different.  It is the idea that “utility” represents some measure of happiness or satisfaction.  They further suppose that this happiness increases at a decreasing rate as consumption increases.  (It is worth noticing that Austrians also indulge in this assumption of diminishing marginal utility but they do so in an even more annoying way because they simultaneously deny the definition which makes it possible.)  The utilitarian then further supposes that the marginal happiness gained from additional consumption at different levels of consumption is roughly comparable across individuals and they still further suppose that, even though it is not measurable or observable in any way, it is the proper role of government to try to maximize the total utility of all people in society by redistributing wealth (or consumption if you prefer) among them.  This last supposition is where it becomes destructive.

Here’s an example.  A billionaire might get a great deal of satisfaction from a 400-foot yacht if his rival billionaire has a 300-foot yacht.  There is data that shows happiness increases all the way up the income scale.  So I do buy that argument.  But I would insist that roughly the same enjoyment would be gained from a 300-foot yacht if his rival had a 200-foot yacht.  If an 80% consumption tax reduces each billionaire’s consumption proportionately, then could it really impact their happiness?

Even though this definition of utility as a measure of happiness/fulfillment/satisfaction etc. is not useful scientifically, it is appealing because it seems like it reflects reality.  I’m not saying it doesn’t.  I agree that, in a very loose, non-scientific sense, the happiness I would gain from having an additional loaf of bread would be much less than that of a starving man who received the same loaf.  And what’s more, I act like a utilitarian to some degree in my personal life.  Every time someone donates food to the hungry or gives the foul ball they caught at a baseball game to the kid in the seat next to him, they are acting out of some form of this sentiment.

However, in those cases, they are still acting in accordance with their own personal preferences, it is just that those preferences have what might be called a utilitarian dimension to them.  They get more happiness out of giving the bread to the hungry than out of eating it or out of seeing a child smile and imagining him lying in bed clutching the foul ball and dreaming about being a major league ball-player than they would from throwing it in their closet and probably forgetting about it.

The problem with utilitarianism is when you try to apply it by force via the government.  The government I think Sumner would prefer is one which leaves people alone to make decisions about how to live their lives in most cases but just does a few things to spread the wealth around to increase total utility.  And I think Sumner’s ideal world would be a lot better than what we’ve got now.  But the problem is that that is not a suitable moral/philosophical foundation for such a system because this notion of utility is entirely imaginary which means it is entirely subjective which means that it can be used to justify any breach of individual property rights.

This way of thinking suggests that someone has a moral right to the possessions of others by virtue of being poorer than they are.  So while it is functionally possible that we could have a specific “progressive” tax system along with an entirely libertarian everything else and that would work pretty well if we had it, it would never lead to that.  The same notion of forced utility maximization across individuals, once accepted, would be (and for that matter is) used to justify all manner of other government interferences in the lives of individuals.

The land your house sits on might generate more “utility” with a highway there, or for that matter a shopping mall.  You will have higher utility if you save more money for retirement but you are too stupid to realize it so the government will just take some out of your paycheck and use it to pay you back later if you survive long enough (and to pay other older people in the interim).  Sure, maybe you could live another year or two if you got the million-dollar treatment for your cancer but would the utility you derived from that extra year really be more than that derived by all the poor children we could feed with that (“your”) money?  Yes, we’re sending you, against your will, to fight and probably die in a foreign country but your sacrifice can’t be compared to the extra utility that will be secured for future generations.  It’s not that we want to tell you what to put in your body, it’s just that when (certain) drugs are legal, crime increases and you can’t possible argue that the added utility you get from smoking dope outweighs the indirect harm that legalizing it does to your neighbors.  Plus we know that drugs are actually hurting you anyway, you are just, again, too stupid or weak to realize it, so we’re actually increasing your utility by taking them away too.  It’s win-win!  I could go on but hopefully you get the picture.

Utilitarianism, at its core, is just a made-up method of collective reasoning.  This type of collective reasoning is at the heart of every usurpation of individual liberty.  It is the foundation of every form of socialism, communism, fascism, etc.  The only alternative to collectivism is to elevate the rights of the individual above all such notions.  This means we have to be willing to look at a rich guy and a poor guy and think that it would be better if the rich guy cut back on his yachts to buy a house for the poor guy without also thinking that we aught to force him to do it.  Once you start down that path, forever will it dominate your destiny.

 

 

Categories: Philosophy Tags: , ,

Why Austrian Economics is Devastating to Libertarians

March 9, 2014 56 comments

Since it’s the weekend, I’m going to take a break from my attempts to reinvent (essentially) the existing macroeconomic paradigm from the ground up using debt (and collateral) as the backing for money and do something much easier–bash Austrians.  This is from a recent post on The Money Illusion.

I constantly hear conservatives complain that elderly savers can’t earn positive interest rates because of the Fed’s “easy money” policy.  Is there any time limit on how long you will make this argument, before throwing in the towel and admitting rates are low because of the slowest NGDP growth since Herbert Hoover was President?  Or is your model of the economy one where decades of excessively easy money leads to very low inflation and NGDP growth?

In other words, is there some sort of model of monetary policy and nominal interest rates that you have in your mind, or do you see easy money everywhere and tight money nowhere?  What would tight money look like?  What sort of nominal interest rates would it produce?

If you have spent any time at all reading econ blogs you should know exactly what answer you will get to this without bothering to check the comments section.  But in this case, you don’t have to wade too deep into the 266 (and counting) responses before you get it.  On the second comment Old Reliable, Major_Freedom, supplies it for us.  (I bet when people see “Free Radical” they expect me to be like that guy but it’s partly tongue-in-cheek!) Read more…

God and Moral Relativism

August 16, 2013 Leave a comment

On RRC

A couple posts about scarcity, God, and house cats.

Part 1

Part 2

Categories: Philosophy, Politics

An Argument for Christian Libertarianism

Categories: Philosophy, Politics