Symposium on Dani Rodrik’s Economics Rules

The latest issue of the Journal of Economic Methodology (2018, 25/3) is a special issue on Dani Rodrik’s Economic Rules. It consists of the following articles:

I hope you will enjoy reading the symposium and join the conversation.

 

Philosophy of Economics Rules: introduction to the symposium

ABSTRACT: Economists have long been criticized for their use of highly idealized models. In Economics rules: Why economics works, when it fails, and how to tell the difference [Oxford: Oxford University Press, 2015] Dani Rodrik responds to this criticism by offering an account of models that emphasizes the diversity of models in economics. Rodrik’s account presents a rare opportunity for economists and philosophers of economics to engage in mutually beneficial exchange that could better our understanding of the power and limits of economics, and the rights and wrongs of the dismal science. The symposium on Rodrik’s Economics Rules is the first attempt to seize this opportunity.
Keywords: economics, philosophy of economics, criticism of economics, history of economics, Dani Rodrik, symposium
JEL Codes: B40, B41

Citation: Aydınonat, N. Emrah (2018) “Philosophy of Economics Rules: introduction to the symposium, Journal of Economic Methodology, forthcoming. https://doi.org/10.1080/1350178X.2018.1503143

Pre-print available at: ResearchGate

Introduction to The Invisible Hand in Economics (Routledge, 2008)

 

This is the Introduction to The Invisible Hand in Economics: How Economists Explain Unintended Social Consequences (Routledge, 2008). If you prefer to read the PDF version, it is available on ResearchGate.

Everyone is familiar with the (aesthetically) unpleasant walking-paths on public green fields. Usually, around these fields there are constructed paths for the service of the beloved citizens. However, citizens seem to deviate from these designed paths and take shortcuts passing through the green fields, through the zones they should not pass. The outcome of this behaviour is the death of the plants and the emergence of paths on these fields. Is there a good and acceptable explanation of why these walking-paths emerge? What kind of an explanation would be acceptable?

One scenario about the emergence of these paths may be the following. The first person to take a shortcut through the aforementioned field believes that his behaviour will do no harm to the green field and proceeds to take the shortcut. Obviously, he will in

fact have a negligible impact on the field. Subsequently, a second person, without being aware of the fact that he is the second person, takes the same shortcut with similar thoughts in mind. However, although the second person’s impact is still negligible, in time the damage on the plants accumulates. After some time, if some other people take that very same shortcut the damage will soon become visible. As a consequence, even if some earlier citizens did not intend the outcome of their behaviour, the damage to the plants will become visible; and hence the emergence of the path.

The plants may recover if everybody ceases to use the path. However, people generally continue taking shortcuts given the fact that they see the damage previously done by others. What are they thinking? Do they intend to bring about and maintain a visible path with no plants on it? Probably (and hopefully) not! Their reasoning is perhaps the following: ‘Even if I do not take the shortcut, some others will, thus the path will stay there anyway. Then, why should not I take the shortcut?’ So in this scenario, although individuals do foresee the outcome of their behaviour, they think that the creation of the path would be inevitable, given that everyone takes the shortcut. Moreover, if one particular individual is the only one taking the shortcut, the consequence of her action would be negligible. Thus, she takes the shortcut without intending to create such a nasty path. In this scenario the damage done to the plants has reinforced other people

to use that same path for it already exists. Thus, unless someone intervenes, the path is there to stay.

Would this scenario explain the emergence of these walking-paths? It sounds reasonable, but definitely not everyone is likely to accept this explanation. In fact, this was just one possible explanation. By introspection some of you may think that there may be other motivations behind taking these shortcuts. You may argue that people do not think about the consequences of their action at all when taking these shortcuts or you may think that these paths are intentionally created. For example, you may argue that one of those paths emerged due to a poorly planned city park which resulted in people intentionally taking a particular shortcut to show their dissatisfaction with the planning of this particular public space.

The above is yet another possible way to explain the emergence of these paths. More importantly, this explanation contradicts the previous general scenario. Thus one is tempted to ask: ‘unless some evidence is provided why should we believe in such speculations?’ If we would ask different people to explain this fact, we would get many different explanations. Many of these explanations would contain a story that makes the emergence of the path plausible. Hence, we would be left with many different (but not necessarily mutually exclusive) speculations or conjectures instead of ‘proper’ explanations. The fact that there are walking paths on public green fields is ostensibly simple to explain; however, it seems we are left only with conjectures.

The Invisible Hand in Economics
The Invisible Hand in Economics (Routledge, 2008)

Broadly speaking, conjectures and their explanatory characteristics are the subject matters of this book. It examines one particular type of explaining practice in social sciences, namely explaining the emergence of institutions (e.g., conventions and norms) and macro-social structures as unintended consequences of human action, from a methodological and philosophical perspective.

Explanations of ‘unintended consequences’ show numerous similarities with the above example of walking-paths on public green fields. The basic similarity however is that they seem to lack empirical content and as such they can be criticised as being simple conjectures with no explanatory value. This book illustrates the merits and demerits of such explanations by examining some of these attempts to explain institutions and macro-social structures as unintended consequences.

UNINTENDED CONSEQUENCES

This is a book about ‘unintended consequences of human action’ and the mechanisms that bring about these consequences. It investigates the explanatory role of the models that characterise institutions and macro-social structures as unintended consequences of human action.

Many economists argue that certain institutions and/or social structures, such as money, language, rules of the road, fairness, segregated city patterns, and localisation are unintended consequences of human action. Similar ideas can be found in other disciplines, such as in philosophy of language (e.g., Lewis 1969), in political philosophy (e.g., Nozick 1974), in linguistics (e.g., Keller 1994) in philosophy of science (e.g., Hull 1988), in sociology (e.g., Merton 1936, Boudon 1982). The above list, which can definitely be extended, illustrates the importance of the problem of explaining unintended consequences in social sciences and in (political) philosophy. Popper (1962: 342) acknowledged the significance of unintended consequences for social sciences by arguing that the explanation of unintended consequences of human action is ‘the main task of theoretical social sciences.’ Yet unintended consequence is a vague concept and as such it may denote many different things. In this book we will be concerned with a subset of the set of possible unintended consequences; the one which is of paramount importance to economics in explaining institutions and macro-social structures. The rough description of this subset is as follows (see Mäki 1990b, and Chapter 2 & 5):

  • Individuals do not intend to bring about a social phenomenon (e.g., a social institution, or a macro-social structure).
  • The consequence of their action is a social phenomenon (i.e., an institution or a social structure)
  • One individual alone is not enough to bring about the ‘social’ consequence—that is, independent actions of similar (in the sense that they do not intend to bring about the consequence) agents are needed.

An explanation of unintentionally hurting your hand, or an explanation of the unintended consequences of a government tax plan does not fall under the above definition and hence are not examined in this book. The former is not examined because the consequence is not a social phenomenon (violates condition b—and c depending on the case); the latter is not examined because the intention is about a social institution (condition a is violated). Given our definition, ‘unintended consequence’ is a crucial component of the ‘theory of spontaneous order’, of Adam Smith’s ‘invisible hand’, of Carl Menger’s notion of ‘organic phenomena’ and of ‘invisible-hand explanations’. It lies at the core of many contemporary models of institutions and macro-social structures.

The theory of spontaneous order finds its origins in 18th century Scottish Thought and it is defined with its characterisation of the social order as ‘unintended consequence of countless individual actions’ (Hamowy 1987: 3). Adam Smith, the founder of modern economics, who was part of this tradition, presented a metaphorical statement of ‘spontaneous order’ with the ‘invisible hand’. Menger, on the other hand, presented a closely related account of spontaneously created social institutions where he considered them as being similar to ‘organic phenomena’. Many social scientists and philosophers followed Smith and Menger by trying to answer versions of their questions about institutions and macro-social structures. Their aim was to show how institutions and social structures could emerge (or persist) without any design. Generally it is believed that neoclassical economists followed Smith’s lead and tried to prove his insights. However, neoclassical economists’ approach is only one of the possible ways to interpret Smith’s insights. There are at least two different interpretations of the ‘invisible hand’: the one that stresses ‘processes’ and the other that emphasizes ‘end-states’ (see Chapter 5). Neoclassical economists’ approach is an end-state interpretation: The ‘invisible hand theorem’ in economics stresses the consequences (e.g., optimum allocation of resources), rather than the processes that bring about these consequences.

This book is mainly concerned with what may be called the process interpretation of the invisible hand. Under this interpretation the ‘invisible hand’ represents causal and structural relationships and processes that may bring about unintended social consequences. Explanations under this particular interpretation can be gathered under the notion of ‘invisible-hand explanations’. An invisible-hand explanation aims to show the process that brings about the unintended consequence. Rather than merely focusing on the properties of the end-state (e.g., equilibrium), it explicates the way in which the end-state may be reached (Nozick 1974, Ullmann-Margalit 1978). It is possible to find many examples of such process models in the contemporary literature. The most prominent examples are game-theoretic models of institutions that show how institutions may emerge (or persist) as an unintended consequence of human action (e.g., Bicchieri 1993, Sugden 1986, Ullmann-Margalit 1977, Young 1998 etc.). Another area where unintended consequences are important is the emerging field of agent based computational economics (e.g., Axelrod 1997, Axtell et al. 1999, Epstein and Axtell 1996, Marimon, McGrattan et al. 1990 etc.). The pioneers of the game-theoretic literature acknowledge David Hume, Adam Smith and Carl Menger as their forefathers (see Lewis 1969, Sugden 1986, Ullmann-Margalit 1977, Young 1998) and similarly agent based computational economists generally acknowledge their intellectual debts to Adam Smith and Thomas Schelling (e.g., see Epstein and Axtell 1996, Tesfatsion 2002).

Carl Menger’s (1892a) story of the emergence of a medium of exchange, Thomas Schelling’s (1969, 1971, 1978) models of residential segregation, Peyton H. Young’s (1993a, 1996, 1998) model of emergence of the rules of the road and Joshua Epstein’s and Robert Axtell’s (1996) ‘Sugarscape’ (where they grow artificial societies from the bottom up) are well known examples of such models. These examples range from verbal models (or stories) to formal game theoretic and computational models. Despite the differences in their methods and research tools there is an important similarity between them. Each shows how institutions and macro-social structures may emerge (or persist) as an unintended consequence of the (inter)actions of individuals. In order to do this, the authors conjecture (in the latter case with the help of computers) about the conditions under which individual actions may lead to the social phenomena in question. The common feature of these examples is that the observed social phenomenon (i.e., institution or macro-social structure) is ‘produced’ within the model-world by conjecturing about the initial conditions (e.g., environmental conditions, characteristics of the agents etc.) that may bring about the social phenomenon in question as an unintended consequence of the interactions of the agents. Moreover, these models are typically ahistorical in the sense that historical facts about the social phenomenon in question do not seem to play any role in these models. They are general and thus they are supposed to be applicable to all instances of the social phenomenon in question in different times and places. These models illustrate the possible ways in which certain mechanisms may interact (or may have interacted) to produce the types of institutions or macro-social structures in question.

More strikingly, some of these models seem to challenge the common sense and the historical knowledge about these social phenomena. For example, while many believe that money is a matter of design and was issued by central authorities in the past, Menger argues that it was brought about by the (inter)actions of individuals who were pursuing their self-interests without the intention to bring about a commonly acceptable medium of exchange. Schelling, on the other hand, shows that if individuals cannot tolerate living as an extreme minority in their neighbourhood, then residential segregation cannot be avoided even if they are happy in a mixed neighbourhood. Of course this seems to go against our belief that strong discriminatory preferences (e.g., racism) and economic factors (e.g., wealth differences among ethnic groups) are the main causes of residential segregation. A more recent example is Young’s model of the rules of the road. He shows that the rules of the road may emerge with the accumulation of the precedent as an unintended consequence of the (inter)actions of the individuals. This model also goes against the belief that the rule that specifies on which side of the road one should drive was designed and imposed by central authorities like other traffic rules. Finally, Epstein and Axtell show how under certain conditions fundamental social structures and group behaviours (e.g., institutions, segregation, cooperation) could emerge from the micro level. In this example, social phenomena are quite literally grown by the authors.

All of the aforementioned examples pose difficult questions for social scientists and philosophers. How could these models explain anything if they are simply speculations about the initial conditions under which social phenomena may be brought about as unintended consequences? In other words, we understand that these authors are able to ‘produce’ a certain social phenomenon in their model world as an unintended consequence of the interactions of model agents. However, given that these models are so abstract, ahistorical and speculative, how could they be used to explain something about the real world?

The philosophical and methodological challenges posed by these models created many debates in related areas. These debates constitute a significant part of the controversies about the role of abstract modelling in social sciences. The related question here is whether we can learn anything about the real world by studying highly abstract models. This is one of the basic questions of philosophy of science. The usual defence of scientific models is the claim that they isolate the relevant parts of the real world and that such realistic representations of the real world give a close to true account of the phenomenon in question when other things are absent or constant. Some economists also use the argument from realistic representation in defence of their models. For example, Young (1998: 10) argues that the assumptions of his models ‘represent a fairly accurate picture of reality.’

However, the main criticism to these models is that they ignore the relevant facts, such as the history of the social phenomenon in question—and therefore they do not realistically represent the relevant parts of the real world. For example Menger’s ‘the origin of money’ does not take into account the way in which money was issued and introduced in history. Moreover, Schelling’s model of segregation seems to sidestep two of the most important facts about segregation—the presence of strong discriminatory preferences and the role of economic factors. Thus the argument concerning realistic representation either has to demonstrate why history is irrelevant, or to show the complementarity between these models and history.

As mentioned above, these models start with the problem (e.g., that there is residential segregation) and try to produce the conditions under which this problem may emerge as an unintended consequence of human (inter)action. This methodology invites criticism for the following two reasons. Firstly, it seems to be one sided, for it tries to construct a model that shows something that the author wishes to see (e.g., residential segregation as an unintended consequence). Secondly, it may be argued that if one devotes enough time and energy it should be possible to construct a reasonable model that is able to show whatever we wish.

Given the focus of this book the relevant place to start seeking solutions to these problems is the literature on ‘invisible-hand explanations.’ It is argued in this literature that invisible-hand explanations are valuable independently from their truth for they explicate the process that may have brought about the social phenomenon at hand (Ullmann-Margalit 1978). This suggests that these models are valuable even if they are false, or even if they do not get the facts right. It is argued that explication of a hypothetical process that is sufficient to bring about the social phenomenon in question is valuable for its own sake. However, it is not explained why this explication would be valuable, or in what sense it would help us understand the real world. Simply this argument does not help us much unless it is explicated! This is merely a statement of the author’s intuition about the value of these ‘explanations’. Economists use these models because they believe that they are valuable. For example, Robert Sugden (2000) argues that the reason we believe that these models are conveying a true message about the real world is that we find them ‘credible’—by way of examining Schelling’s segregation model. He argues that these models are credible like a good story or a novel. Sugden’s basic argument boils down to the statement that we think these models are valuable because we find them plausible. This argument cannot demonstrate the value of these models unless it explains why they are plausible and in what sense plausibility of a conjectural process sheds light on the real world.

Another type of justification comes from computer simulations. It is argued that artificial environments (models, computer models) are used to gain insights about the social phenomenon in question (e.g., see Gilbert and Doran 1994a, Liebrand et al. 1998) or that models and computer simulations are like experiments where we test our ideas (e.g., see Drogoul and Ferber 1994) or that they are similar to thought experiments (e.g., Liebrand 1998, Liebrand et al. 1998). Briefly it is argued that models and simulations help us in finding out the necessary conditions under which certain results (e.g., segregation) are brought about (within the computer model) and in easily exploring the properties of these model environments. In this account these models are not for explanation but for exploration. However, this does not answer our question about moving from the model world to the real world. Specifically, a satisfactory defence of these models would have to tell us how to translate the results of the model in order to interpret the real word.

The discussions about the interpretation of game theory are also relevant in this respect. As mentioned above, some economists like Young use the argument from realistic representation to justify game-theoretic models. Yet not every game theorist would agree with this. One of the most prominent scholars of this field, Robert Aumann (1985) (also see van Damme 1998) argues that realisticness of the models does not matter that much. According to him, the conclusions are much more important: If the model is applicable to many situations and is productive, then it is a good model. He also argues that game theory (and other sciences—in his opinion) ‘is not a quest for truth, but a quest for understanding.’ He says, ‘science makes sense of what we see, but it is not what is “really” there’ (van Damme 1998: 181, 182). Aumann basically argues that game-theoretical models help us in putting together what we observe in a coherent framework, that they help us in fitting things together. He also argues that they lead to prediction and control. However, if we accept Aumann’s interpretation of game theory (and science) we are still faced with the following questions: Firstly, if the models of institutions and macro-social structures do not represent the reality how could they lead to prediction and control, and most importantly to understanding? Secondly, Aumann emphasises the productiveness and applicability of the models. Yet the current state of the modelling of institutions and macro-social structures (as unintended consequences) cannot be considered to have many real world applications or satisfactory predictive power. Should we then conclude that these models are not valuable?

It is the argument of this book that all of the interpretations expressed above convey justifiable intuitions about these models. That is, ‘realisticness’, ‘explication’, ‘credibility’, ‘exploration’, and ‘fitting things together’ are all parts of a framework that would help us in making sense of these models. However, there is no existing framework where these things are presented coherently and satisfactorily. It is the main task of this book to develop such a framework and to use it to gain new insights into the contemporary literature that characterises institutions and macro-social structures as unintended consequences of human action.

PLAN AND SUMMARY OF THE BOOK

To be able to develop such a framework one has to understand what these models really accomplish. The most obvious way to do this is to carefully examine these models and their methodology. But before doing this, a clarification of the very idea of ‘unintended consequences’ is needed. The Second Chapter analyses and explicates the concept of unintended consequences to prevent misunderstandings that may be caused by its vagueness. In particular, the subset of the set of possible unintended consequences, which is relevant for understanding the models of institutions and macro-social structures as unintended consequences, is specified.

In Chapters Three and Four, the most prominent examples of such models, Menger’s ‘origin of money’ and Schelling’s ‘checkerboard model of segregation’ are examined. It appears they are natural candidates for several reasons. First of all, these models are paradigmatic examples of ‘explaining unintended consequences of human action’ and of invisible-hand explanations. Contemporary authors consider these models as conveying the key insights about their subject matter and about the way in which related issues should be handled. Their models are the predecessors of contemporary research in modelling institutions and macro-social structures as unintended consequences of human (inter)action. Menger is considered to be one of the founding fathers of the theoretical approach to institutions as opposed to the historical approach (e.g., see Rutherford 1994, Schotter 1981). Schelling’s model is one of the main predecessors of agent-based computer models (e.g., see Epstein and Axtell 1996, Blume and Durlauf 2001, Pancs and Vriend 2003, Rosser 2000, and Casti 1989) and it is considered to be the paradigmatic example of explaining with mechanisms in social sciences (e.g., see Hedström and Sedberg 1998). Briefly, since their models play an important role in the history of ‘explaining unintended consequences of human action’ understanding Menger’s and Schelling’s models should shed light on the related areas of contemporary research.

Another good reason to start our examination with these models is the fact that both Menger and Schelling are explicit about their methodology. In their work, they explain why they prefer the type of research they are engaged in. Moreover, in the literature there is a considerable amount of philosophical discussion about their methodology. As previously mentioned, their works are predominantly considered to be paradigmatic examples of invisible-hand type of ‘individualistic’ explanations (e.g., see Nozick 1974, Pettit 1996, Rosenberg 1995, Rutherford 1994, Ullmann-Margalit 1977). It is also common to examine the recent game-theoretical models of institutions alongside invisible-hand explanations (e.g., see Langlois 1986bc, Mäki 1993, Rosenberg 1994, Rutherford 1995, Vanberg 1994). It has also been stated that the authors of these models (including the authors of the computational models) consider themselves as following the invisible-hand tradition, or providing the mechanisms behind the invisible hand. For these reasons there is a considerable amount of resources that may help us in our quest. Thus we are more likely to find hints about the nature of similar models by starting our examination from Menger and Schelling’s models and their relation to the invisible hand. In addition, this choice makes it easier to see the common misunderstandings about ‘explaining unintended consequences of human action’ for the literature on invisible hand type of ‘individualistic’ models is abound with controversies. The Fifth Chapter undertakes the task of examining ‘invisible-hand explanations’ in light of the chapters on unintended consequences, and Menger and Schelling’s models. This examination sheds light on the nature of invisible-hand explanations. Particularly, an important misunderstanding about the relation between ‘unintended consequences’ and the ‘invisible hand’ is removed. By way of removing this misunderstanding the chapter prepares the ground for examining contemporary examples of invisible-hand explanations.

Menger and Schelling’s models and insights were reconsidered and remodelled by contemporary authors. For this reason there is an explicit link between these models and the contemporary literature we wish to understand. This gives us a chance to evaluate the progress of this ‘research program’. For example, some of the papers directly related to Menger’s account of the medium of exchange can be listed as follows: Duffy and Ochs (1999), Gintis (1997), Kiyotaki and Wright (1989), Marimon, McGrattan et al. (1990), Schotter (1981), Selgin and Klein (2000), Townsend (1980), Young (1998). Some of the follow-ups to Schelling’s segregation model are the following: Clark (1991), Epstein and Axtell (1996), Sander et. al. (2001), Young (2001), and Zhang (2000, 2004ab). By examining these reconsiderations we may indeed see whether there is any progress or whether contemporary tools (e.g., game theory and computer modelling) improve the way in which we understand and explain the origin of money and segregation. Accordingly, the Sixth Chapter examines the more recent models of the emergence of money in detail, while recent reconsiderations ‘residential segregation’ are used as examples in Chapter Seven.

Particularly, in Chapter Six it is argued that we should not evaluate models that characterise macro-social phenomena as unintended consequences in isolation from other related models of the same phenomenon. In order to substantiate this proposition, recent reconsiderations of Menger’s explanation of the origin of money are examined. The chapter shows how Menger’s intuitions are further explored in the modern literature in various ways. It is argued that these recent models test the logical soundness of Menger’s arguments but do not bring us any closer to the real world. Recent models of the origin of money do not introduce new mechanisms but test the plausibility of the mechanisms that were suggested by Menger. While these models increase the plausibility of the idea that media of exchange may be brought about unintendedly, it is argued here that the idea that fiat money may be considered as an unintended consequence of human action does not appear to have a firm basis. Moreover, the chapter examines and demonstrates the relation among these models. This examination supports the thesis that different models have different functions and different models of the same phenomenon may be considered as forming a loose framework for explaining particular instantiations of it.

Chapter Seven explores the philosophical literature on models and explanation to provide a firmer basis for the arguments of the previous chapters. In particular, firstly, the concept of partial potential explanations is explicated. Secondly, it is argued that models help us explain by way of providing a proper way to conceptualise the phenomenon under question. Yet this further implies that the relationship between the model world and the real world is rather complex. Thirdly, it examines this complex relationship by way of discussing the related philosophical literature in light of the previous chapters. Fourthly, it is argued that similarity between models that are examined in this book and the real world amounts to the existence of certain (known) tendencies (individual mechanisms) in the model world. For this reason these models may be interpreted as revealing the possible ways in which these tendencies may interact, even if some of the assumptions of these models do not hold. Fifthly, the chapter emphasises the importance of exploration. Particularly, it shows how one may gain confidence about the implications of an existing model by way of further exploring its premises and results. To do this the chapter discusses reconsiderations of the checkerboard model. Finally, the chapter fortifies the idea that no model of this sort should be evaluated in isolation from other related models.

Chapter Eight examines the modern game theoretical models of conventions in light of the ideas developed in previous chapters. These models may be considered as attempts to provide a general theory of the emergence of conventions. The chapter reviews some of the existing game-theoretic literature on conventions and shows that existent conventions and norms, particular institutions and history are crucial for explaining the emergence of conventions. Six arguments are put forth in the chapter: (i) Static models of coordination (and convention) are concerned with examining the conditions under which certain outcomes are plausible, rather than explaining why and how such outcomes are brought about. Hence such models are in line with the end-state interpretation of the invisible hand. (ii) Dynamic models of coordination provide partial potential (theoretical) explanations of the emergence of coordination and conventions. Hence such models are in line with the process interpretation of the invisible hand. (iii) None of these models rule out the possibility that coordination and conventions may be brought about intentionally. Rather they examine whether successful coordination and conventions may emerge as unintended consequences of human action. The interpretation of these models as providing partial potential explanations is well in line with this remark. (iv) Explaining particular cases (e.g., explaining the emergence of a particular convention) necessitates empirical research. Nevertheless, general models of coordination and conventions need not be empirical or historical. (v) The collection of different models of coordination and conventions may be considered as providing a general framework for empirical research and providing singular explanations. (vi) Game-theoretic models in general may be interpreted as providing a framework for analysis, rather than providing ultimate explanations concerning social phenomena and individual behaviour. The Final Chapter concludes the book with questions for further research.

To learn more about The Invisible Hand in Economics (Routledge, 2008), visit this page.  Or buy the book.

The diversity of models as a means to better explanations in economics

ABSTRACT. In Economics Rules, Rodrik [(2015). Economics rules: Why economics works, when it fails, and how to tell the difference. Oxford: Oxford University Press] argues that what makes economics powerful despite the limitations of each and every model is its diversity of models. Rodrik suggests that the diversity of models in economics improves its explanatory capacities, but he does not fully explain how. I offer a clearer picture of how models relate to explanations of particular economic facts or events, and suggest that the diversity of models is a means to better economic explanations.

KEYWORDS: Theoretical modelsexplanationdiversity of modelshow-possibly reasoningfunctions of models

JEL CODES: B40B41

Citation: Aydinonat, N. Emrah. 2018. “The Diversity of Models as a Means to Better Explanations in Economics.” Journal of Economic Methodology, June, 1–15. https://doi.org/10.1080/1350178X.2018.1488478
Pre-print available at SSRN ResearchGate.

Understanding Economic Models (Course)

Course code: FILM-353, Understanding Economic Models, 5 cr, University of Helsinki

Syllabus (fall 2016)

This is a course that will improve your understanding of economics, and broaden your horizon concerning what economists do. We will present you the necessary tools and tricks to tackle very difficult questions concerning the status of economics as a science. The course will cover many exemplary models and their use in theory and policy in order to improve your understanding of economics. We will also have heated debates. Really! After finishing this course, you will be able to defend your discipline better against criticism and skepticism. But also you will be able to criticize it better—just in case you would like to do that. We have one requirement: You should have successfully completed the introduction to economics course. Otherwise, all economics students from all levels are welcome. Students of other social sciences and philosophy who have a basic knowledge of economics are also welcome.

 

INSTRUCTORS

N. Emrah Aydinonat
Researcher at TINT
neaydinonat.com
@aydinonat
Michiru Nagatsu
Researcher at TINT
michirunagatsu.com
@michurin

 

Introduction

Students of economics sometimes complain about economics and economics education. They say things like the following:

Economics education and textbooks are so far away from the real world that I do not see how they can be useful in any meaningful sense. In fact, we are learning a lot of unrealistic models that have nothing to do with the real world. Real people are not like Homo Economicus; we are not as calculative, as selfish, and as weird as Homo Economicus. No one I know thinks at the margin. And thanks god, no one is maximizing utility. Of course, even if they want to do that, they do not know enough math. Also, you know, economic decision making is much more complex than choosing between apples and bananas. Monetary incentives do not always work. People are not rational, they are emotional. They do crazy things. Markets are not perfect. The invisible hand is an illusion. And do not get me started with the failure of economics before, during and after the 2007-8 crisis…

Students sometimes complain about economics. So what? Why should we care? Well, most importantly, learning economics is not only about memorizing the ten principles of economics and taking derivatives. Understanding economics requires a good understanding of the nature and scope of economic models. Our representative student above is challenged by some very fundamental questions about economics.

01

Consider the following seemingly simple questions. Can a scientific model which is obviously wrong explain anything? Can it help us understand the real world? If people are mostly irrational creatures when compared with Homo Economicus, can economic models help us understand how people behave? If markets are never perfect, can we trust the invisible hand? Before answering these questions, also consider Nobel Prize winner economist Paul Krugman’s comment on economics and economists. He said “the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth.” So according to Krugman, economists should not mistake their fancy models with truth. The question is, if this is true, what should they do with these fancy models?

02

In fact, it is not only our representative student or Krugman who criticizes economics. Heterodox economists and other social scientists also criticize economics for similar reasons. But not only that! Methodological debates concerning economics are abundant in the history of economics. Competing schools of economic thought disagree about the nature and scope of economics, and about the way in which economic research should be conducted. Mainstream economists also disagree about how economics should be. Moreover, now that we have research areas such as behavioral economics, experimental economics, and neuroeconomics (btw, are they different?), there is more disagreement concerning the assumptions that economists make and the models that they use to explain the world.

So, in brief, it is a mess out there! And that is why we have this course. We would like to bring some order to this mess by way of studying economic models with the help of some tools and tricks from philosophy of science. Yes, this is a course in philosophy of economics. But do not worry, we have a practical approach. We will talk about economics all the time and introduce the philosophical tools without you realizing it :)

03

The main aims of the present course are

  1. to provide the student with the tools and abilities that are necessary to discuss and understand debates concerning the status of economics as a science; and
  2. to give a broader view of different schools of economic thought with a special emphasis on new developments in economics.

The course covers fundamental issues in the philosophy and methodology of economics and discusses some of the different schools of thought in economics from a methodological perspective. The mainstream economics (which forms the core of economics education) is at the center of the course and other schools of thought are discussed in relation to this mainstream. Particularly, the course focuses on how alternative schools in economics criticize the mainstream. Defining common assumptions and concepts of mainstream economics (such as rationality, equilibrium, efficient markets) and their criticism will get special attention throughout the course.

If you are still reading this, we assume that you are taking this course. However, if you’d rather not take this wonderfully interesting course, let us give you the answer to all the questions we will ask during the semester. It is 42.

Warning!

Warning! Philosophy challenges complacency. It is hard to know what the truth is concerning hard questions like the ones we will be addressing this semester.

Dan Hausman’s syllabus for his Philosophy of Economics (Fall 2006) contains the above warning. Same applies to our course.

Expectations

Participation: The course will be interactive and students are expected to make the required readings  before  coming  to  the  class  and  to  join  the  discussion  throughout  the semester. Do not forget! There is a 10% participation bonus!

Attendance: Attendance is required in the sense that in exams you are responsible from the materials covered in lectures.

Response papers (RPs): At least one reading will be assigned for each class. Based on these readings you are required to write 10 response papers for this course. RPs will be submitted via Moodle before class. In the first week we will explain what a RP is. Briefly, it is a short (e.g., one-page) essay where you evaluate, criticize or amend the required reading. For example, you may consider answering some of the following questions for this task.

  • What question does the paper address? Is it important? Why?
  • What is the hypothesis or theoretical argument?
  • Is the argument convincing? Why or why not?
  • What are the weak and strong parts of the paper?
  • How does the paper relate to the other readings (or to your other courses)?

The response papers are worth 40% of your final grade. You need to send in your response papers on time. If you are late, there will be a penalty. Here is how it works. If you miss the deadline you’ll lose 25 points (out of a 100). If you miss the deadline, we will give you another chance to submit your response paper. If you also miss the second deadline, you will not be able to submit your response paper anymore.

Grading

  1. Response papers 40%
  2. Midterm 10%
    Taking the midterm exam is obligatory. If you do not take the midterm you cannot take the final exam.
  3. Final Exam 50%
  4. Participation Bonus: 10% of the final result (1+2+3).

Recommended Reading

9780393246414_300 Economics Rules
The Rights and Wrongs of the Dismal Science
Dani RodrikW.W. Norton, 2015
ISBN-10: 0393246418
ISBN-13: 978-0393246414

Weekly Plan

1 12.09 Vocational Guidance Counsellor

Why be an economist? Why not a lion tamer? What is wrong with economics education? What do critics say?

2 19.09 NEA The Funniest Joke in the World

Pop-Economics explains the global financial crisis! Well, maybe not! It turns out that pop-econ explains everything including the logic of life but not the crisis. Could a science that cannot answer its core questions explain the logic of life? In answering this question we will have go back to the definitions of economics and discuss economics imperialism.

3 26.09 NEA How to Irritate People Economists I

How? Tell them that their models are unrealistic and they cannot explain anything. How do economists defend their models against this type of criticism? In this part of the course we will discuss the marginalism debate in economics and discuss how economists rationalize their unrealistic assumptions.

4 03.10 NEA How to Build Certain Interesting Things I

For example, how to build a linear city with two sellers in order to explain the excessive sameness in markets (e.g., the fact that all jeans, serials, cars, toothpastes, etc. are similar, but not exactly the same). Our question is whether it is possible to give a true explanation with “false” (unrealistic) models.

5 10.10 NEA The Dirty Fork

How can a complaint about a dirty fork at a restaurant trigger a series of actions ending up with the restaurant manager stabbing himself in the stomach with the dirty fork? How could seemingly harmless neighborhood choices bring about total racial segregation in a city? Or how could individuals who are trying to get the best trade at the moment end up creating a generally accepted medium of exchange? Some unintended consequences are important for economics. This week we will study the wonders of the invisible hand.

6 17.10 MN How to Build Certain Interesting Things II

Economists can build perfect models of markets. But real markets are not perfect. So why not make real markets similar to our perfect model markets? This week we will study how economists construct real markets from abstract models.

24.10 EXAM
7 31.10 MN How to Irritate People Economists II

This week we will discuss the modern critics of the standard economic theory of choice. This is our introduction to behavioral economics.

8 07.11 MN How to Irritate People Behavioral Economists

Is behavioral economics really different from neoclassical economics? Is it just neoclassical economics in disguise? Let us discuss some discomforting comments concerning behavioral economics.

9 14.11 NEA The Dead Parrot

“We feel much like the customer in the pet shop, beating away at a dead parrot.” Rabin and Thaler (2001: 230)

What to do when the pet shop sells you a dead parrot and does not accept it that the parrot is dead? In 1898 Thorstein Veblen criticized economists for not accepting the fact that Homo Economicus is like a dead parrot. OK he did not say dead parrot. He said “He is not the seat of a process of living.” Our subject this week is institutional economists (including Veblen) and their criticism to economics. Asking questions like “why do firms exist?”, or “why everyone misunderstood the Coase theorem?” we will slowly make our way to the motto “institutions matter”!

10 21.11 NEA Nobody expects the Spanish Institutional Inquisition!

Once upon a time institutional economics was yet another heterodox school of thought in economics. Today almost all economists—even those working at the IMF and the World Bank—accept that institutions matter. How did this happen? This week, we will start from mainstream models of economic growth and explain how and why economists explain why nations fail with institutions.

11 28.11 MN Nudge, nudge

This is the story of behavioral economists going to Washington. Nudge, nudge! Wink, wink! Say no more! How did economists get interested in nudging people into doing things? They have built models, they have built markets, now some of them are trying to build better people and better societies. This week we will discuss why and how people defend nudging.

12 05.12 MN Seduced Milkmen

A seductive woman lures (nudges?) the milkman into entering her house, the milkman ends up in a room with other milkmen, some of whom are very old, including one who is a skeleton. Our questions this week are: How much nudging is too much? Should economists be allowed to manipulate people’s behavior? We will discuss nudge paternalism and its critics and alternatives.

13 12.12 Self Defense Against Fresh Fruit

How to defend economics against an attacker armed with fresh fruit?

19.12 EXAM

Weekly Plan & Reader

[*] indicates a required reading

12.09.2016 | Vocational Guidance Counsellor
(What is wrong with economics education?)

Introduction to the course. Please make sure that you have read the following article before coming to the lecture. (You do not need to write a response paper!)

  • [*] Vromen, Jack (2009) “Economics and philosophy: More than having fun and making fun”, inaugural speech at Erasmus University Rotterdam.

19.09.2016 | The Funniest Joke in the World
(Pop-Economics explains the global financial crisis)

  • [*] Krugman, Paul R. 2009. “How Did Economists Get It So Wrong?” The New York Times Magazine, September 2. http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html.
  • Robbins, Lionel (1945) “Chapter 1: The Subject Matter of Economics”, in An Essay on the Nature and Significance of Economics, London: MacMillan, pp. 1-23.
  • [*] Backhouse, R. E. & S. G. Medema (2009) “On the definition of economics”, Journal of Economic Perspectives, 23 (1): 221—33.

26.09.2016 | How to Irritate People Economists I
(Economists and Theır Assumptions)

  • [*] Hall, R. L. and C. J. Hitch (1939) “Price Theory and Business Behaviour”, Oxford Economic Papers, 2 (May): 12-45.
  • Vromen, Jack (1995) Economic Evolution: An Enquiry into the Foundations of New Institutional Economics, London: Routledge. Chapter 1
  • Friedman, M. (1953) “The Methodology of Positive Economics”, reprinted in Uskali Mäki (ed.) The Methodology of Positive Economics: Reflections on the Milton Friedman Legacy, Cambridge: Cambridge University Press, pp. 3-43.
  • Gibbard, A., & Varian, H. R. (1978). Economic Models. The Journal of Philosophy, 75(11), 664–677.

03.10.2016 | How to Build Certain Interesting Things I
(e.g., a linear city, a fictional market and a stable equilibrium)

  • [*] Reiss, Julian. (2012) “The Explanation Paradox.” Journal of Economic Methodology 19 (1): 43–62..
  • [*] Mäki, U. (2013). On a Paradox of Truth, or How Not to Obscure the Issue of Whether Explanatory Models Can Be True. Journal of Economic Methodology, 20(3), 268–279.
  • Rosenberg, A. (2001) “Why Philosophy of Science” in Philosophy of Science: A Contemporary Introduction, London: Routledge, Chapter 1
  • Little, D. (2005) “Philosophy of Economics” in Sarkar, S. & J. Pfeifer (eds) The Philosophy of Science: An Encyclopedia, London: Routledge.
  • Rosenberg, A. (2001) “Explanation, causation and laws” in Philosophy of Science: A Contemporary Introduction, London: Routledge, Chapter 2
  • Glennan, S. (2005) “Explanation” in Sarkar, S. & J. Pfeifer (eds) The Philosophy of Science: An Encyclopedia, London: Routledge.
  • Mäki, Uskali (1992), ‘On the method of isolation in economics’, in Uskali Mäki and C. Dilworth (eds.), Intelligibility in Science (Poznan Studies in the Philosophy of the Sciences and the Humanities, 26; Atlanta and Amsterdam: Rodopi), 319-54.

10.10.2016 | The Dirty Fork
(How things get out of control with the invisible hand)

  • Any introductory economics textbook on the invisible hand (Homework: before coming to the lecture prepare a summary of how the invisible hand is explained in an introductory textbook)
  • [*] Stiglitz, J. E. (1991). The invisible hand and modern welfare economics. NBER Working Paper.
  • Sugden, Robert (2000), ‘Credible Worlds: The Status of Theoretical Models in Economics’, Journal of Economic Methodology, 7 (1), 1 – 31.
  • Cartwright, Nancy (2009), ‘If no capacities then no credible worlds’, Erkenntnis, 70 (1), 45-58.

17.10.2016 | How to Build Certain Interesting Things II
(Constructing real markets from economic models)

  • [*] Guala, Francesco. (2007) “How to do things with experimental economics.” In  Donald MacKenzie, Fabian Muniesa, and Lucia Siu (eds) Do economists make markets?: 128-162.
  • Alexandrova, Anna. (2006) “Connecting Economic Models to the Real World: Game Theory and the FCC Spectrum Auctions.” Philosophy of the Social Sciences 36.2: 173-192.
  • Mirowski, Philip, and Edward Nik-Khah. (2007) “Performativity, and a problem in science studies, augmented with consideration of the FCC auctions.” In MacKenzie et al.

31.10.2016 | How to Irritate People Economists II
(Critics of standard economic theory of choice)

  • [*] Thaler, Richard H. (2000) “From Homo Economicus to Homo Sapiens”, Journal of Economic Perspectives, 14 (1): 133-141.
  • [*] Henrich, Joseph, Robert Boyd, Samuel Bowles, Colin Camerer, Ernst Fehr, Herbert Gintis, and Richard McElreath. (2001) “In search of homo economicus: behavioral experiments in 15 small-scale societies.” The American Economic Review 91(2): 73-78.
  • Ashraf, Nava, Colin F. Camerer, and George Loewenstein. “Adam Smith, behavioral economist.” The Journal of Economic Perspectives3 (2005): 131-145.
  • Henrich, Joseph, Steven J. Heine, and Ara Norenzayan (2010) “The weirdest people in the world?.” Behavioral and Brain Sciences2-3: 61-83.

07.11.2016| How to Irritate People Behavioral Economists
(Neoclassical economics in disguise?)

  • [*] Berg, Nathan, and Gerd Gigerenzer (2010) “As-if behavioral economics: Neoclassical economics in disguise?.” History of Economic Ideas: 133-165.
  • Ross, Don. (2014) “Psychological versus economic models of bounded rationality.”Journal of Economic Methodology 21.4: 411-427.

14.11.2016 | The Dead Parrot
(From the lightning calculator to ‘institutions matter’)

  • [*] Veblen, T. (1898). Why is Economics not an Evolutionary Science. The Quarterly Journal of Economics, 12(4), 373–397.
  • Coase, R. (1937). The Nature of the Firm. Economica, 4, 386–405.
  • Coase, R. H. (1960). The Problem of Social Cost. Journal of Law and Economics, 3, 1–44.

21.11.2016 | Nobody expects the Spanish Institutional Inquisition!
(Economists explain why nations fail)

  • [*] Olson Mancur (1996) “Big Bills Left on the Sidewalk: Why Some Nations are Rich, and Others Poor” Journal of Economic Perspectives, 10(2): 3—24.
  • World Economic Outlook, Growth and Institutions, April 2003, 3
  • Greif, Avner (2006) Institutions and the Path to the Modern Economy: Lessons from Medieval Trade, Cambridge: Cambridge University Pres (Chp. 1 & Chp. 2).
  • James A. R and D. Acemoglu (2013) Why Nations Fail, Crown Business. Chp. 1 & 2.

28.11.2016 | Nudge, nudge
(Behavioral economists go to Washington)

  • [*] Thaler, Richard H., and Cass R. Sunstein (2003) “Libertarian paternalism.” The American Economic Review2: 175-179.
  • Amir, On, et al. (2005) “Psychology, behavioral economics, and public policy.”Marketing Letters3-4: 443-454.
  • Chetty, Raj. (2015) “Behavioral economics and public policy: A pragmatic perspective.” The American Economic Review5: 1-33.

05.12.2016 | Seduced Milkmen
(Nudge and its critics/alternatives)

  • [*] Grüne-Yanoff, Till. (2012) “Old wine in new casks: libertarian paternalism still violates liberal principles.”Social Choice and Welfare4: 635-645.
  • Beaulier, Scott, and Bryan Caplan. (2007) “Behavioral economics and perverse effects of the welfare state.” Kyklos4: 485-507.
  • Bolton, Gary E., and Axel Ockenfels. (2012)”Behavioral economic engineering.” Journal of Economic Psychology3: 665-676.

12.12.2016 | Self Defense Against Fresh Fruit
(Defend economics against an attacker armed with fresh fruit)

  • [*] Rubinstein, Ariel. “A Sceptic’s Comment on the Study of Economics.” The Economic Journal, 510 (2006): C1-C9.
  • Frank, R.H., Gilovich, T.D.and Regan, D.T. (1996). ‘Do economists make bad citizens?’, Journal of Economic Perspectives, vol.10, pp. 187–92
  • Frey, B. S. and Meier, S.(2003). ‘Are political economists selfish and indoctrinated? Evidence from a natural experiment’, Economic Inquiry, vol. 41, pp.448–62.
  • Cipriani, Giam Pietro, Diego Lubian, and Angelo Zago. “Natural born economists?.” Journal of Economic Psychology3 (2009): 455-468.
  • Bauman, Yoram, and Elaina Rose. “Selection or indoctrination: Why do economics students donate less than the rest?.” Journal of Economic Behavior & Organization3 (2011): 318-327.
  • Hummel, Katrin, Dieter Pfaff, and Katja Rost. “Does Economics and Business Education Wash Away Moral Judgment Competence?.” Journal of Business Ethics (2016): 1-19.

Using and Abusing Models in Economics: A Review of Rodrik’s Economics Rules

“There is much to criticize in economics, but there is also much to appreciate” Dani Rodrik (in Economics Rules, p. ix)

Dani Rodrik’s new book Economics Rules: The Rights and Wrongs of the Dismal Science will be available soon. Here is an early quick review of the book.

If you do not have much time, here is the main message of this review: Economics Rules is an excellent book; a must read for economists, philosophers of economics, and policy makers, and of course for economics students. And if you consider yourself as a critical economist, a heterodox economist, or a social scientist who is critical of the way in which economists work, behave, etc., the book has a lot to offer to you too (probably a lot to disagree about, but also a new perspective on economic models). While Dani Rodrik defends economics against popular lines of criticism; he also presents his own critique.

If you have more time, please read on.
[If you prefer a PDF version, it is available @Research Gate ]

The Book

9780393246414_300Economics Rules is a book on the nature of economics and economics models. It defends economics against main lines of criticism. It argues that what makes economics powerful is its diversity of abstract and unrealistic models—but this is not a Friedman 1953 type of defense of unrealistic assumptions, as you’ll soon see.

In Economics Rules, Rodrik tries to show that critics have been criticizing economics for the wrong reasons. Economists, on the other hand, were right in defending economics, but they (well, at least most of them) have been doing it all wrong. In order to make his case, Rodrik presents an alternative account of economic models. He argues that this alternative account will provide economists “a better story about the kind of science they practice” (p. ix)—a story that will render most popular lines of criticism useless. As Rodrik puts it Economics Rules explains “why economics sometimes gets it right and sometimes doesn’t” (p. 4) and defends the core of economics—”the role that economic models play in creating knowledge”—but criticizes “the manner in which economists often practice their craft and (mis)use their models” (p. 6).

Rodrik argues that abstract theoretical models are useful, but they are also limited by the assumptions they make. Economic models do not provide us with fundamental economic laws. Their results are dependent on the conditions described by their assumptions. Thus one should be careful in generalizing a model’s results. A common mistake in economics, he argues, is to mistake a model, with the model. In fact, same applies to critics. Popular lines of criticism against economics models also mistake a model, with the model. Critics argue that economic models are too abstract and too detached from the world by way of comparing a model with the real world. However, Rodrik argues that this criticism misses the point because it ignores the diversity of models in economics. Economists’ toolbox is filled with a variety of models, and which (combination) of these models are relevant depends on the case at hand. Thus, he argues, by focusing on one model at a time many critics fail to see what makes economics so powerful.

Economics Rules is filled with interesting and thought provoking ideas and examples from economics, but (I think) its main contribution is Rodrik’s alternative account of economic models. For this reason, in what follows I will only discuss Rodrik’s account of economic models.

Unrealisticness of Economic Models

In the aftermath of the 2008 economic crisis, many economists raised concerns about the way in which economics is practiced. Probably, everyone remembers Paul Krugman’s article in The New York Times Magazine. He argued:

“[…] the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth. […] When it comes to the all-too-human problem of recessions and depressions, economists need to abandon the neat but wrong solution of assuming that everyone is rational and markets work perfectly. The vision that emerges as the profession rethinks its foundations may not be all that clear; it certainly won’t be neat; but we can hope that it will have the virtue of being at least partly right.” (Paul Krugman, in How Did Economists Get It So Wrong?)

Krugman’s piece sparked a debate concerning the nature of economics and usefulness of abstract mathematical models that utilize a set of extremely unrealistic assumptions—such as perfect rationality. The debate concerning how economists got it so wrong is still going on—see for example, see Jeff Madrick’s Seven Bad Ideas: How Mainstream Economists Have Damaged America and the World (2014), or Philip Mirowki’s Never Let a Serious Crisis Go to Waste: How Neoliberalism Survived the Financial Meltdown (2013), among others.

2008 crisis is one reason why economists have become worried about the assumptions they make, but it is not the only reason. Developments in behavioural-experimental economics and neuroeconomics were also pushing economists in a direction that many of them would prefer not going: discussing philosophical issues concerning the nature and scope of economics. Nevertheless, the challenge was powerful and some economists tried to defend their field against criticism coming from these new research areas (e.g., see Gul and Pesendorfer’s The Case for Mindless Economics). For example, the debate concerning neuroeconomics produced at least two journal special issues (1, 2) and one book entitled The Foundations of Positive and Normative Economics: A Handbook (Chaplin and Schotter 2008). (For the story of behaviroal economics and the challenges it presented, I recommend Richard Thaler’s excellent book: Misbehaving: The Making of Behavioral Economics). And there was the students: Revolting against the way in which economics was taught; demanding a more pluralistic economics education and more real world content. This started with the post-autistic economics movement (later changed its name) and after the economic crisis student revolt spread out. Post Crash Economics Society, for example, demanded that economics education should reflect the post-crash world. Now there is a global network for students, called Rethinking Economics who are working to transform economics education for the better

Although debates concerning the explanatory power of economics became popular in the last decade—especially after the 2008 crisis—such debates were not foreign to economists. History of economics is full of debates like this. Take for example the marginalism controversy in 1940s (for a good review, see the 2nd chapter of Jack Vromen’s Economic Evolution). But heterodox economists started criticizing the assumptions that economists much earlier than that. Consider the Methodenstreit (method debate) between Carl Menger and the German Historical School in late 19th century (Carl Menger’s defense of economics is presented in his Investigations—originally published in 1883). Or consider Thorstein Veblen’s criticism of the hedonistic conception of individuals in economics and its psychological foundations in his in Why is Economics not an Evolutionary Science? in 1898 (read at your own risk!).

To cut the long story short, heterodox economists and other social scientists have long argued that economics is disconnected from reality. They thought that it is way too abstract, unrealistic, value laden, atomistic, reductionist etc. Many still argue that that—because of these reasons—economic models cannot explain real world phenomena. That economic models are too abstract and unrealistic—also, mathematical and sometimes mathy—is still the most popular criticism against mainstream economics. And it is in fact true that theoretical models in economics utilize unrealistic assumptions: Perfect rationality, perfect foresight, perfect competition, etc.; you name it! Economics also ignore obviously important explanatory—historical, sociological, institutional, psychological, biological, neural, etc.—factors. In fact, economic models look like fictional worlds, fairy tales, or just so stories that have nothing to do with the real world. But does this mean that economics is useless?

The question is whether we can trust economic models and economists on important policy matters that affects millions of people. Or more generally, can we learn anything from abstract, unrealistic economic models? If so how? Economics Rules is yet another attempt to settle the answers to these questions. In order to do so, it presents an account of economic models that accept the aforementioned properties of economic models and argues that it is because of these properties (simplicity, abstraction, unrealisticness, etc.) that economics is a powerful science.

Models are Experiments

Rodrik’s Economics Rules starts with an account of what models are and what models do. Not surprisingly, Rodrik argues that models are simplifications. Economic models isolate specific mechanisms and how these mechanisms work under certain conditions. These conditions are specified by the assumptions of the model.

Rodrik’s account of models has a close resemblance to Uskali Mäki’s account of models. The method of isolation helps economists theoretically remove the influence of some elements on a set of other elements in a given situation, so that they can focus on their desired set of relations in isolation. This makes models similar to experiments. In laboratory experiments, scientists physically isolate the environment from the influence of other factors in order to study the relationships they wish to understand. So, they engage in material isolation. Models are similar to experiments in that they utilize isolation; but that is theoretical isolation rather than material isolation.

“Models are the laboratories of economic theorists. This is a claim most economic theorists will accept, and many of them have explicitly made it. Just as laboratory scientists design and examine the artificial worlds of experimental situations in their laboratories, economic theorists design and examine the artificial worlds of their theoretical models.” Uskali Mäki (in Models are experiments, experiments are models)

Rodrik agrees with this view of models. He argues:

“As with real experiments, the value of models resides in being able to isolate and identify specific causal mechanisms, one at a time” (p. 24)

All this, however, does not fully explain how we can trust economic models that utilize unrealistic assumptions. How can it be that a model that does not describe reality in a faithful manner can help us explain real world phenomena? And how can we know that causal mechanisms specified by a certain highly abstract model is working in the world? This is not an easy question. In fact philosophers of science and particularly philosophers of economics have been struggling to answer this question for a long time (see the reading list at the end of this review).

Rodrik’s answer partly comes from his depiction of critical assumptions and causal mechanisms specified by the model. Despite the fact that economic models are abstract and unrealistic, Rodrik believes that there should be some grain of truth in a model. Although he does not explicitly say this, successful models depict real causal mechanisms—or real tendencies (more on tendencies later). And by way of studying these real mechanisms (or, tendencies) under different conditions, models teach us about possibilities, and likely outcomes that we may encounter in the real world.

I made a similar argument in The Invisible Hand in Economics (Routledge, 2008). Using examples of Schelling’s models of segregation, models of emergence of a medium of exchange and game-theoretical models of conventions, I argued that highly abstract economic models (in my case, invisible-hand models) provide partial potential theoretical explanations. They are theoretical, because they abstract from the specifics of any particular case (there are exceptions to this of course, like applied models that are fine tuned to the particular case at hand). They are partial, because they are limited by the assumptions (isolations) they make. Each model starts with a specific question and represents only specific aspects of reality. A particular model is very unlikely to provide a full explanation of a specific case at hand. They are potential because they may or may not help us in explaining particular cases. As Rodrik argues, the problem of external validity is not specific to physical experiments, theoretical (or, thought) experiments also suffer from this problem. Thus we cannot know right away whether the results of the model can be generalized and carried to the real world (also see Robert Sugden’s Credible Worlds on this). Once we make sure that the model (or, a combination of some models) applies to a particular situation—that is, it represents the case at hand in a satisfactory manner—we may use the model in explaining that particular case. This commonly requires knowledge about the specific case at hand, and sometimes input from other sciences. But why do we trust in highly abstract models? The reason we believe that some of these models (providing partial potential explanations) have a chance of enlightening us about the real world is that we think that they represent a real causal (or, structural) relation—albeit in isolation.

I think Rodrik would agree with most of this. Nevertheless, here is what Rodrik says:

“The correct answer to almost any question in economics is: it depends. Different models, each equally respectable provide different answers. Models do more than warn us that results could go either way. They are useful because they tell us precisely what the likely outcomes depend on.” (p. 17) “The value of models resides in being able to isolate and identify specific causal mechanism, one at a time. These mechanisms operate in the real world alongside many others that obfuscate their workings is a complication faced by all who attempt scientific explanations. Economic models may even have an advantage here. Contingency—dependence on specific postulated conditions—is built into them” (p. 24).

By utilizing a different set of assumptions each model helps economists to study the possibilities in the real world. Thus, in Rodrik’s account, unrealistic assumptions help economists investigate likely outcomes in different settings. However, Rodrik argues, one should still have a reality check: Some assumptions are critical and model results will be true “only to the extent that their critical assumptions approximate reality” (p. 17). “For a model to be useful in the sense of tracking reality, its critical assumptions also have to track reality sufficiently closely” (p. 26). Note however that this concept of critical assumptions is not entirely clear (more on this later).

Tendencies

So, Rodrik argues that each model focuses on some aspects of the real world rather than others. For this reason, he argues, in economics it is more appropriate to talk about tendencies. This emphasis on tendencies echoes John Stuart Mill and Nancy Cartwright. Although Rodrik does not explicate his conception of tendencies in a way that would satisfy philosophers, his basic point is that what we learn from models is context-specific: Model results help economists explore tendencies in the sense that models help us specify likely outcomes of certain isolated causal factors in different settings. Thus, Rodrik argues, it is a mistake to forget this. One should not carelessly generalize a model’s results, because its result are dependent on its assumptions. Rodrik claims that “economics is a social science, and society does not have fundamental laws” (p. 45), thus economists should not behave as if they have discovered fundamental economic laws.

Models as Fables

Rodrik’s characterization of economic models does not end here. He also uses another analogy: Economic models are like fables. Of course, Rodrik is not the first economist to use this useful analogy. See, for example, how Ariel Rubinstein explains the similarity between fables and models:

“As economic theorists, we organize our thoughts using what we call models. The word “model” sounds more scientific than “fable” or “fairy tale” although I do not see much difference between them. […] A good model in economic theory, like a good fable, identifies a number of themes and elucidates them. We perform thought exercises that are only loosely connected to reality and that have been stripped of most of their real-life characteristics. However, in a good model, as in a good fable, something significant remains.” (Rubinstein, in Dilemmas of an Economic Theorist, p. 881)

In contrast to Rubinstein, Rodrik makes a good use of the fable analogy in defending explanatory power of economic models. According to Rodrik, fables are similar to economic models because, fables are simple, fictional (not real), have clear story lines and morals:

 

Economics Rules for the BLOG_2[Source: Rodrik’s slides]

The most important part of the analogy is that there are a multiplicity of fables—sometimes with contradictory morals—each for a different situation. But why is this the most important part of the analogy?

“There are countless fables, and each provides a guide for action under a somewhat different set of circumstances. Taken together, they result in morals that appear contradictory.” (p. 20)

Economic models are like fables in the sense that different models give us different and sometimes contradictory results. The moral of the story—policy conclusions we can derive from the model—is context-dependent. Because different models utilize a different set of assumptions, each model tells us about how the specified mechanism might behave under different conditions. Thus, although economic models are simplifications, using a variety of models economists are able to explore a wide range of possibilities. The same mechanism can produce different results under distinct conditions.

The interaction of the rational and economizing agents give us different results in different models. Rodrik gives several examples. For example, he compares firms in a perfect competition setting with firms in a prisoner’s dilemma setting. The difference is: The first setting (model) describes competition among many firms and the latter is used to describe competition among two large firms. Under perfect competition profit maximizing rational firms will bring about a Pareto efficient result. However, in a prisoner’s dilemma setting, Rodrik argues, the market “is not at all efficient” (p. 15). Each model represents two “different versions of how markets function (or don’t). None of them is right or wrong” (p. 16).

So, we have a diversity of models that sometimes contradict each other. However, according to Rodrik, just like simplicity and unrealisticness of economics models, the diversity of models is not a bug, it is a feature. Having multiple models—each representing a different set of circumstances—is why economics is a powerful social science. One may think of models as providing us with a menu of explanatory factors, or a menu of possible explanations. By exploring the model world by way of changing the assumptions of previous models and by developing new models, economists expand their menu of possible explanations. The cluster of models that are relevant to the case at hand become economists’ toolbox in providing explanations to particular cases. By choosing and fine tuning a (or, a set of) model(s) among the long list of available models, economists try to explain particular cases. The longer the list of models, the wider their menu of possible explanations, and the higher their chances to explain the case at hand. This is why the diversity of models in economics is not a bug, but a feature.

Understanding with theoretical models

I may be biased here (you’ll see why), but I think, Rodrik’s most important contribution in this book is to clearly show—with a lot of examples—how the collection of economic models contribute to our understanding despite the limitations of each individual model.

Let me insert another shameless reference to my own work here. Together with Petri Ylikoski from the University of Helsinki, we wrote a paper entitled Understanding with Theoretical Models. The argument in this paper has some similarities to Rodrik’s argument—although in our case it is filled with philosophical jargon. In this paper we have presented a number of claims concerning the epistemic contribution of theoretical models in economics (and elsewhere). Let me list some of the arguments in this paper together with how I think Rodrik’s argument as an economist parallels (confirms?) our thinking:

  • One should not evaluate theoretical economics models in isolation from other models. This is a mistake that many philosophers and critics—and sometimes economists—make. To put it like Rodrik, they focus on a model, think that it is the model, and criticize it because it is not sufficiently similar to the real world enough.
  • A theoretical economic model’s contribution to our understanding can only be fully understood if it is considered in a context of a family of related models and of competing explanations for the same phenomenon. In Rodrik’s words, it is the diversity of economic models that gives power to theoretical reasoning in economics.
  • Theoretical economic models provide modal understanding: they tell how things could be. They also teach us what cannot happen by showing that certain mechanisms cannot generate the specified outcomes. In fact, theoretical modelling should be understood as how-possibly reasoning. In Rodrik’s terminology this is to say that economics models helps us answer “what questions?” such as “what is the effect of A on X?” and investigate the answer of this question in isolation under different conditions. By way of doing this they teach us about likely outcomes, possibilities: “Just as social reality admits a wide range of possibilities, economic models alert us to a variety of scenarios.” (p. 209)
  • A theoretical economic model provides us with an essential understanding of certain causal mechanisms—albeit in isolation. By developing a variety of models economists provide us with a more detailed understanding of mechanisms and the possible ways in which they may interact under different conditions. This makes it easier to adapt the mechanisms specified by economic models to particular cases—in providing explanations to a particular case in hand. In Rodrik’s words: “[Economic models] are contextual and come in almost infinite variety. They provide at best partial explanations, and they claim to be no more than abstractions designed to clarify particular mechanisms of interaction and causal channels.” (p. 114, emphasis added).
  • Main contribution of economists in developing a variety of theoretical economic models is to refine, systematize, and expand the menu of possible explanations. Or in Rodrik’s words: “The multiplicity of models does not imply that anything goes. It simply means we have a menu to choose from and need an empirical method for making that choice.” (p. 73-4)
  • Scientific understanding consists of an ability to make correct what-if inferences. Theoretical economic models contribute to our general ability to construct an explanation, new models expand the scope of our explanatory understanding. They allow us to make what-if inferences about a wider set of phenomena. In Rodrik’s words: “What makes economics a science is models. It becomes a useful science when those models are deployed to enhance our understanding of how the world works and how it can be improved.” (p. 83) “Knowledge accumulates in economics not vertically, with better models replacing worse ones, but horizontally, with newer models explaining aspects of social outcomes that were unaddressed earlier. Fresh models don’t really replace older ones. They bring in a new dimension that may be more relevant in some settings.” (p. 67)

I am happy to see that a prominent economist like Dani Rodrik, at least partially, confirms our intuitions concerning theoretical models in economics. Moreover, he presents a lot of examples from history of economics and current debates on economic matters that will help us fine tune our intuitions.

Critical Assumptions

Although I agree with most of what Rodrik says, I also have some small complaints. One of them concerns Rodrik’s conception of critical assumptions. As mentioned earlier Rodrik thinks that there should be some grain of truth in theoretical models: Model’s critical assumptions should reflect reality. But what are critical assumptions? How can we decide whether an assumption is critical, or not? Although Rodik gives some hints, this is not entirely clear. He argues:

“We can say an assumption is critical if its modification in an arguably more realistic direction would produce a substantive difference in the conclusions produced by the model” (p. 26)

This is not very helpful, because one can think of many examples where the results of a model changes as a response to changes in many of its assumption. Is rationality a critical assumption? Is perfect competition a critical assumption? Is “convex preferences” a critical assumption? Is assuming a Cobb-Douglas production (or utility) function critical? The list can go on. Changing these assumptions—making them more realistic—will give us different results under some settings. So how are we going to decide which assumptions are critical?

Although Rodrik gives some examples, I do not think that he resolves this matter satisfactory. But there may be a reason for this. Rodrik argues that “what makes an assumption critical depends in part on what the model is used for” (p. 29). However, as Rodrik—and, Robert Sugden, Uskali Mäki, and David Colander—argues economists do not always provide a users’ guide to abstract theoretical models. More often than not they are silent about what the model could be used for. Moreover, economists sometimes use the same model for different purposes. For this reason identifying critical assumptions may not be as easy as it sounds. It is probably an art, or a craft—requiring economic intuition, experience, etc.—as Rodrik argues: “Good judgement and experience are indispensable, and training can get you only so far” (p. 83). (Note here that Rodrik provides some guidance in the 3rd Chapter of the book.)

How to evade criticism?

So how does Rodrik help economists evade criticism concerning economics? In order to learn that—and many other things–you need to read the book. But here is a chapter by chapter guide to the book.

Chapter by chapter guide to Economics Rules

  • Chapter 1: What Models Do. The first chapter of the book discusses what models are and what models do. It is in this chapter that Rodrik introduces the variety of models thesis and argues that both unrealistic assumptions and mathematics are useful in economic modelling. He also dismisses the idea that economic models should be more complex and tries to show why we should appreciate the simplicity of economic models.
  • Chapter 2: The Science of Economic Modeling. In the second chapter, Rodrik makes the case for economics as a social science—distinct from physics. He argues that economics does not have fundamental laws, and economists should not behave as if they have discovered the fundamental laws of economics and society. This chapter also presents a review of what makes models scientific: Models clarify hypotheses, enable accumulation of knowledge, imply an empirical method, and help economists generate knowledge based on shared professional standards. Moreover, in this chapter, Rodrik explains the importance of “second best” thinking, the difficulty of testing economic models, and why knowledge accumulation in economics depends on the development of new models (including explorations of older models—i.e., by way of changing some of their assumptions). Finally, in this chapter, Rodrik presents his take on the Reinhart and Rogoff debate.
  • Chapter 3: Navigating among Models. In this chapter, Rodrik guides the reader in navigating among models using his own growth diagnostics Then he goes on to explaining the general principles of model selection: How to verify (i) critical assumptions of models, (ii) mechanisms specified by a model, (iii) direct implications of models, and (iv) incidental implications. This chapter also discusses lab experiments, (randomized) field experiments, natural experiments and the problem of external validity.
  • Chapter 4: Models and Theories. As its title suggests, this chapter discusses the relationship between theories and models. Rodrik demarcates between three questions: What questions (“what is the effect of A on X?”), why questions (“why did some particular event take place?”) and big, timeless questions (“what determines the distribution of income?”). Rodrik argues that economic models answer what questions. Answering why questions requires using particular models or a set of models fine tuned to the specific case at hand—and maybe input from other sciences. Big questions require universal theories, and according to Rodrik it is impossible to formulate universal theories in social sciences. One important argument in this chapter is that general economic theories are frameworks for organizing our thoughts, “rather than stand-alone explanatory frameworks” (p. 116). In order to show this, Rodrik sweeps through history of economics; exemplifying his argument with discussions of theory of value and distribution, and theory of business cycles and unemployment. Later in the chapter he discusses how theories are used in order to explain specific events; using the example of the rise of inequality in US. These types of explanations in economics, Rodrik argues, are not like universal theories, rather they are specific to particular cases. Finally Rodrik argues that economics is a modest science that mostly tries to answer what questions, investigating one cause at a time.
  • Chapter 5: When Economists Go Wrong. In this chapter Rodrik explains what happens when economists mistake a model with the model and warns against the apparent agreement among economists concerning certain policy proposals. In is in this chapter that Rodrik discusses the financial crises and its aftermath, and the case of Washington Consensus. This chapter clarifies that mistaking a model (more appropriately, economists’ preferred models at the time) for the model is the most important reason why economists go astray. In the case of the financial crisis, the preferred models were models that support the efficient market hypothesis. In the case of Washington Consensus, the preferred models were the models that assume that the main drivers of growth were saving and access to investable funds. So how did economists get it so wrong in both of these cases? Not because they did not have appropriate models (they did), rather they became overconfident concerning some models, and ignored others. They have confused a model, with the In brief, Rodrik argues that economics is not the problem, economists are. Here are some of the mistakes that economists makes: Mistaking a model with the model, overconfidence in a (set of) model(s), false sense of understanding concerning the way in which markets work, market favoritism, inability to connect models with the real world and—for empirical economists—empirics without models.
  • Chapter 6: Economics and Its Critics. In this chapter, Rodrik responds to critics. He argues that idealization, abstraction, utilization of unrealistic assumptions, methodological individualism are not problems as long as one appreciates the diversity of economic models and accepts the fact that each economic model is an attempt to understand some real world relationships in isolation. Market favoritism is not a problem of economics, and does not require a remaking of economics; it is rather a problem created by some overconfident economists who do not appreciate the diversity of economic models. It is true that economic models cannot be tested like the models in physics, but this is because economics is a social science. Economics deals with this “problem” by way of “expanding the collection of potential applicable models, with newer ones capturing aspects of social reality that were overlooked or neglected by earlier ones” (p. 183). Similarly, because economics is a social science economic models should not be expected to provide precise predictions; rather economics help us make conditional predictions. Contrary to what many critics say, economics is more pluralist than it appears—exemplified by behavioral, experimental and institutional economics. Finally, this last chapter has a discussion concerning whether economic thinking and marketization undermine social values.
  • Epilogue: The Twenty Commandments. This chapter presents, Ten Commandments for economists and ten for non-economists: these summarize the basic messages of the book for economists and non-economists.

Conclusion

In sum: Economics Rules is an excellent book; a must read for mainstream and heterodox economists, philosophers of economics, policy makers, and of course for economics students.

Let me end the review with Rodrik’s Ten Commandments for economists:

Ten Commandments for Economists

  1. “Economics is a collection of models; cherish their diversity.
  2. It is a model, not the model.
  3. Make your model simple enough to isolate specific causes and how they work, but not so simple that it leaves out key interactions among causes.
  4. Unrealistic assumptions are OK; unrealistic critical assumptions are not OK.
  5. The world is (almost) always second best.
  6. To map a model to the real world you need explicit empirical diagnostics, which is more craft than science.
  7. Do not confuse agreement among economists for certainty about how the world works.
  8. It’s OK to say “I don’t know” when asked about the economy or policy.
  9. Efficiency is not everything.
  10. Substituting your values for the public’s is an abuse of your expertise.”

(Rodrik 2015: 213-4).

Note: All references are to the Kindle (UK) edition:

Rodrik, Dani (2015). Economics Rules: Why Economics Works, When It Fails, and How To Tell The Difference. Oxford University Press. Kindle Edition.

Further Reading

Here is a reading list for those who would like know about what philosophers and philosophers of economists has to say about these matters (in no particular order).

Textbooks

Handbooks