The problem at the heart of modern economics is buried in the logical positivist methodological foundations created in the early twentieth century by Lionel Robbins. Substantive debates over the content actually strengthen the illusion of validity of these methods, and hence are counterproductive. As Solow said about Sargent and Lucas, you do not debate cavalry tactics at Austerlitz with a madman who thinks he is Napoleon Bonaparte, feeding his lunacy. Modern Macro Models are based assumptions representing flights of fancy so far beyond the pale of reason that Romer calls them “post-real”. But the problem does not lie in the assumptions – it lies deeper, in the methodology that allows us to nonchalantly make and discuss crazy assumptions. The license for this folly was given by Friedman: “Truly important and significant hypotheses will be found to have “assumptions” that are wildly inaccurate descriptive representations of reality”; see Friedman’s Methodology: A Stake through the Heart of Reason. In this sequence of posts, I will explain how economic methodology went astray in the 20th Century, abandoning empirical evidence in favor of mathematical elegance and ideological purity. Many authors have noted this problem — for instance, Krugman writes that the profession (of economists) as a whole went astray because they mistook the beauty of mathematics for truth (see Quotes Critical of Economics). To explain the flaws of economic methodology, we need to discuss the relationship between economic models and reality.
Science is about looking at the appearances and grasping the nature of the hidden reality which creates these appearances. For example, we might look at falling apples and deduce the existence of a force of gravity. Dalton looked at how compounds combine in fixed proportions and deduced the existence of molecules. The deep structures of reality are hidden, and we can never be certain if our guesses are correct. Early astronomers saw the motions of the planets and hypothesized the existence of Celestial Spheres orbiting around the Earth, on which the stars were pasted. This was a bold hypothesis, later proven wrong, like many other scientific theories.
How can we go from appearances to hidden reality? This is always an intuitive process, which is neither deductive nor inductive. There are two important philosophical concepts involved in conjectures about hidden realities. The first of these is Epistemology – the theory of knowledge. How can we human being acquire knowledge about reality? What it does it mean to have knowledge? How can we know if the knowledge that we have is true and correct? The second important concept is about Ontology – the study of being (existence). What are the kinds of objects and effects that exist in external reality? So, the question “Does God Exist?” is a question of ontology. Similarly, the questions about the existence of electrons, gravity, electro-magnetic forces, dark matter, quasars, black holes are all questions of ontology. The second and different question is: how can we know whether or not these objects exist? This is a question of epistemology, referring to our knowledge about objects, rather than the existence of the objects themselves.
It is useful to introduce these terms because there is a common confusion between the two. In particular, a very common mistake is to say that I cannot learn about the existence of God (epistemological problem) and therefore God does not exist (ontological conclusion). This has been called the “epistemic fallacy” by Bhaskar Roy. A simpler and more vivid name would be the “ostrich fallacy”. If I bury my head in the sand, the threat I cannot see does not cease to exist. Just because our senses do not see ultraviolet, and our minds cannot grasp the complexities of subatomic particles, this does not mean that they do not exist. Limitations of our sensory and mental apparatus for acquisition of knowledge does not create barriers to objects and effects to exist in external reality. Models are the link between epistemology and ontology. Models are a special type of KNOWLEDGE that we use to create a MAP of external reality within our minds. The relation between the knowledge we have (represented by models) and external reality is of central importance. Unfortunately, this is not discussed directly and explicitly in conventional textbooks of economics. But this does not mean that they have nothing to say about these topics. In fact, in a process of learning-by-doing, textbooks teach us an epistemology and an ontology without using these words. Unfortunately, this implicit philosophy is deeply and fundamentally flawed. In subsequent posts, I will try to dig out the hidden logical positivist foundations of modern economic methodology, and explain why these foundations lead to very bad models.