How Economic Models Became Substitutes for Reality

This is the introduction of my recently published paper “Models and Reality: How did models divorced from reality become epistemologically acceptable?” (May 3, 2020). Real World Economics Review, Issue 91, p20-44, March 2020. Available at SSRN: https://ssrn.com/abstract=3591782

1: Intro: From Surrogates to Substitutes

The problem at the heart of modern economics is buried in its logical positivist foundations created in the early twentieth century by Lionel Robbins. Substantive debates and critiques of 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 macroeconomic 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 (1953, reproduced in Maki 2009A): “Truly important and significant hypotheses will be found to have ‘assumptions’ that are wildly inaccurate descriptive representations of reality”. In this article, I sketch an explanation of 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.

To begin with, it is important to understand that modern economics is entirely based on models. There is a lot of merit to the idea that economic knowledge must be encapsulated in models. This is because economic systems are complex and interactive. We may well have strong intuitions about some local aspects of the system, but when we put all our intuitions about the different parts together, something unexpected may emerge. This is now well known as the phenomenon of complexity, and emergent behavior. This also explains the central importance of mathematics in modern economics. When we want to piece together parts of a complex system into a whole, mathematics is necessarily and inevitably involved, because the required integration cannot be done intuitively and qualitatively. The central hypothesis which drives this paper is that the relationship between economic models and reality shifted over the course of the 20th century. The nature of this shift can be described by borrowing some insightful terminology from Maki (2018). He defines two types of models. One is a surrogate model: such a model is a simplification which attempts to match some complex reality, and can be judged by the degree of resemblance it achieves. The second type is a substitute model: the imagined mini world of the model is a substitute for the target maxi real world, rather than an attempt to approximate the latter. As Maki (2018)) notes: “surrogate models can be wrong (or right), while substitute models cannot even be wrong about the world (since they are not presented and examined as being about the world).” Our main thesis in this paper is that economists started to use models as surrogates, but eventually fell in love with their own creations, and began to treat them as substitutes for the real thing.  The goal of this paper is to sketch how and why this happened.

2:A middle-brow history of methodology

Our goal in this essay in NOT to add to the debunking of economics – this task has been done in many books and essays, and the debunking has been contested by many other books and essays. A balanced state of the art survey is available in Uskali Maki (2002) who opens the book with:
Fact or fiction? Is economics a respectable and useful reality-oriented discipline or just an intellectual game that economists play in their sandbox filled with imaginary toy models? Opinions diverge radically on this issue, which is quite embarrassing from both the scientific and the political point of view.

Instead of joining this debate, we take the second option as a given: economics is an intellectual game that economist play with toy models. We are interested in the meta-question of how did this become possible? What are the trends in history of thought which allowed the development of models completely divorced from reality?

A book length detailed treatment of the answer to this question has been provided by Manicas (1987) in “A history and philosophy of the social sciences.” The central thesis of this “embarrassingly ambitious” book challenges the very notion of “social science”, suggesting that it was built on the wrong foundations. A very brief outline of the central ideas of this book is as follows.

  1. The practices of the modern sciences which emerged in the sixteenth and seventeenth centuries were incorrectly characterized. For various historical reasons, this remained unrecognized in the more refined and sophisticated ‘philosophies’ of science which subsequently came to be articulated.
  2. Social sciences took their modern shape in the early 20th Century as the result of a deliberate attempt to apply the ‘scientific method” to the production of knowledge about human societies. But the understanding of the scientific method was deeply flawed. As a result, the “methodology” adopted for use in social science was also deeply flawed.

According to Manicas, “The upshot is the possibility of a thoroughgoing revolution in the received ideas of science, natural and social. It allows us to ask whether there is a huge gap between the ideology of science and practices in the physical sciences, and whether, more disastrously, the social sciences have been ideologically constituted in the sense that they were based on a misconception about what the physical sciences are.”

In a commentary on Rodrik’s (2015) defence of economic methodology, Maki (2018) writes that “The portrait of economics offered by philosophers of economics… (is)… too refined for practicing economists, but the degree of refinement… (in understanding economic methodology)… currently held by practicing economists is often too low.” The message of Manicas (1987) is central to understanding current methodology of social science, and leads to the possibility of a thoroughgoing revolution. However, reading and understanding this book requires background in history and philosophy which very few economists have. As a partial remedy, I have attempted to provide a coarse-grained and crude summary of some of the highbrow philosophical ideas which have driven the development of methodologies in the social sciences in general, and economics in particular. The goal is to explain how it became possible to think that it is reasonable to develop models without connecting them to external real world structures. We begin with a rough description of what this methodology is, based on an experiential view, rather than a theoretical perspective.

To read remainder of paper, see https://ssrn.com/abstract=3591782

6 comments
  1. I started reading the paper on SSRN. There are a lot of interesting things in it.

    But I am confused about the basic analysis. The theoretical framework is presented as a criticism of empiricism, and its role in the social sciences and especially economics. For example, you say ‘that “empiricism” is at the heart of the failure in constructing a valid realist philosophy of science’. But the actual examples of where economic theory goes wrong are criticising the lack of correspondence with the real world. For example, you approvingly quote Bergmann (2007): ‘She explains how biologists spent thousands of hours studying dolphins to learn some principles of their behavior. In contrast, economic theories of firms are based entirely on mental considerations, without any study of firm behavior at all: …’. There are other instances throughout the paper. So shouldn’t the criticism of logical positivism focus on its elevation of logic – deduction from axioms/a priori principles – rather than on the way it draws on Bacon and the later empiricists?

    I appreciate that some versions of empiricism, usually called (and disparaged as) positivism, are totally inadequate as a view of how the natural sciences work. Science is a combination of the empirical method (admittedly not the same as empiricism) and realist thinking. It iterates between observations (in the broadest sense, and including experiments) and theorising about how the observed phenomena are brought about. The latter is often referred by scientists to as trying to understand the mechanism. (Beware though: philosophers of science have written a lot about mechanisms in the last 20 or so years, but use the term in a different way from scientists, despite claiming that they are following scientists’ usage.)

    To sum up: shouldn’t it be apriorism, and excessive use of logic in its mathematical expression, that is criticised as the main problem with the way economists theorise? (Or possibly, the wrong use of mathematics rather than its excessive use.) And to go beyond criticism to a more constructive analysis, i.e. how economic (and other) theorising should actually be done: shouldn’t one be advocating an iterative combination of the empirical study of observed real-world phenomena, and realism in the sense of hypothesis generation about the mechanisms involved (which may well be unobservable), so that they can then be tested against reality?

    What have I missed?

    • Scientific process involves (1) looking at data (phenomena), (2) guessing at the hidden reality (noumena) which generates the data, and (3) finding ways, direct or indirect, to verify these guesses — Empiricism stops at (1) and argues that noumena cannot be discovered/known.

      • Thank you. So basically, the empiricist view is incomplete, in that it does not recognise the importance of your (2) and (3), what I refer to as the iterative process of science.

        But I still don’t see why that is regarded as the main problem with theoretical economics, where the problem seems to me to be with the a priori method and reliance on logic. This is the natural interpretation of at least some, but probably almost all, of the examples where economic theory is seriously at odds with reality. More empirical method (if not empiricism as a doctrine) is needed, not less?

      • You are right — Economists start in a fairytale and stay in the fairytale and NEVER refer to reality at any stage of the process. I thought that I explained this in the article – this is the difference between surrogate and substitute models,. The article explores how we got here

      • Sure – I think your description is spot on. It’s getting my head around your descriptions of the philosophical “ism”s that is the part I’m having difficulty with.

        Normally I don’t pay any attention to “ism”s. But it seems to me that getting the analysis right at the abstract level is important in this case, because in trying to find a positive way forward, people tend to criticise perfectly sensible approaches using philosophical terminology – e.g. throwing around terms like positivism, without (it seems to me) much thought about what’s actually going on. Not that I’m saying that you are doing this, but I’ve come across it many times.

  2. Craig said:

    Your observations are correct Asad.

    Unfortunately mathematics and science have become 95% memorization and then addiction to that memorization. Wisdom however, is being in the present moment and integrating the truths in apparent opposites so that one can actually see and control their own abstractions moment to moment instead of, like Marley’s ghost, them blinding, distracting and/or weighing down one’s conclusions.

    The ancients utilized debt jubilee’s to resolve its build up, but the debt always grew back to de-stabilizing levels. That is a clear sign that an old/present paradigm has gone on too long. When paradigm/pattern concept change occurs “emergent qualities” generally drop out and a new level of simple truth, workability and applicability comes to the body of knowledge/area of human endeavor that the paradigm applies to. Let us be smarter than the ancients.

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