Home > economics community, foundations of econ, philosophy of science > You wouldn’t like me when I’m angry blogging: Peter Dorman Edition

You wouldn’t like me when I’m angry blogging: Peter Dorman Edition

Following another long microfoundations-in-macro-are-crap debate (see here, here and here),  Peter Dorman says some things that really annoy me–he criticizes not just macro, but micro.   As a micro theorist working on some of these issues; I have to say not only is Peter wrong on some of this, but he’s wrong in a way that seriously disrespects the ongoing state-of-the-art work that people are actually doing.   I’m going to deal with his post in reverse order, from most in agreement to least.

3. Path dependence.  Microfoundations means general equilibrium theory, but the flavor it uses is from the mid-1950s.  The Sonnenschein-Debreu-Mantel demonstration (update to the 1970s)  that initial conditions and out-of-equilibrium trades alter the equilibrium itself (they assume away problem #2) has turned GET upside down.

Notice that I haven’t mentioned the standard heterodox criticisms of representative agents and ergodicity.  You can add those if you want.

This is certainly true.   Although, it is not as though people don’t think about this sort of thing: in fact I wrote a post not too long ago which touched on the topic.   “Equilibrium” requires a disequilibrium, but equilibrating, process to maintain itself:  the informational requirements of equilibrium are enormous, even in a simple 2 by 2 game, and so agents will need to observe “off-path punishments” to understand the “proper” equilibrium course of action.   As I like to say, signals require realizations.

But again, people think about this sort of thing.   There’s a whole literature about self-confirming equilibria and the application to macro.   For example, things like path-dependence or mutually inconsistent beliefs.   Its not the fault of the micro people that the macro people ignore that work.   Peter would know this if he gave the micro people credit for not being idiots and did a quick search on Google Scholar.

Next up:

2. Mono-equilibrium assumptions.  There are no interaction effects to generate multiple equilibria in the microfoundations macro theorists use.  Every individual, firm and product is an isolated atom, floating uninterrupted through space until it bumps into another such atom in the marketplace.  Social psychology, ecology, nonconvex production and consumption spaces?  Forget about it.  In evolutionary biology, by contrast, fitness surfaces are assumed nonconvex from the get-go; it’s central to the discipline.  Failure to recognize the interactive character of economic life leads economists to ask fundamentally wrong questions, like “what’s the equilibrium?” and “what’s the optimum?”  If this isn’t obvious to you already, you can get a longer version of the argument here.  (Note for those who are wondering: no, nonconvexity stemming from interaction effects has nothing to do with market failure.  The existence of externalities is neither necessary  nor sufficient for these effects.  See for yourself.)

This isn’t even an assumption the macro-economists are making anymore.   Peter can be forgiven for his point 3), since the macro people do seem to ignore it, but there is less of an excuse here.   Hasn’t he read anything from Farmer or Basu or DeGrauwe?   All of them deal  with multiple equilibria in macro.    There’s plenty to criticize there, but not considering multiple equilibria is not among those criticisms.   Hell, this is considered a hot topic in macro right now.

Finally:

1. Utility theory.  Andrew Gelman calls this “folk psychology”; that may be generous.  It is rife with anomalies (see “behavioral economics”), and, most important, it is oblivious to the last several decades of work in psychology, evolutionary biology, neuropsychology, organization theory—all the disciplines where people study behavior in a scientific way.

This is a major peeve of mine.   I already have a couple posts about it.   This is just about as wrong as you can possibly be.   To overturn utility theory, you need one thing and only one thing can possibly do it: preference reversals.   There has never been a preference reversal observed ceteris paribus.   Trust me on that.

The frontier in behavioral theory is not “utility theory doesn’t work, let’s find a replacement”.   Rather, it’s clear at this point that apparent violations, i.e. preference reversals, to utility theory are not on the “utility” side of the problem, but on the budget side.   There are hidden variables that act as constraints.

Utility seems wrong to people–especially people who haven’t thought too deeply about it–but when it comes down to it, utility is a trivial, almost circular concept.   It is not that people have a utility function in their heads which they maximize: rather it is that if people’s behavior can be predicted, then you can always write down a utility function when you’ve properly accounted for constraints.   It is “as if” people have a utility function, which is enough to make it a useful formulation–and then it’s just up to the psychologists and the behaviorists to tell us something about the form it takes (i.e. not time-separable, nor purely hedonistic, etc).

Why does this annoy me so much?  Well, its true that, as an almost circular concept “utility theory” is almost impossible to disprove… meaning that you shouldn’t really call it a “theory” at all.   Not worth defending, right?   Well, what sticks me the wrong way is the “folk psychology” argument.   Utility is at least a marginally successful attempt to do economics without an appeal to psychology–and should be understood as an attempt to sidestep psychology.   We are interested in the problem of scarcity, not directly in behavior.

Behaviorism has taught us that we need the psychologists anyway, but  that doesn’t mean that we learn nothing from utility; we still learn quite a bit just comparing different candidate forms of utility to each other.

On a broader note, the heterodox types like Peter, always seem to be too quick to reject out of hand the real contributions of the standard theory.   Science is not about truth but observable fact and on that score, the standard theory works surprisingly well–most of it, at least.  Even the parts that are no longer considered at the forefront–like expected utility, which has now been replaced by prospect theory–work far more often than they don’t.   If you want to contribute, then you have to take as your starting point what the theory does right before you reject the whole menu willy-nilly.

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  1. Peter Dorman
    July 28, 2012 at 7:50 am

    A brief reply, since I’m sworn to shun work this week: (1) You are absolutely right about disequilibrium adjustment. It is a mess in 2×2 and, to my knowledge, not analyzable (yet) in nxn. Macro people ignore it, and it would drive them nuts if they didn’t. (2) Yes, utility theory can be made almost infinitely flexible, since any behavioral function can be written as an optimization function (I think), although that strikes me as an extra, almost ritual step. But the practical point is that macro people generally rely on very simple optimization functions that are empirically disconfirmed, perhaps throwing in, for a single agent, one with a trendy behavioral flavor. (3) Sorry: my point about mono-equilibrium is not that macro people don’t play with them, but that they are so restricted in their use that the effort is mostly vitiated. You’ll note that in the linked paper (which I wrote in less than a day on the way to conference, alas, which is why it has no references) I do mention Farmer in particular, favorably. But it is one thing to have a model with two identifiable equilibria, one good and one bad, and another to have an indefinitely large number, beyond your ability to globally evaluate, based on pervasive nonmarket interaction. Maybe you should look at the longer paper to get the point. As the number of equilibria expands, the predictive power of equilibrium-identifying analysis dissipates.

    In any case, sorry to ruin your day.

    • BSEconomist
      July 28, 2012 at 11:21 am

      I, too, have to keep this brief (sadly, I have work to do). Thank you for replying, though.

      On (2) Almost. I thought I included enough caveats in my original post, but perhaps not. The flexibility of utility theory ends when you’ve identified preference reversals/cycles, which can’t be explained away on the grounds that all else is not quite equal.

      I agree, and have said so myself, that this flexibility does not mean that utility will always be useful. If utility theory falls, it will be on the grounds that it is no longer useful. Even if utility theory is decisively proven “wrong”–something the behaviorists have tried and failed to do–it’s still not clear that would kill utility theory, on grounds of usefulness. Science is about results, not truth, and we are in the science of scarcity, not behavior.

      On your critique of macro, I am entirely with you, though. My goal is to keep the macro wars out of micro–which is in my opinion a much healthier subject–not to defend macro.

      I may take a look at your paper if I have a chance, although you’re preaching to the choir on this point. Actually, this is one point that I definitely have a disagreement with my adviser, which perhaps means that I am heterodox, at least in this area…

      It seems obvious to me that if you put any reasonable tatonnement process into this high dimensional phase space that the Lyapunov exponent–measuring convergence to equilibrium–would have to be positive (if for no other reason than because of the local nature of the equilibrating process and the global nature of the equilibrium… different agents could be converging to different equilibria) which would mean the system is fully chaotic. There is a massive coordination/informational requirement at the heart of Walrasian dynamics which is “solved” by the Walrasian auctioneer–which means that it’s not solved since there’s no such thing.

      As far as I know, there’s been some work in this area, but not much–I could be wrong… maybe that’s what you’re doing in that linked paper. My adviser actually wants me to use my ideas for equilibrium selection when my view is that–the ideas in question (which I’d rather not get into in a public forum)–worsen chaos, if anything.

      Regardless, you didn’t ruin my day, I enjoy a good argument and I also (usually) enjoy what you write.

  1. July 22, 2012 at 1:50 pm

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