economic models

Interpretation is Everything

Rick Weber Current Events, Economics, Philosophy , , ,

I’ve got a thing for models. And COVID has meant a lot of cool little models of disease transmission have been coming across my desk. This has been fun for me. But it’s also an intellectual minefield. Models help us tell stories and think through versions of the world that haven’t happened, but could. And they leave us feeling confident that we understand the world we’re operating in.

But it’s worth remembering a key inescapable fact: you always have to use your best judgment. There are no straightforward conclusions you can get for free without taking a risk of being wrong. A model showing that masks are worth it misses knock on effects. That doesn’t mean the model is useless, just that it only captures one part of the world.

Take the humble supply and demand model. We take a couple of lines, add in some other conditions (e.g. taxes, transaction costs, price controls, etc.), do a little algebra, and voila! You’ve got yourself a conclusion: subsidizing a good will result in people buying more (despite the private benefits of those extra units being less than the private costs). If you find some reasonable estimates of the elasticity of supply and demand for a product you can figure out how much impact a subsidy would have. Ceteris paribus.

All models rely on the ceteris paribus assumption in some form. If a model didn’t hold something constant it wouldn’t be a model anymore, it would just be a copy of reality.

In the case of supply and demand we’re rolling pretty much all the interesting things into that all-else-held-equal assumption. Language, history, legal structure, current events, politics, technology, and all the infinite possible interactions between things. Subsidizing face masks in 2019 would have seemed like a mistake, holding constant the state of affairs in 2019. Sure, we could have figured out that there was some sort of positive spill-over for masks even without a pandemic. But we could have also identified any number of other threats competing for scarce resources.

My advice to students: maintain humility. (My advice to non-students: maintain a student mindset.) Economics provides an incredibly powerful set of tools, but it doesn’t make you a god. There’s no getting around the fact that you’ve got to simplify reality to understand it and there’s no fool-proof formula for identifying things that make sense to hold constant in a constantly changing world.

Nomic-nomics?

Rick Weber Culture, Law, Liberty, Philosophy , , , , ,

Perhaps the coolest thing I’ve found on the Small Internet so far is the game Nomic. From where I found it:

Nomic was invented in 1982 by philosopher Peter Suber. It’s a game that starts with a given set of rules, but the players can change the rules over the course of the game, usually using some form of democratic voting. Some online variants exist, like Agora, which has been running since 1993.

It’s a game that’s about changing the game. Besides offering a tempting recreational opportunity, I think this could be formalized in such a way to make it rival the Prisoners’ Dilemma (PD) in shedding light on the big social scientific questions.

The PD is a simple game with simple assumptions and a variable-sum outcome that lets it work for understanding coordination, competition, and cooperation. One of my favorite bits of social science is Axelrod’s Evolution of Cooperation project. It’s basically a contest between different strategies to an iterated PD (you can play a variation of it here). That the “tit for tat” strategy is so successful sheds a lot of light on what makes civilization possible–initial friendliness, willingness to punish transgressions, and willingness to return to friendliness after punishing these transgressions.

A fantastic extension is to create a co-evolutionary simulation of a repeated PD game. Rather than building strategies and pitting them against each other, we can be totally agnostic about strategies (i.e. how people behave) and simply see what strategies can survive each others’ presence.

The evolutionary iterated PD is about as parsimonious a model of conflict/cooperation as we could make. But there is still a lot of structure baked in; what few assumptions remain do a lot of heavy lifting.

But if the structure of the game is up for grabs, then maybe we’ve found a way to generalize the prisoners’ dilemma without assuming on extra layers of complexity.

Of course, the parsimony of the model adds complexity to the implementation. Formalizing Nomic presents a formidable challenge, and getting it to work would surely create a new

But even if it doesn’t lend itself to simulation, it strikes me as the sort of exercise that ought to be happening in classrooms–at least in places where people care about building capacity for self governance (I’ve heard such places exist!).

Let’s play!

A bit of stage setting, then let’s start a game in the comments section. I get the impression that this game is nerdier than Risk, so you’ve been warned (or tempted, as the case may be).

The basic premise is that are mutable rules and immutable rules (like Buchanan’s view of constitutions). Players take turns to propose rule changes (including transmuting rules from a mutable to an immutable state). As part of the process, we will almost surely redefine how the game is won, so the initial rule set starts with a pretty boring definition of winning.

We’ll use Peter Suber’s initial rules with some variations to suit our needs. The rules below will be (initially) immutable.

117. Each round will happen in a new comment thread. A new round cannot start until the rule change proposed in the previous round has been voted on. If technical problems result in having to start a new comment thread, that thread should include the appropriate reference number and it will be understood to be part of the same comment thread.

I will take the first move to demonstrate the format in the comments section.

118. The final vote count will be determined after 24 hours of silence. Players may discuss and cast votes, and change their votes. But after 24 hours of no new comments, the yeas and nays will be tallied and the outcome determined accordingly. In cases requiring unanimity, a single nay vote is enough to allow a player to start a new round without waiting the full 24 hours. The final vote will still occur (for purpose of calculating points) after 24 hours of silence.

Despite being numbered 118, this rule will take priority over rule 105.

119. Anyone who is eligible to comment is eligible to play. If it is possible to start a new round, anyone may start that round. In the event that two people attempt to start a round at the same time (e.g. Brandon and I post a comment within a couple minutes of each other) priority will be given to whichever was posted first and the second comment will be voided.

120. The game will continue until someone wins, or everyone forgets the game, in which case the winner will be the last person to have had their comment replied to.

Nightcap

Brandon Christensen Links , , ,
  1. Iran’s Afghan fighters, in Syria Ahmad Shuja Jamal, War on the Rocks
  2. The Africans of 16th Century Britain David Dabydeen, New Statesman
  3. What Books Did American Blacks Read Before the 1960s? Jonathan Rose, History News Network
  4. Padmaavat loathed by fundamentalists of all stripes Barkha Dutt, Washington Post

On doing economic history

Vincent Geloso Economics, History , , , , , , , , , , ,

I admit to being a happy man. While I am in general a smiling sort of fellow, I was delightfully giggling with joy upon hearing that another economic historian (and a fellow  Canadian from the LSE to boot), Dave Donaldson, won the John Bates Clark medal. I dare say that it was about time. Nonetheless I think it is time to talk to economists about how to do economic history (and why more should do it). Basically, I argue that the necessities of the trade require a longer period of maturation and a considerable amount of hard work. Yet, once the economic historian arrives at maturity, he produces long-lasting research which (in the words of Douglass North) uses history to bring theory to life.

Economic History is the Application of all Fields of Economics

Economics is a deductive science through which axiomatic statements about human behavior are derived. For example, stating that the demand curve is downward-sloping is an axiomatic statement. No economist ever needed to measure quantities and prices to say that if the price increases, all else being equal, the quantity will drop. As such, economic theory needs to be internally consistent (i.e. not argue that higher prices mean both smaller and greater quantities of goods consumed all else being equal).

However, the application of these axiomatic statements depends largely on the question asked. For example, I am currently doing work on the 19th century Canadian institution of seigneurial tenure. In that work, I  question the role that seigneurial tenure played in hindering economic development.  In the existing literature, the general argument is that the seigneurs (i.e. the landlords) hindered development by taxing (as per their legal rights) a large share of net agricultural output. This prevented the accumulation of savings which – in times of imperfect capital markets – were needed to finance investments in capital-intensive agriculture. That literature invoked one corpus of axiomatic statements that relate to capital theory. For my part, I argue that the system – because of a series of monopoly rights – was actually a monopsony system through the landlords restrained their demand for labor on the non-farm labor market and depressed wages. My argument invokes the corpus of axioms related to industrial organization and monopsony theory. Both explanations are internally consistent (there are no self-contradictions). Yet, one must be more relevant to the question of whether or not the institution hindered growth and one must square better with the observed facts.

And there is economic history properly done. It tries to answer which theory is relevant to the question asked. The purpose of economic history is thus to find which theories matter the most.

Take the case, again, of asymetric information. The seminal work of Akerlof on the market for lemons made a consistent theory, but subsequent waves of research (notably my favorite here by Eric Bond) have showed that the stylized predictions of this theory rarely materialize. Why? Because the theory of signaling suggests that individuals will find ways to invest in a “signal” to solve the problem. These are two competing theories (signaling versus asymetric information) and one seems to win over the other.  An economic historian tries to sort out what mattered to a particular event.

Now, take these last few paragraphs and drop the words “economic historians” and replace them by “economists”.  I believe that no economist would disagree with the definition of the tasks of the economist that I offered. So why would an economic historian be different? Everything that has happened is history and everything question with regards to it must be answered through sifting for the theories that is relevant to the event studied (under the constraint that the theory be consistent). Every economist is an economic historian.

As such, the economic historian/economist must use advanced tools related to econometrics: synthetic controls, instrumental variables, proper identification strategies, vector auto-regressions, cointegration, variance analysis and everything you can think of. He needs to do so in order to answer the question he tries to answer. The only difference with the economic historian is that he looks further back in the past.

The problem with this systematic approach is the efforts needed by practitioners.  There is a need to understand – intuitively – a wide body of literature on price theory, statistical theories and tools, accounting (for understanding national accounts) and political economy. This takes many years of training and I can take my case as an example. I force myself to read one scientific article that is outside my main fields of interest every week in order to create a mental repository of theoretical insights I can exploit. Since I entered university in 2006, I have been forcing myself to read theoretical books that were on the margin of my comfort zone. For example, University Economics by Allen and Alchian was one of my favorite discoveries as it introduced me to the UCLA approach to price theory. It changed my way of understanding firms and the decisions they made. Then reading some works on Keynesian theory (I will confess that I have never been able to finish the General Theory) which made me more respectful of some core insights of that body of literature. In the process of reading those, I created lists of theoretical key points like one would accumulate kitchen equipment.

This takes a lot of time, patience and modesty towards one’s accumulated stock of knowledge. But these theories never meant anything to me without any application to deeper questions. After all, debating about the theory of price stickiness without actually asking if it mattered is akin to debating with theologians about the gender of angels (I vote that they are angels and since these are fictitious, I don’t give a flying hoot’nanny). This is because I really buy in the claim made by Douglass North that theory is brought to life by history (and that history is explained by theory).

On the Practice of Economic History

So, how do we practice economic history? The first thing is to find questions that matter.  The second is to invest time in collecting inputs for production.

While accumulating theoretical insights, I also made lists of historical questions that were still debated.  Basically, I made lists of research questions since I was an undergraduate student (not kidding here) and I keep everything on the list until I have been satisfied by my answer and/or the subject has been convincingly resolved.

One of my criteria for selecting a question is that it must relate to an issue that is relevant to understanding why certain societies are where there are now. For example, I have been delving into the issue of the agricultural crisis in Canada during the early decades of the 19th century. Why? Because most historians attribute (wrongly in my opinion)  a key role to this crisis in the creation of the Canadian confederation, the migration of the French-Canadians to the United States and the politics of Canada until today. Another debate that I have been involved in relates to the Quiet Revolution in Québec (see my book here) which is argued to be a watershed moment in the history of the province. According to many, it marked a breaking point when Quebec caught up dramatically with the rest of  Canada (I disagreed and proposed that it actually slowed down a rapid convergence in the decade and a half that preceded it). I picked the question because the moment is central to all political narratives presently existing in Quebec and every politician ushers the words “Quiet Revolution” when given the chance.

In both cases, they mattered to understanding what Canada was and what it has become. I used theory to sort out what mattered and what did not matter. As such, I used theory to explain history and in the process I brought theory to life in a way that was relevant to readers (I hope).  The key point is to use theory and history together to bring both to life! That is the craft of the economic historian.

The other difficulty (on top of selecting questions and understanding theories that may be relevant) for the economic historian is the time-consuming nature of data collection. Economic historians are basically monks (and in my case, I have both the shape and the haircut of friar Tuck) who patiently collect and assemble new data for research. This is a high fixed cost of entering in the trade. In my case, I spent two years in a religious congregation (literally with religious officials) collecting prices, wages, piece rates, farm data to create a wide empirical portrait of the Canadian economy.  This was a long and arduous process.

However, thanks to the lists of questions I had assembled by reading theory and history, I saw the many steps of research I could generate by assembling data. Armed with some knowledge of what I could do, the data I collected told me of other questions that I could assemble. Once I had finish my data collection (18 months), I had assembled a roadmap of twenty-something papers in order to answer a wide array of questions on Canadian economic history: was there an agricultural crisis; were French-Canadians the inefficient farmers they were portrayed to be; why did the British tolerate catholic and French institutions when they conquered French Canada; did seigneurial tenure explain the poverty of French Canada; did the conquest of Canada matter to future growth; what was the role of free banking in stimulating growth in Canada etc.

It is necessary for the economic historian to collect a ton of data and assemble a large base of theoretical knowledge to guide the data towards relevant questions. For those reasons, the economic historian takes a longer time to mature. It simply takes more time. Yet, once the maturation is over (I feel that mine is far from being over to be honest), you get scholars like Joel Mokyr, Deirdre McCloskey, Robert Fogel, Douglass North, Barry Weingast, Sheilagh Ogilvie and Ronald Coase (yes, I consider Coase to be an economic historian but that is for another post) who are able to produce on a wide-ranging set of topics with great depth and understanding.

Conclusion

The craft of the economic historian is one that requires a long period of apprenticeship (there is an inside joke here, sorry about that). It requires heavy investment in theoretical understanding beyond the main field of interest that must be complemented with a diligent accumulation of potential research questions to guide the efforts at data collection. Yet, in the end, it generates research that is likely to resonate with the wider public and impact our understanding of theory. History brings theory to life indeed!

On granting the Nobel to Kirzner

Vincent Geloso Economics , , , , ,

In a little over a week, the Nobel Prize in economics will be unveiled. A part of me wishes that Robert Barro wins or maybe Dale Jorgenson or even William Baumol. However, I would be thrilled if Israel Kirzner won. Back in 2014, he was mentioned for the prize and it was the year that Jean Tirole, deservedly, won the prize. Since then, I have been dreaming of it as it would cement into the mainstream the best that the Austrian school of economics can offer.

Unlike many of colleagues, I have always had sympathies for numerous points made by the Austrians. Throughout my training, the Austrian school of economics was largely derided as cranks. Initially, I jumped on the bandwagon and I believed the Austrians to be crazy. However, I became exposed to many of their key points and like Edmund Phelps, I felt that the “best of the Austrians” could not be rejected so easily. True, there is some wheat to sort from the chaff, but the same applies for every school of thought.  I realized that most of their inputs in macroeconomics were largely incorporated in models like Lucas’ Islands Model or in Prescott’s Time to Build. However, what most intrigued me was how they used general equilibrium as a teaching tool, but not as a research tool. General equilibrium is useful for understanding key axiomatic assertions, but when you have an “applied economics” question, it is a hard tool to use – especially for an economic historian like me.

Kirzner is the perfect representation of the best that the Austrian school has to offer. In a way, his entire work can be summarized as such: it is the process leading to (new) equilibrium(s) that is the most interesting aspect of economics.

It is when I understood that insight that I finally grasped the deeper meaning of Hayek’s claim that “competition is a discovery process”. Entrepreneurs are people who look for the $100 bill on the sidewalk by innovating, by exploiting arbitrage opportunities and by discovering what consumers really want. They are constantly heading towards an equilibrium point. But as they try to do so, they shift the ability to produce and consume to greater levels and, in doing so, they generate a new equilibrium. And the process continues as long as human beings are humans.

For someone who studies economic history like I do, this is the most fruitful way of looking at social interactions. After all, the industrial revolution is everything except an equilibrium and the industrial revolution is most momentous structural break in history. The search for equilibrium and the creation of new equilibriums are by far more useful tools for questions like the end of “Malthusian pressures” or the beginning of the Industrial Revolution.

Of course, I am veering into excessive simplification of Kirzner’s contribution. But consider his book, Competition and Entrepreneurship. Alone, it has 7,362 citations (according to google scholar).  This is half the citations obtained by the most cited article in the American Economic Review (Armen Alchian and Harold Demsetz’s Production, Information Costs and Economic Organization). It’s close to 3,000 more citations that Deaton and Muellbauer’s “Almost Ideal Demand System” (4,775 citations). And Deaton won the Nobel last year!

By virtue of being affiliated with the Austrians, mainstream economists could have relegated him to obscurity. However, for such a citation count to be achieved, he must have been to showcase the best that the Austrian school has to offer. Just for that, maybe his contribution should be recognized.

What Good Are Mathematical Models for the Science of Economics?

Brandon Christensen Economics, Links , , ,

This question comes from co-blogger Warren Gibson’s piece in Econ Journal Watch titled “The Mathematical Romance: An Engineer’s View of  Mathematical Economics”:

Mathematics can be very alluring. Professional mathematicians speak frequently of “beauty” and “elegance” in their work. Some say that the central mystery of our universe is its governance by universal mathematical laws. Practitioners of applied math likewise feel special satisfaction when a well-crafted simulation successfully predicts real-world physical behavior.

But while the mathematicians, some of them at least, are explicit about doing math for its own sake, engineers are hired to produce results and economists should be, too. It’s fine if a few specialists labor at the outer mathematical edge of these fields, but the real needs and real satisfactions are to be found in applications.

Western civilization has brought us an explosion of human welfare: prosperity, longevity, education, the arts, and so on. We very much need the wisdom that economists can offer us to help understand and sustain this remarkable record. What good are engineers’ accomplishments in crash simulations if the benefits are denied to the world by trade barriers, stifling regulation, congested highways, or bogus global warming restrictions? What can mathematical economics contribute to such vital issues?

You can read the whole thing here (it’s also in the newly-renovated ‘recommendations’ section). Highly, uh, recommended! Mathematics is an important aspect of economics, I think, but Dr. Gibson and other Austrian critiques are more focused on the models that economists create rather than all of the wonderful data that can be quantified for calculation purposes.

I may be wrong, and I hope that my co-bloggers or others will correct me if I am, but either way Dr. Gibson’s critique of the mathematical models employed in the economics profession needs another good look.

Some Great Links From Around the Web

Brandon Christensen Economics, Links , , , , , , , , , , , , , , , ,

A fascinating blog post on Indian domestic politics and foreign policy by a Ph.D. student living in New Delhi and studying at Jawaharlal Nehru University.

Alex Warren, a journalist with extensive experience in the Middle East, writes about Libya’s decentralization.

“The Current Models Have Nothing to Say.” That is economist Robert Higgs’s analysis of modern, orthodox economics.

Might regionalism help solve Central America’s woes?  Be sure to check out the rest of the blog, by Seth Kaplan, too.

Conor Friedersdorf of the Atlantic has a penetrating look at the logic of a drug warrior (h/t Brian Aitken)

Co-editor Fred Foldvary, writing in the Progress Report, explains that value is subjective.  This is an important concept when it comes to understanding economics.