The End of Economics

Neoclassical economics is a product of mixed metaphors and confused calculus, in denial of its basic failure to become a predictive science.

By Mark Rickerby

5th July 2009

I am most often irritated by those who attack the bishop but somehow fall for the securities analyst — those who exercise their skepticism against religion but not against economists, social scientists, and phony statisticians.

Nassim Nicholas Taleb

In the wake of the market meltdown of 2008, it’s fascinating to see mainstream opinion starting to focus on the reality of just how badly economics has failed as a predictive discipline. Although it may be unfamiliar to many people, this criticism is nothing new. It emerges from the long term structural failure of economics to become the science it wished it was.

Despite its privileged position at the best universities and the prestige of accolades such as Nobel Prizes, economics still seems to be missing basic scientific consensus on fundamental issues. This emperor is almost certainly wearing no clothes and may well have reached the end of the parade.

Criticisms of economics establishing itself as a science date back to the 19th century, but are mostly moral in character. A modern explanation of how economics has misinterpreted itself as a science requires a background excursion into 20th century philosophy, specifically the philosophy of science, a distinct area of scholarship that is mostly concerned with epistemology (trying to explain what knowledge is). After the influence of Karl Popper, one of the central elements of this subject became how to separate non-science from science.

Popper’s most significant contribution was to generalize the theory of what is and isn’t science—to show, not just how science works, but how science improves. He did this by emphasising that theories must be falsifiable. In other words, although you may never confirm that a theory is true, it must be logically possible to prove that it is false. This turned out to be a remarkably successful and succinct reformulation of the scientific method. Popper firmly believed that continuous experimental testing and falsification would yield better and better theories.

In the 1930s, scientists intuitively understood this view of experimental progress (it was how they worked), yet philosophers at the time were apt to describe science as a complete mosaic of knowledge with new blocks of knowledge being added to enlarge the picture. It took until the 1950s and ‘60s for many scholars to agree that scientific reality is not such a comfortable process of knowledge accumulation. One of the most famous books of its time, Thomas Kuhn’s Structure of Scientific Revolutions lined up an array of historical evidence to show that scientific progress is wild and messy, with radical new theories exploding on the scene every so often, tearing down previous traditions, until eventually the radical new theory settles into the mainstream and becomes the normal science. Many literate people have been touched by the book, even if they are unaware of Kuhn himself-his usage of the phrase ‘paradigm shift’ to explain the onrush of a new scientific consensus is now deeply embedded in popular culture.

One of the most problematic aspects of Kuhn’s Structure is that when it came to defining a clear outline of how science operates, the actual prose of the book was as foggy and turbulent as the science it described. Critics of Kuhn later came to view the book’s reception as an open letter to humanities disciplines, encouraging them to view themselves in a more scientific light. Everyone wanted to be scientific. Everyone wanted a paradigm of their own.

It is much easier in hindsight to pick apart the bizarre contradictions this trend implied. Sociologists, psychologists and anthropologists who desired the institutional prestige of science could throw down the concept of ‘paradigm shifts’ in support of their mission. The book rose in popularity, perhaps not-coincidentally, at the same time as certain post-structuralist tendencies were emerging in the humanities disciplines, leading to endless arguments for philosophers over how Kuhn was misinterpreted. It is certainly understandable why so many academics sought this status. The value of a research field being recognized as science was more than just a matter of prestige. It also opened the door to vast amounts of research funding.

Which brings us to economics, also considered a social science, and exerting an enormous institutional influence during this same time period. It is interesting then, that the impact of Kuhn was nowhere near as great for economics at this time, as it was for other social sciences.

Economists—perhaps because of relentless mathematization of their work—appeared to be operating in a bubble of security away from endless doubting of their scientific integrity. Few economists would question that economics was a science at all, an attitude reinforced by what seems to be remarkable absence of writing on the history of economics during the mid-20th Century. And unlike sociology and other so-called social science disciplines, the economics establishment never faced serious resistance from insiders as to whether it actually should strive to be a science.

The study that seeks to address this lack of history in the most depth is Phillip Mirowski’s More Heat Than Light, a complex and deeply challenging historiography that is not as widely known as it deserves to be. Mirowski argues that late 19th century economists were able to capitalize on the success of the energy concept in mainstream physics. This led to a new discipline of economics breaking away from its traditional foundations of moral philosophy to become mired in a very specific kind of algebraic intricacy, obsessed with building equilibrium models. In pop-psychological terms, we would describe this branch of economics as having ‘physics envy’. But the energy conservation principles were misused by economists, leading to serious flaws in the mathematical formalisation of economic theory.

Despite these flaws, the mathematisation and quantification of the discipline was extremely compelling. The mixed metaphors and confused calculus actually contributed to the explosive growth of this new economics in the early 20th century, and it was not all one way—Mirowski also documents instances where physics borrowed ideas from economics.

By World War 2, economics had built up a vast archive of mathematical literature and a distinctly separate community. By this point economists were no longer studying the economy per-se, they were studying a complicated series of algebraic puzzles - games that only insiders with the requisite mathematical knowledge could play. Modeling techniques became more baroque, and attentions drifted towards researchers with a grasp of complex linear algebra, leaving psychologists and sociologists who still looked at the behavior of ordinary human beings in the dust.

Enjoying major institutional and military support, the discipline of economics prevailed in its own hubris, and was never forced to justify itself in existential or epistemological terms. This led to a stability that other social sciences—with their perpetual crises of identity—could not maintain. This faux-stability had far reaching consequences, entrenching the neoclassical ideas to the point of being beyond reproach in the academy.

By constructing increasingly abstract models, economists became distanced from the actual economic behavior they were claiming to represent. Normative assertions about social reality were treated as mere parameters to equations, and thus vital questions were never asked about these fundamental assumptions; a situation that has generated an endless stream of criticism of economics from outside the discipline, in contrast to the remarkable lack of questioning from within.

The biggest point of contention was the basic list of assumptions that formed the very bedrock of neoclassical economics:

  1. People have rational preferences among outcomes that can be identified and associated with a value.
  2. Individuals maximize utility and firms maximize profits.
  3. People act independently on the basis of full and relevant information.

Instead of trying to establish a testable, empirical foundation for these assertions (which would have come up short, due to peculiar aspects of the human condition), generation after generation of economists accepted them as rote, in order to get on with the task of mathematical model building.1

If classical economics was improving like a science should, it would have continued to generate concrete testable predictions about the future of the economy, of which, there would be widespread agreement and a record of experimental testing and confirmation of theories. Instead, the neoclassical economics establishment spent most of the 20th century bickering and equivocating over displays of mathematical one-upmanship. Unsurprisingly, today we find this branch of human thought being wholly useless in real world practice, with mainstream economics degenerating into a complete and total mess:

What arises in my mind is the strong suspicion that economic theory, as it is practiced and taught at the world’s leading institutions, is so far from consensus on certain fundamental questions that it is basically useless for adjudicating many profoundly important debates about economic policy. One implication of this is that it is wrong to extend to economists who advise policymakers, or become policymakes themselves, the respect we rightly extend to the practitioners of mature sciences. There is a reason extremely smart economists are out there playing reputation games instead of trying to settle the matter by doing better science. The reason is that, on the questions that are provoking intramural trashtalk, there is no science.

Are economists completely clueless? Maybe only partially clueless, but clueless enough to consider it time for a new hybrid discipline to eclipse everything we currently know as economics:

Much of the work that we now think of as economics, political science and other social sciences will likely be displaced by some hybrid of biology, experimental economics, psychology and other fields that can evaluate hypotheses for the quantified prediction of human behavior through structured falsification tests (or, sometimes, true “natural experiments” in which non-intentional random assignment has occurred).

As it turns out, there is a fundamental obstacle to the predictive potential of economics, one that has been glaringly apparent in recent months as the global financial sector collapses under its own greed and derangement. This show-stopper is the plain fact that economic agents are themselves knowledgeable about economics. They can assess a situation and change the situation to benefit their own interests. This reflexive effect is a contradiction that economics cannot cope with:

Any algorithm that can reliably predict the behavior of a financial market will be used by participants in that market to earn money, altering the system in a way that leaves you right back where you started. In this sense our ability to model economics will always be worse than our understanding of the weather, since we don't have to worry about a raindrop anticipating that it will hit the ground before it even forms, and taking steps to change the outcome.

An important lesson to learn here is that the deployment of rigorous mathematical models is not enough to make a theory scientific. Falsifiability, testing of assumptions, learning how to be wrong, is what science depends on, and the problems with applying economic theories to some of the most complex scenarios in human development are clearly evident.

Compartmentalization of knowledge is not complimentary to the goal of developing a comprehensive social science.

Economics in its traditionally enshrined format is an awkward relic of the infancy of Western techno-scientific industrial culture. The hubris, arrogance, and anti-social disunity of 19th and 20th century academia needs to be better recognized so that we can move away from it. In fact, it seems this is already happening.