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Sunday, July 30, 2017

Dani Rodrik and pluralism

About a month ago, I read the book Economics Rules by Dani Rodrik. I believe that the central message of the book is that economists should embrace a large tool kit of economic models. He also emphasizes the importance of being able to select the right model depending on the specific economic situation. Rodrik also has some interesting things to say about mathematical economics and critics of the economics profession.


This post is some of my favorite quotes from the book. I received permission in an email from Rodrik to create this post.


Support for pluralism


"Rather than a single, specific model, economics encompasses a collection of models. The discipline advances by expanding its library of models and by improving the mapping between these models and the real world. The diversity of models in economics is the necessary counterpart to the flexibility of the social world." (page 5)


"In part because economists take the natural sciences as their example, they have a tendency to misuse their models. They are prone to mistake a model for the model, relevant and applicable under all circumstances." (page 5)


"Knowledge accumulates in economics not vertically, with better models replacing worse ones, but horizontally with newer models explaining aspects of social outcomes that were unaddressed earlier." (page 67)


"In the end, it was clear that no single theory could fully explain the story of the U.S. inequality since the 1970's. Nor was there a good way of parsing the relative contributions of different theories. Certain theories (models) gave us a better understanding of the channels through which trade, technology and other factors may have operated. The failure of other theories allowed us to rule out mechanisms that appeared equally plausible at the outset. There was no closure, but there was plenty of learning along the way." (page 143)


"Today it is almost a mantra for development economists, finance experts, and international agencies that no single set of policies is appropriate for all countries that domestic reforms must be tailored to specific circumstances." (page 167)


How to choose the right model


"[A model's] conclusions are true only to the extent that their critical assumptions approximate reality. When they don't, we need to rely on models with different assumptions." (page 18)


"As Stanford economist Paul Pfleiderer explains we always need to apply a 'realism filter' to critical assumptions before a model can be treated as useful." (page 26)


"Economic models are cases that come with explicit user's guides (teaching notes on how to apply them). That's because they are transparent about their critical assumptions and behavioral mechanisms." (page 73)


"Freshly minted PhD's come out of graduate school with a large inventory of models but virtually no formal training (no course work, no assignments, no problem sets) in how to choose among them." (page 84)


"Eventually, we developed a decision tree that helped us navigate across potential models... We would start at the top of the tree by asking whether the constraints on investment were mainly on the supply side or on the demand side... At each node of the decision tree, we tried to develop informal empirical tests to help us select among models that would send us down different paths." (page 89)


Support for simple models


"In truth, simple models of the type that economists construct are absolutely essential to understanding the workings of society. Their simplicity, formalism, and neglect of many facets of the real world are precisely what make them valuable." (page 11)


"What are economic models? The easiest way to understand them is as simplifications designed to show how specific mechanisms work by isolating them from other, confounding effects." (page 12)


Support for mathematical economics


"Math ensured that the elements of a model (the assumptions, behavioral mechanism and main results) are clearly stated and are transparent. Once a model is stated in mathematical form, what it says or does is obvious to all who can read it." (page 31)


"[Math] ensures the internal consistency of a model (simply put, that the conclusions follow from the assumptions). (page 32)


"Verbal arguments that seem intuitive often collapse or are revealed to be incomplete under closer mathematical scrutiny. The reason is that 'verbal models' can ignore nonobvious but potentially significant interactions." (page 34)


Critique of mathematical economics


"Math plays a purely instrumental role in economic models. In principle, models do not require math, and it is not the math that makes the models useful or scientific." (page 33)


"Too many economists fall in love with the math and forget its instrumental nature. Excessive formalization (math for it's own sake) is rampant in the discipline." (page 35)


"The profession's stars and most heavily cited economists are those who have shed light on important public problems... not its mathematical wizards." (page 37)


"Efforts to construct large-scale economic models have been singularly unproductive to date. To put it even more strongly, I cannot think of an important economic insight that has come out of such models." (page 39)


Analysis of the 2008 financial crisis


"That economists were mostly blind-sided by the crisis is undeniable. Many interpreted this as evidence of a fundamental breakdown in economics... But what makes this episode particularly curious is that there were, in fact, plenty of models to help explain what had been going on under the economy's hood. Bubbles (steady increases in asset prices divorced from their underlying value) are not a new phenomenon." (page 154)


"Models of self-fulfilling panic (a coordination failure in which individually rational withdrawals of credit lines produce collective irrationality in the form of a systemic drying up of liquidity) were well know to every student of economics." (page 155)


"A key pattern in the run up to the crisis was excessive risk taking by managers of financial institutions. Their compensation depended on it, but their behavior was not consistent with the interests of the banks' shareholders. This divergence between the interests of managers and shareholders is a centerpiece of principal-agent models." (page 155)


"In sum, economists became overconfident in their preferred models of the moment: markets are efficient, financial innovation improves the risk-return trade-off, self-regulation works best, and government intervention is ineffective and harmful. They forgot about the other models." (page 159)


What are the critics saying?


"I felt that many of the criticisms coming from outside the field missed the point. There was too much misinformation about what economists really do." (page xiii)


"Many of the complaints are well known: economics is simplistic and insular; it makes universal claims that ignore the role of culture, history and other background conditions; it reifies the market; it is full of implicit value judgments; and besides, it fails to explain and predict the developments in the economy. Each of these criticisms derives in large part from a a failure to recognize that economics is, in fact a collection of diverse models that do not have a particular ideological bent..." (page 6)


"One of the most frequent complaints about economics labels it a club that shuns outsiders. This exclusiveness makes the discipline insular, according to the critics, can be closed to new and alternative perspectives on economics. Economics should become more inclusive, they argue, more pluralistic and more welcoming of unorthodox approaches." (page 196)


"Pluralism with respect to conclusions is one thing; pluralism with respect to methods something else. No academic discipline is permissive of approaches that diverge too much from prevailing practices, and economics is unforgiving of those who violate the way work in the discipline is done. An aspiring economist has to formulate clear models and apply appropriate statistical techniques." (page 199)


"For some, these constraints represent a kind of methodological straitjacket that crowds out new thinking But it is easy to exaggerate the rigidity of the rules within which the profession operates." (page 200)