Monday, June 8, 2009

Is the canonical model "useful"?

At the ACE anniversary conference in April, I delivered a plenary address in which I argued that the standard, canonical model in economics is discredited, has been effectively abandoned for research purposes, and needs to be abandoned for teaching and prescriptive purposes too. My interlocutors made the claim that the model should be kept because it is "useful." For some, this seemed to mean that it is useful the way a map is useful, using abstract symbols to present a model of reality accurate enough to give directions to reach a goal. If you want to get from Waco to Houston, it will get you there. This seems to echo the famous statement of Robert Solow: "All theory depends on assumptions which are not quite true. That is what makes it theory." (QJE, Feb. 1956) Others claimed that without a general model that connected different phenomena together in a common causal framework, we would have no way to get a handle on what we know, and no framework for conducting research. Gabriel Martinez even made the remarkable claim that having a false framework is better than having no framework at all.

In that famous paper, Solow went on to say, "(I)t is important that the crucial assumptions be reasonably realistic," which he did not think was true of the Harrod-Domar model. A map is not useful if it puts the freeway exits in the wrong places, so that you think you are in Houston when in fact you got off in Galveston. The canonical model assumes perfect competition, which is a crucial assumption, and is not realistic. It answers questions (as Martinez said), but it gets the answers wrong. So the model predicts there will be equilibrium in labor markets, when in fact there is unemployment. It predicts the law of one price will hold, when it hardly ever does. It predicts that financial markets will be efficient, when in fact they periodically collapse. And it doesn't answer questions about some extremely important issues, like the size distribution of income or the optimal scale of the economy for ecological sustainability. It ignores the complexity of human decision-making, and the reality of economic power. This is not useful, but pernicious.

In my talk, I made some proposals about basic principles that a new economics should be founded on. But the frustration expressed with heterodoxy (by Robbie Mochrie and others at the conference) is that it doesn't offer a general, all-encompassing model. My claim is that we don't need one. Post-modern methodology suggests that they are dangerous anyway, but our research in economics is being guided by new questions, new techniques, and new basic principles that don't issue in a comprehensive mathematical construct, and we are still learning more every day. There is no shortcut to truth. Often you have to dig for it with your bare hands. The principles we need come from a basic biblical understanding of the nature of human beings, our relationship with God, and God's will for our relationships with each other. That will tell us where to dig.

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