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Problem analysis vs. Problem solutions January 26, 2009

Posted by thedukeofurl in Economics, logic.
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Unfortunately, there is no necessary logical connection between the analysis of a problem and its solution. The two are essentially independent. So, someone could analyze a problem correctly but provide incorrect proposals for solving said problem. In accepting Roubini’s assessment of the problem, we do not need to accept his ideas on how it can be solved or what he thinks might be poor solutions, as his philosophical/theoretical stance will largely determine what he believes to be viable.

This is a problem with a lot of discussions in economics. Lots of assumptions not made either explicit enough or at all. Others introduce ideas that they think are new but have actually been around for years. For example, Soros’s introduction of the notion of reflexivity (a kind of feedback loop in economic behavior) has been a known problem in philosophy and parts of social science for over 50 years. Yet most economists fail to acknowledge this except for Soros and a few others. Neoclassical economists like Stigler and Friedman ignored it completely and possibly weren’t even aware of the issue. Keynes was aware of this problem though he didn’t discuss it in these terms.

Since a solution of a serious economic problem invariably involves a political (policy) dimension, economists aren’t very good at incorporating socio-political policy considerations into their analyses, hence their solutions should be inspected closely.

Skidelsky on Ferguson on money January 26, 2009

Posted by thedukeofurl in Economics.
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Robert Skidelsky, who has produced a renowned biography of Keynes, has recently reviewed Niall Ferguson’s book and TV program on the ascent of money. He thinks the book superb. While rightly critical of Ferguson, he is too “nice” to him. He doesn’t drive the dagger in far enough.

http://www.skidelskyr.com/site/article/book-review-can-you-spare-a-dime/

Skidelsky rightly rejects Ferguson’s adherence to neoclassical economic principles and his quasi-social Darwinism along with his views on behavioral finance. Ferguson’s views on behavioral finance are not as sophisticated as those of one of the founders of this perspective, Robert Shiller, but Skidelsky considers behavioral finance to be a dead end. He may be right, though this is an exceedingly problematic area.

Skidelsky is right to insist that there is a distinction between the notion of “uncertainty” and that of “risk”. But there is another essential distinction to make and that is between these and “ignorance”. Uncertainty and ignorance are not identical and in ignorance lies an inability to assess risk at all. Just as with uncertainty, we need to distinguish between personal ignorance and what could be called “real” ignorance, that of which we are all truly ignorant. For example, there were many trading in complex derivatives who were ignorant of what they were dealing with and hence unable to assess the risks inherent in these instruments, but it would have been possible for some of them to have informed themselves and thus acquired some ability to assess the degree of risk involved in dealing with these financial instruments. On the other hand, we are truly ignorant of what the future may bring and the further away the future is, the greater our ignorance and the greater our inability to inform ourselves. Both sorts of ignorance are involved in the current financial crisis, in addition to various degrees of uncertainty and risk.

Skidelsky is right to pour scorn on the Black-Scholes calculation of the degree of risk of investment, set at some millions of years. The number is so large that it is almost inconceivable that anyone actually believed it. It might, however, have led some to believe that the probability of a bad slump was near zero in the short term. Even this suggests an unacceptable degree of ignorance, credulity, or stupidity on the part of those charged with managing other people’s money. Social systems have never been that stable or regular. And it is absurd to believe otherwise.

Skidelsky is also right to be skeptical of any intrusion of social Darwinism into the realms of society and culture. Nevertheless, at the end of the 19th and the beginning of the 20th century, Darwin’s theory of natural selection was applied rather crassly to counter social movements such as trade union agitation, welfare for the indigent, health care for the poor, and the like. So crude was this application that it discredited itself. It rose again in the form of social biology, a more subtle but still inadequate theory of human behavior and social organization. It has now insinuated itself into the field of evolutionary psychology and related disciplines and, it seems, into some contemporary interpretations of economic history. You can find forms of this argument in criticisms of Roosevelt’s New Deal, though the perspective is not usually explicitly mentioned – it may even be unconsciously appealed to. Some of these critics have been influenced by monetarist doctrines, as Ferguson has. Whatever the faults of Roosevelt’s New Deal or, indeed, of economic theory, a social Darwinist-based critique, however couched, can not and does not “deliver the goods” (as Keynes once said in a different context). That this perspective is still in play is nothing short of an intellectual scandal.

I take some issue with Skidelsky’s unconditional attribution of Platonism to mathematics. There is an alternative tradition, primarily derived from Kant, that avoids Platonist excesses, that of constructivism. Kant viewed mathematics as a construction of the human mind. We can view it as a cultural construct. This means that mathematical objects are not real in the way that physical objects are, and it means that terms like “discovery” and “invention” become more complicated in their application. Irrespective of this, Skidelsky’s view that mathematical economics has little application to social reality is, I believe, well founded. And the belief that such mathematics can be used to significantly reduce unknown future risk requires at the very least an ahistorical approach to the subject, which Skidelsky himself accuses some monetarists of being.  I am skeptical whether this charge can truthfully be leveled at Stigler, whose sometimes vicious ad hominem attacks on the views of others may have other roots.

There is another reason that I think mathematics plays a role in certain areas of economics, and this is that it is seen by some of its practitioners as akin to a technology, viewed as not being unlike engineering and applied physics.  Except that economics is not a science in that sense if it is one at all.  I would have liked Skidelsky to make more of this and possibly brought in Keynes’ theory of probability, but this is no doubt expecting too much of a review.

I believe I am more optimistic than Skidelsky with respect to Keynes’ view of our economic future, though it is clear that Keynes’ timeline is much too short. We are probably going to go through a Depression-like period, though hopefully unaccompanied by the disastrous policies of that time. Nevertheless, I would like to believe, with Keynes, that sometime in the future people could be relieved of the necessity of scrabbling for an economic livelihood and be able to leisurely cultivate science, art, literature, and life itself. Maybe, just maybe, we can even find a way to live free of fear, at least of each other.

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I have come across an unusual historical account of economic theory, The Wealth of Ideas by Allesandro Roncaglia (CUP 2006), which has been influenced by the ideas of Kuhn and Lakatos, a refreshingly novel approach, I think.  Then there is The Romantic Economist: Imagination in Economics by Richard Bronk (CUP 2009).

http://www.rgemonitor.com/financemarkets-monitor/255257/everything_you_wanted_to_know_about_credit_default_swaps–but_were_never_told
is a defense of credit default swaps.  It is from Roubini’s site.  With Roubini, I am beginning to feel that I have to separate his analyses of the current financial crisis from his proposed solutions, as I am not convinced that what he has said so far is adequate.  But I may well be wrong.