Ideas for Constructive Procrastination (Part 1)

Critiques of “Mainstream” Economics

In case you haven’t noticed, my blog is meant to be an outlet for constructive procrastination… mostly for me, its author… but also for you, gentle readers. On that note, let me begin what I am sure will be a long, long series of ideas for constructive procrastination.

I’ll start with one of the most outstanding outlets I’ve found: critiques of “mainstream economics”.

Before continuing, let me emphasize why I put “mainstream” in quotes. As a friend of mine who’s in Stanford’s PhD Economics program rightly reminded me a few months ago:

In many ways “mainstream economics” is a very rickety and much abused straw man, and no one really does it any more. I think the basic tenets of modern economics are:

a) It is useful to assume that in making decisions, individuals are maximising something, given their limited information and cognition.

b) Equilibrium is a useful way to study behaviour.

Apart from this, everything else is open season. When doing policy, you have to either agree that

1) People are stupid, or

2) Society and its institutions are evil.

When thinking about policy, I tend to be more comfortable with (2): the idea that institutions (including markets) fail more often than not, but individuals do the best they can given the circumstances. Of course, behavioural economists are more willing to believe the people are stupid thesis.

But the much-maligned “mainstream” economics has not been studied, at least in active research institutions for quite some time. Doing it is not likely to get you published in a top journal. However, even then, there are a few people around, particularly in France (and amongst my old buddies in Cambridge, England), who feel that there is a lot lacking from the way economics is approached today. Their main concern is that we are too mathematical in our approach, thus confining the questions we ask. After all, Adam Smith and Ricardo did not use Kuhn-Tucker theorems or dynamic programming to find their insights. For more on this, it’s good to check out www.paecon.net.

With those requisite words of caution from a professional out of the way, let’s start the critiques. I’ll start with the best one I’ve found and understand: Section 6.14 of Herb Gintis’s Game Theory Evolving. It’s short, sweet, comprehensive, rigorous, chock-full of “news-you-can-use”, and diplomatic to boot. As he writes:

6.14.1 Costless Contract Enforcement: Achilles’ Heel of Neoclassical Economics

At the heart of neoclassical economics is the notion that the price mechanism equates supply and demand. The Fundamental Theorem of Welfare Economics, in particular, says that in a general equilibrium model, under appropriate conditions every competitive equilibrium is Pareto-optimal, and every feasible distribution of utility among agents can be attained by a suitable initial distribution of property rights, followed by competitive exchange (see Section 3.19). There have been many critiques of this model, and despite its enormous contribution to economic theory, it is no longer on the cutting edge of research these days. (Sidenote: That it is still taught to students as the “ideal case” from which the real world is an imperfect realization strikes me as scandalous.) Nonconvexity, externalities, multiple equilibria, and the absence of equilibration mechanisms entailing local stability, as well as other arcane issues, are often mentioned as the problem with the neoclassical model. But the biggest problem, easily trumping the others, is that the model assumes that agents can write costlessly enforceable contracts for all goods exchanged on markets. This may be reasonable for standardized goods (for instance, raw materials, basic chemicals, and easily graded agricultural goods) but, as we have seen, is misleading when applied to labor, credit, and consumer goods markets.

And then Gintis goes on to emphasize the key thing about labor, credit, and consumer goods markets that causes neoclassical economics to be misleading is that they are contingent renewal markets (i.e., an essential aspect of them is they’re repeated games in which the principal can tell an agent to take a hike if the agent doesn’t satisfactorily keep a promise). In particular, Gintis claims that the salient points about contigent renewal markets are:

In general, intuitively, “where product quality cannot be ensured by explicit contract, goods are in excess supply.” [Gintis, p. 138]

And specifically:

a) “In a Nash equilibrium of a contingent renewal market, there is an excess supply of agents.” [Gintis, p. 137]
b) “Contingent renewal markets do not clear, and in equilibrium they allocate power to agents located on the short side of the market.” [Gintis, p. 139]

Such facts make a lot of things that are actually observed in real-world labor, credit, and consumer goods markets a heck of a lot more explicable theoretically, so much so that Gintis believes the contingent renewal market model should be the second thing taught in any introductory economics class, right after supply and demand. Alas, it isn’t, and thus introductory economics courses have an annoying side effect of producing 19 year old libertarians who think the question of what constitutes the optimal society is a long-settled one (and worse, think that the pro-business wing of the modern Republican party is basically libertarian).