The Real Problem with Microfoundations

Peter Dorman’s post ‘The Problem with Microfoundations: Bad Micro’ (at http://econospeak.blogspot.de/2012/07/the-problem-with-microfoundations-bad.html) instantiates a thicket issues that I presume economic science might address in a more useful manner.

First, let us agree that “all the disciplines where people study behavior in a scientific way” have safely established that neoclassicism’s ‘economic man’ does not occur in sufficient proportions for his behaviors to register in studies of our familiar, everyday interactions.

Second, we would all observe that neoclassicism attributes the orderliness of our macroeconomic system to a mutual affinity between marginal revenues and marginal costs. This premise has begotten the conjoined conceptual twins of utility/optimality (neither can survive the other’s demise) which in turn necessitates the existence of an ‘economic man’ devoted entirely to gain and endowed with perfect knowledge.

Current economic thought divides as to what we are to make of these contradictory verities: orthodoxy somehow manages to dissemble the first observation, while heterodoxy asserts that it is sufficient to falsify the second. But have not both these attitudes tacitly accepted a planted axiom to the effect that micro behaviors must be foundational to our science of value?

This foundational axiom has had its fullest development by the Austrians, whose science is sourced in von Mises’ Human Action (at http://mises.org/document/3250/). Here we see ‘foundationalism’ getting us precisely nowhere: the causal link between individual behavior and macroeconomics must be interrupted by what von Mises and his current acolytes persistently describe as “the literal miracle of the market”. If there is to be a science of economics, then markets must cease to be the plaything of an omnipotent and inscrutable deity and become data to be explained.

Comparisons with specifically Western scientific thought reveal foundationalism to be a remnant of medieval Scholasticism. The medieval mind required unity of its universe, and this would (for example) logically require that the utility function for an economic sector be built up from the utility functions for all the firms or households composing that sector. Conversely, if the optimization of utility functions cannot be found in the observable affairs of actual firms or households, then they cannot describe the economic affairs of larger economic aggregates.

Science in the Western tradition begins with a realization that such God-like knowledge of the universe is not given to man. Our shamans no longer proclaim Truth. Rather, they create metaphors that are valid in certain degrees for certain applications. They accept that observations taken by instruments having different lengths of focus will reveal different phenomena requiring their specific, unique, explanatory models, e.g.:

Schrödinger’s wave equation explains the periodic chart of elements; but it has no grasp of the Newtonian world that is familiar to us. And Newton’s mechanics have no application in the sub-atomic world.

However useful Schrödinger and Newton are in their respective realms, neither is complete even in its own area of application. Schrödinger does not explain why the number of stable elements should be limited; and Newton’s particle – mass without volume – is philosophically absurd.

(While it is true that unified field theories are sought-for in the hard sciences, these efforts have yet to be productive, and might never constitute more than an acceptably modern form of seeking the deity.)

Summing to this point, we should conclude that economics’ current (medieval) habits of dispute would, by their very nature, disestablish all of what we know as ‘science’. So let us try thinking about our discipline as a Western scientist might.

Economics’ scientific pretensions might begin having some validity if its tacit ‘foundationalism’ were dismissed for its hostility to practical application. Liberated from any obligation to microeconomics, a true creature of macro thought such as the economic sector would be entitled to its own, unique, descriptive apparatus. Rejecting the utility/optimality premise as inoperative for actual firms and households would then commend, rather than disallow, its application in multi-sectoral contexts.

What would this require? First, a reasonable approximation for neoclassicism’s economic man would have to be identified as operational at the sectoral level of abstraction. It should not be difficult to project the securities analyst into this role: he is preoccupied by gain; his placements of capital among sectors are undertaken for the sake of overall efficiency; and he has proprietary knowledge of the firms in his sector because he is inevitably among these firms’ directors. Finally, we note that securities analysts are not likely to have their unique vocation’s peculiar behaviors reflected in studies conducted by behavioral psychologists because they are as much a rarity among the general population as would be the case for any other division of labor.

Second, the utility/optimality duo would have to be shown emerging as a useful scientific metaphor when viewed at a macroeconomic level of abstraction. A useful analogy here would be to Newton’s force/mass duo, which emerges into its own out of its subatomic foundation because ‘mass’ has proven to be an exploitably consistent property of matter.

Newtonian practice for measuring a theory’s boundary conditions is to run the theory ‘in reverse’. His notion that force equals mass times acceleration provides the theory: a unknown mass is subjected to a standard force; its acceleration is measured; and mass is computed as force divided by acceleration.

The analogous process for orthodox macroeconomics is a bit more complex, but the principle is the same: we observe physical transactions with the prices at which they occur in some general I/O format; we presume the observations are optimal because actual; and we calculate the utility parameters implied by our premise. If the utility parameters so measured are usefully consistent, and change meaningfully over time, then we might conclude that utility is exploitable as a measure of economic potential. This empirical conclusion would further indicate that tendencies toward general optimality are objectively real for processes of macroeconomic adjustment.

While economists might find these possibilities agreeable as possibilities, they are universally rejected as sterile. To be an economist of any persuasion one must have professed that neoclassical macroeconomics is complex to a point that there can be no non-trivial quantification of general optimally. Hence there can be no formal dynamic representing an economy’s progress through the chaotic physical states and disequilibrium prices toward the unique, equifinal general optimum to be realized if (as will never be the case) utility remained constant. Hence there is no theory that might be run ‘in reverse’ in order to test the neoclassical premise by Newtonian criteria.

Except that the necessary theory was synthesized more than forty years ago at a quite prominent institution, MIT/Sloan. Its emulation prototypes for ordinary Excel workbooks have been downloadable to your desktop since there has been an internet (see www.sfecon.com). This SFEcon system has been run in reverse to track the economic potential of several economies over decades. It was the basis of my course in international business economics at USF’s less-than-prominent business school. And it has received peer review in several disciplines at economics’ perimeter, e.g.: complex non-linear system dynamics, managerial cybernetics, and computable general equilibrium.

In other words, all of the issues cited through the body of Peter Dorman’s post have objective, quantified embodiments that have been tested (and can be re-tested) by the strict scientific criteria he laments as missing from economics. Indeed. And the 17^th Century Curia would not look into Galileo’s telescope because they reeeeeally wanted Ptolemy confirmed. Methinks economics’ real problem is its parallel unwillingness to submit its bases for moral authority to scientific confirmation.