From: thompson@atlas.socsci.umn.edu (T. Scott Thompson)
Subject: Re: Problems with Neo-Classical Economics
Reply-To: thompson@atlas.socsci.umn.edu
Organization: Economics Department, University of Minnesota
Date: Wed, 30 Sep 1992 17:35:01 GMT

jmo@livia.princeton.edu (Mike Orszag) writes:

>Mr. Thompson, let us talk about macroeconomics only.

Personally, I am extremely skeptical about most of modern
macroeconomics, largely because of some of the problems you list.

> The theory
>does not match the data well at all except when it is cooked to
>do so by dishonest manipulation of Solow residuals. The theory
>has no predictive power or policy usefullness. The theory 
>is not self-consistent and predicts no numbers without mindless
>manipulation of parameters.

You are contradicting yourself.  If the theory "has no predictive
power" then there is no way to falsify it using data.  In particular,
you cannot claim that the theory "does not match the data well" and
simultaneously claim that the theory does not predict anything.

> Now, let us talk about assumptions
>and why the models might not work. Let us confine ourselves
>to three key assumptions: (1) representative agent, (2) expected
>utility, (3) stationary environment. None of these assumptions
>has empirical support and they all drive the results.

(1) I have not seen any empirical falsifications of the representative
agent hypothesis itself.  The empirical work I have seen on this
typically falisifies the predictions of a fairly complicated model
that includes the representative agent assumption.  Rejection of these
models does not logically lead to a conclusion that the representative
agent hypothesis is wrong.

BTW I do not believe in the representative agent hypothesis because it
seems somewhat far fetched.  But this is a subjective opinion.
Scientifically, I cannot reject the hypothesis.

(2) I agree that expected utility is routinely falsified in laboratory
experiments.  To the best of my knowledge there are no workable
replacements available.  It may still be the best _available_ model of
decision making under uncertainty even if it is not 100% correct.

(3) Detecting/rejecting stationarity in an economic time series is a
notoriously difficult problem.  Witness the unit root controversies in
macroeconometrics of recent years.  It is not clear that failures of
stationarity are disasterous for neoclassical theory, however.  I do
fully support efforts to seriously model economic nonstationarity.

The original poster seemed to be interested in questions about the
pros/cons of neoclassical arguments for free trade.  I was simply
pointing out that you don't have to go outside the neoclassical theory
to develop good arguments against the optimality of free trade.  At
the same time, I think that arguing about the assumptions is unlikely
to get us to definite answers to any policy questions.  This will
require far more serious empirical work than has been attempted so
far.

The biggest single problem in macroeconomics today is that there isn't
enough data.  We need _lots_ more observations, and at a much more
disaggregated level, before we are going to have much succes with long
run policy analyses of the kinds involved with free trade.  Until
then, most of what you read claiming definite recommendations will
include a healthy dose of personal opinion.  This is true for
neoclassical economists, but also true for any other observer/
commentator on the modern economy.

> The
>important thing is to get the models to work

No question about that, although I don't think you will ever find
models that work for all purposes.  We are unlikely to discover
absolute, unambiguous truth.  A model is just that -- a model.  It is
not, nor is it meant to be, truth.  Lets be clear about what we want
the model to do, and judge it according to how well it achieves those
goals.

> but in terms
>of listing bad assumptions which lead to bad theory and bad
>predictions, I think I have answered your question.

Which question was that?

>-- MIKE ORSZAG, University of Michigan


--
T. Scott Thompson              email:  thompson@atlas.socsci.umn.edu
Department of Economics        phone:  (612) 625-0119
University of Minnesota        fax:    (612) 624-0209
Newsgroups: sci.econ