Economics as an inductive science.

• Author: Clower, Robert W.

Logic is the art of going wrong with confidence.

Anonymous |30, 197~

It seems appropriate to begin by recalling something from our founder, so I start with a passage from the Wealth of Nations where Smith writes about "Institutions for the Education of Youth" |48, 763~:

If the teacher happens to be a man of sense, it must be an unpleasant thing to him to be conscious, while he is lecturing his students, that he is either speaking or reading nonsense, or what is very little better than nonsense.

All who have taught macroeconomics at any time during the past forty years will know this feeling well; for macroeconomic theory has been riddled with Kuhnian anomalies |32, 202 ff.~ since its inception. Strangely, few teachers of microeconomics seem embarrassed by the purely theoretical material they teach and which their students are required to read and regurgitate, although microtheory is at least as objectionable as macroeconomic theory. That we who teach any kind of "pure" theory ought to be as embarrassed with microeconomics(1) as with macroeconomics is the position I propose to argue here.

Before I proceed, let me emphasize that by "pure theory" I do not mean what most working economists, including, I imagine, our most recent Nobel Laureates, Douglas North and Robert Fogel, mean when they use the word "theory" without further qualification. Generally speaking, we mean by "theory" the fact-oriented creative mixture of intuition, casual empirical knowledge, and seat-of-the pants logic that is found in virtually all "applied economic analysis" and, indeed, in virtually everything called "economics" before 1950 |20, 284~. By pure theory I mean the axiomatically-based neowalrasian analysis of Arrow-Debreu |3~, Debreu |15~, Arrow and Hahn |4~ and closely related offshoots that serve as a standard of "economic correctness" in all modern teaching not only in microeconomics but in macroeconomics, money and banking, finance, and econometrics.

The phrase "economic correctness" corresponds to what Peter Howitt, in a recent paper |26~, calls "The Neowalrasian Code":

Adherence to an increasingly complex code of formal ideas has become the overriding criterion of success, rather than fruitful modelling of observed phenomena. The code of modern economics has become for the most part that of neowalrasian analysis, with its rules for modelling all behaviour as the outcome of rational choice. | . . . ~ But accounting for some phenomenon in a discipline dominated by an elaborate code consists not of telling stories designed to convince others that this is why the phenomenon exists, or why it appears the way it does, but of telling stories, no matter how ad hoc, that incorporate some aspect of the phenomenon, no matter how trivial, without violating the code. | . . . ~ Economists building "rational models" to account for things not found in conventional theory think of themselves as seeking explanations in the usual sense, whereas in fact they are addressing purely semantic questions that don't even arise once one ventures out of the neowalrasian cloister. Only by the rarest fluke could someone working under such a delusion come up with a convincing scientific explanation of anything.

I have titled my paper "Economics as an Inductive Science" in recognition of the contrast between inductive (fact-oriented) science and the kind of microeconomic theory--really "verbal mathematics" |20, 278~--our contemporary textbooks contain, which Whewell |56, 14~ aptly characterized as a philosophy (some might say catechism)

. . . constructed on notions obscure, vague, and unsubstantial, and held in spite of the want of correspondence between its doctrines and the actual train of physical events | . . . ~ . . . the object is not to interpret nature, but man's mind.

Joan Robinson |42, 122~ long ago described the central problem of economics as being to understand how the economic system works, or as Keynes once expressed the issue |28, 35~, "Is the economic system self-adjusting?" More generally, as the astronomer Simon Newcomb |35, 9~ observed:

There is nothing in the wonders of the heavens or the mysteries of chemical combination better fitted to kindle our curiosity, and to gratify our desire to understand what is going on around us, than the study of the social organism.

To date, however, we economists have failed to seriously address much less resolve these issues.

How are the myriad economic activities of the millions of independent transactors in private ownership economies coordinated? It is correct, of course, to assert that the coordination of economic activities is performed by an "invisible hand," or "the price system," (2) through variations in prices and quantities in response to changing "market conditions": correct, to be sure, but just as surely inane, because such a response is no more informative than an appeal to Jupiter or Providence |1, 144~. An intellectually respectable answer should consist of something more than tired cliches; observable economic events derive ultimately not from unspecified coordinating mechanisms, whether invisible hands, price systems or neowalrasian "auctioneers" but, as James Tobin has indicated, from definable actions of real people |54, 796~. What we economists have yet to explain is the working of the fingers of the invisible hand |9~.

A partial explanation for our failure heretofore to explain the modus operandi of "the market" may lie in our infatuation with technique. It is widely believed that a great achievement of postmarshallian (neowalrasian) economics was the "discovery" of exact conditions under which perfect coordination of individual economic activities will be achieved automatically |44, 469-70; 30, 41-53~. The truth is quite otherwise. The neowalrasian version of general equilibrium theory provides a mathematically rigorous statement of conditions under which a competitive equilibrium "exists," but the statement is interpretable only for a hypothetical world where coordination uses no resources, where no agent ever imagines that a failure of coordination might prevent trading plans from being completed, and where institutions such as business firms and markets through which agents routinely interact in real-world economies are not just absent but otiose. In truth, neowalrasian theory makes no mention of any mechanism or agent that undertakes the task of coordination.(3) The closest it comes is in the theory of "tatonnement," where it is postulated that prices adjust to eliminate discrepancies between demand and supply. But if we ask, Who changes prices?, Who pays whom, and with what?, Who matches buyers with sellers?, Who pays the costs of arranging and executing transactions?, Who goes long or short when demands don't match supplies?, and What incentives motivate any agent to perform coordinating tasks?, then the theory is silent.

How might we resolve these and similar questions? Einstein wrote |18, 98~:

Science is the attempt to make the chaotic diversity of our sense-experience correspond to a logically uniform system of thought. | . . . ~ The sense experiences are the given subject matter, but the theory that shall interpret them is man-made. It is the result of an extremely laborious process of adaptation: hypothetical, never completely final, always subject to question and doubt.

Of course, Einstein's reference is to Physics and Astronomy; but from a non-normative point of view, economics is just Social Astronomy. Its purported aim is to enhance understanding of the working of the economic universe. If we are ever to be taken seriously as scientists we would be...