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The Modeling “Problem” in Economics

Summary:
Consider the situation of a complex adaptive system with intricate moving parts, and the critical element in all of this has purposes and plans of its own. Welcome to the world of economics. As Carl Menger pointed out over a century ago, “… man, with his needs and his command of the means to satisfy them, is himself the point at which human economic life both begins and ends.” Principles of Economics (1871, 108) Friedrich Wieser in Social Economics (1927, 8-9) would stress this point about the social sciences versus the natural sciences in stark terms as follows: The object of investigation is man in a condition of activity. Hence our mind ratifies every accurate description of the processes of his consciousness by the affirmative declaration that such is the case, and by the

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Consider the situation of a complex adaptive system with intricate moving parts, and the critical element in all of this has purposes and plans of its own. Welcome to the world of economics. As Carl Menger pointed out over a century ago, “… man, with his needs and his command of the means to satisfy them, is himself the point at which human economic life both begins and ends.” Principles of Economics (1871, 108) Friedrich Wieser in Social Economics (1927, 8-9) would stress this point about the social sciences versus the natural sciences in stark terms as follows:

The object of investigation is man in a condition of activity. Hence our mind ratifies every accurate description of the processes of his consciousness by the affirmative declaration that such is the case, and by the compelling feeling that it must be so necessarily. In this way the description becomes an exposition, although it may always be true that the final "why" is never brought forward, as no explanation is at any time forthcoming of stimuli which subconsciously affect consciousness. For all actions which are accompanied by a consciousness of necessity, economic theory need never strive to establish a law in a long series of inductions. In these cases we, each of us, hear the law pronounced by an unmistakable inner voice. What unequalled advantage to the naturalist, could he, too, appeal to the voice of nature for their confirmation of the laws prevailing in the organic and inorganic world! Where the natural sciences can only offer proof, the theory of economics can persuade; it can enlist the unqualified inner consent of readers.

And, in their own way this was a point stressed repeatedly by Mises, Hayek and Machlup.  But there are even very subtle issues of a technical nature that this point raises for those who want to follow a more unity of science research agenda, such as Morgenstern.  The Austrian School of Economics produced a rich debate on these issues ranging from the Menger-Mises strict dichotomy between natural and social sciences, to a more or less methodological dualism by degree as advocated by Hayek and Machlup, to a unity of science and consilience aspiration of say Morgenstern, to finally a more radical hermeneutical stances that stressed that all science is human science because only humans practice science as articulated by Lavoie (and McCloskey). I don't have any desire to adjudicate these ultimately philosophical positions here in this post, but I want to stress the implication for the modeling "problem" in economics from the fact that we are dealing with the study of human beings that have purposes and plans of their own that must be accounted for.  This problem is even deeper, I think (?), than a serious discussion of the fixed or free nature of the parameters in our modeling.  It is that our modeling has to constantly account for endogenous change in the behavior of those who populate the model which will then necessarily change the nature of the model.  In Morgenstern this is called the "theory absorption" problem, to the extent that actors in the model begin to believe the predictions of the model they will adjust their behavior to avoid the negative consequences and then as a result undermine the predictions of the model. And, this is ongoing.  Quick quiz -- think about the relationship between that point and the Lucas critique. Also, think about the difference or similarity between this point and the demand for placing the theorist within the model as well as stressed recently by both Levy/Peart, Escape from Democracy and Towards an Economics of Natural Equals and Koppl, Expert Failure.

I would argue, though this idea needs to be much more subject to critical dialogue with others, that there is a subtle but significant difference between the knowledge assumptions in economics made by Hayek and made by Lucas. To Lucas the agents in the model know everything that the economic theorist knows, but to Hayek the economic theorist can never possibly know everything the agents in the economy know (that pesky knowledge of particular time and place upon which they act).  This matters and matters in a significant way for how we think about parameters and predictions, about the subject and object of our investigations, and the limits and promise of scientific economics.

Many years ago, Ulrich Witt wrote a wonderful paper on what he termed "the endogenous public choice theorist" where the very predictions of the model result in recommendations for improvement which if followed will mean that the predictions of the model will necessarily change.

And, yes, this modeling "problem" is relevant for the chaotic crisis we are living through at this particular moment in time.

Peter Boettke
Peter Joseph Boettke (January 3, 1960) is an American economist of the Austrian School. He is currently a University Professor of Economics and Philosophy at George Mason University; the BB&T Professor for the Study of Capitalism, Vice President for Research, and Director of the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics at the Mercatus Center at GMU.

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