Thursday, October 16, 2014

Nessun Dorma Part 2

A few days ago there was a review by Steven Pearlstein of several books, one of which, “We Are Better Than This” by Edward D. Kleinbard,  I have already ordered from Amazon because of this quote in the Pearlstein review:

“Both our native talents and our good fortune are distributed through processes that we cannot fathom and do not ‘earn.’ Our loud proclamations that what we take from the market is our just deserts is just noise made against the darkness, trying to still the voice inside that asks, why me and not them?”

Yes!!  Exactly.

In my last post I wrote about the limits of information, the fact that because information is widely distributed and always changing, and because human beings are constantly striving and pushing and working toward their own ends, unexpected and unpredictable change is not the rare departure, the “exogenous shock”, that is envisioned by modern model-bound economists, but instead is the steady, constant economic norm.  Because of this shoving and pushing we can’t really make long run economic forecasts, and that the agents in our models cannot predict the future any better than we can.  They can’t know their own futures with any security: all of what I called the “the restless magma of human dedication” is bubbling under them, and it can bury them or it can push them to great heights.  They can’t really know which it will be.  They have to live their lives to find out.

 And that should form at least part of the ground on which our economic models stand; the agents in our models should not be rational agents who trade present against a simplistic future in which all possible outcomes are known to them well enough to attach probabilities to each, because in the real world all possible out comes are not known at all, to anyone, and in small or large ways the future will always be something we haven’t even imagined until it gets here.   I don’t know how to create models like that, but if we want our economic models to depict the way the real world works it has to be done.

And that brings us to a dangling thread that needs to be tied up from my last post.  It ended with the sense that economic models can’t be used to forecast very far into the future.  So we might ask: what good are they?  What are they for?  And this relates to a question that I have to answer from time to time, when I admit in some social setting that I do sometimes read the economic blogs.  People ask: what are they forecasting, what are they saying will happen?  Because, of course, that’s what everyone really wants to know, probably because it’s what no one actually can know.  And I have to tell them: they aren’t.  The economics blogs, and economists in general, usually don’t make forecasts.  Oh, just before the release of some new economic statistic, they’ll play the forecast game about what the new release will say---but that’s actually “forecasting” what has already happened, which is what those statistics report.

So if economists don’t forecast the long run, except for those few courageous people who make their living doing nothing else, what on earth do they do?  Why study economics at all?

The answer, I think, is that that we create economic models for at least three purposes.  First, We should recognize that our simple models are parables only, and like any parables they present basic ideas to help us understand the world we find ourselves living in, as humanity has tried to do for thousands of years.  They help us know how people are able to work together, in a sense as cooperative strangers, in a country or in a culture, or on a planet, to provide (or fail to provide) a good standard of living for everyone.  Perfect competition doesn’t exist in the real world, but understanding how it would work tells us some very powerful things about some of the forces that act on us and around us.  Second, models help us figure out the less obvious implications of assumptions we make, or simple things we believe to be true: by embedding those assertions in mathematics, and in models, we can derive implications that we would never find by just contemplating the assertions on their own.  And third, while we may not know what the long run future will be we know what the present is and what the recent past has been.   We can, if we are successful in understanding something about how the world works, still make strong arguments about what will make the near future in some way better, and even what will make the more distant future better or keep it from getting worse, no matter what its exact features will be.  We can do this in the same way that we can say that providing oil will make your car last longer and run better, but adding too much oil can damage seals.  I can’t really forecast what will happen to your car in the future.  You might run over a nail, or get a dent in a parking lot, or there might be some deeper mechanical problem waiting to emerge next week or next month or next year. But I can make conditional predictions about the impact that certain actions might have: put oil in, or the situation will get worse; don’t put in too much or the situation will get worse in a different way.  Similarly in economics we can make conditional forecasts: policy X will have impact Y.  In my view, stimulus will stimulate, which may be good or bad depending on the situation (stimulus during a boom is bad; stimulus in a recession is good).  Austerity will depress, which may be good or bad depending on your situation.  Investing in infrastructure will make the future economy more affluent, in part by making future businesses more productive and perhaps even more profitable.    In making these predictions about the impact of various policy actions, simple economic models help if they depict something true about the world. And if they depict something false, they may mislead us into policy actions that are dangerous, or outright harmful.  That’s why there are so many arguments about the foundations of economic theory: it matters, and our future welfare depends on finding simple models that are true, and avoiding simple models that are false.

And similarly, in each “agent’s” life, he or she has to accept the fact that his or her future can’t be known exactly, and that the farther away the future period is they’re looking at the less can possibly be known about it.  But we do all care about the future, and so the agent in our models still has to make choices about actions in the present that may impact the unknown and unknowable future.  So the agents have to decide what they believe about the future, and they have to decide what present actions will give them the best chance to prosper, or at least survive.  We may not know what the future will be, but we know we’ll have more flexibility to deal with it if our debts are all paid and current, and if we’ve saved something.  We will be better able to deal with whatever comes along if we are more educated, or we have good friends and a strong family to help us through, than if we aren’t or don’t. 

But no one makes present decisions based on any real knowledge of what their taxes will be in some imagined distant future.  They have no idea what their taxes will be, partly because they have no idea what their income will be in that future, and they have no idea what the whole country’s income will be either: their share of future taxes will depend on both.  People save to give themselves a better future, period.  It makes no sense to build a simple economic model, as, for example, the modern version of Ricardian Equivalence does, that assumes that people save today in order to pay taxes in the future, taxes that they can’t know will ever be imposed, and can’t know, even if the taxes are imposed, what portion of those taxes will fall on them.   That is a simple model that seems to me to be false, and so I think that depending on it will lead us to national actions that might cause actual damage to the future we are trying to achieve.

I once read an interview with a multimillionaire who (of course) was asked how others could achieve wealth.  His very honest response was: “I don’t know”.  But later he did amend that.  He said something like this: “Save your money.  Everyone gets a couple of opportunities in their life.  If you have money saved you have one more tool you can use to pursue an opportunity when it comes.  Who knows?   It might succeed, and make you richer than you are.”

Doesn’t that sound more like the life we all lead than the models that assume we all can calculate our expected futures with mathematical precision?

1 comment:

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