Dave Altig on Phillip Ball's Rant on Neoclassical Economics

Dave Atlig (macroblog) has a good rejoinder to Phillip Ball's Criticism of Neoclassical Economic Theory. Here is a snip:

…It is true that neoclassical economists tend to be the methodological children of Milton Friedman, heirs to a positivist tradition that directly connects explanation and predictability. But predictability in this sense is conditional: If X occurs then, all else equal, Y will follow. As a matter of logic, large forecast errors may only prove that the arrival of X is especially uncertain, and that economists are not clairvoyant (a trait that I think is shared with physicists and other human beings).

To be fair, if Y equals a stock market crash, I cannot really tell you what X equals. I am unaware of any serious economist who claims they can. Even those economists who express knowledge of a "bubble" in some asset market or another shy from taking definitive stands on when and how the bubble will burst.

I do know this, however: Economists have devoted a lot of energy to thinking about the lessons delivered by the Great Depression. At least part of the conventional wisdom formed from that thinking is that it is a very bad idea to restrain liquidity when liquidity is most desired. For an example of that wisdom in practice, I refer to you to the actions of the Federal Reserve in the aftermath of the 1987 market crash in the United States. I'll stick my neck out and claim that the world was more pleasant as a result of putting that lesson into action.

[Ball]…The usual defence is that you have to start somewhere. But mainstream economists no longer consider their core theory to be a "start". The tenets are so firmly embedded that ... it is ... rigid dogma. To challenge these ideas is to invite blank stares of incomprehension – you might as well be telling a physicist that gravity does not exist.

That is disturbing because these things matter. Neoclassical idiocies persuaded many economists that market forces would create a robust post-Soviet economy in Russia (corrupt gangster economies do not exist in neoclassical theory)...

Economists accept -- insist, actually -- that institutions matter, and nobody would argue that market forces alone can create a "robust" economy absent well-defined property rights, functioning legal systems, and the like. If you doubt that, check out the latest John Bates Clark award.

[Ball]...Neoclassical economics asserts two things. First, in a free market, competition establishes a price equilibrium that is perfectly efficient: demand equals supply and no resources are squandered. Second, in equilibrium no one can be made better off without making someone else worse off.

Wrong. Mr. Ball is thinking of the concept of Pareto efficiency, which does indeed describe a situation in which "no one can be made better off without making someone else worse off." But there is no presumption among economists that free markets and competition will deliver such an outcome. Any time an economist speaks of asymmetric information (conditions in which one person knows something another does not), externalities (things like pollution that is not paid for by the polluters), inflexible prices or wages, or taxes on any sort of economic activity, he or she is starting from the presumption that the free-market outcome is not efficient. In fact, any time an economist speaks it is quite likely they are contemplating a world in which free-market outcomes are not efficient. To not recognize this is demonstrate a startling ignorance of what economics is actually about. …

There is more.. Go to to Dave's post and read on….
And if you are really a glutton for punishment, read Mark Thoma's post and as of now 110 follow-up comments that got things rolling.

Here's my reaction to Dave's post:

Yes, but ... look what a great discussion Ball's reactionary commentary has produced in various blogs. Ball's article is, I believe, a reaction to what the press, some politicos, and sometimes we as underinformed or ideologically blinded economists spin up as economic theory/practice--not adequately owning up to limits, nuances, etc. of our methods.

Hence we economists are not guiltless as to some general criticism well-aired on Mark Thoma's blog. Sometimes too, we are not well-enough covered by the press as to contrasting views/theories, etc. (then again who is).

Still, as Dave A. aptly points out we economists (taken collectively) are not shy about criticising each other and learning from our criticism, our practice, etc.
Posted by: Dave Iverson | November 01, 2006 at 05:51 PM

Maybe, just maybe, Beware of Economic Fundamentalism, by Fred Argy, covers the main bases for effective criticism of "economic fundamentalists." Or maybe it just adds more fuel to the fire...