Formal Economic Theory: Beautiful but Useless?

22 May 2006 at 1:22 pm 8 comments

| Peter Klein |

Greg Mankiw, reflecting on the "poetry" of Paul Romer's growth theory, offers this assessment of modern, mathematical, neoclassical economic theory: "Too much of it is beautiful but useless."

Let's leave beauty in the eye of the beholder, for now, and focus on the second part of Mankiw's description. How much has formal, mathematical economic theory contributed to our understanding of the world? What economic phenomena do we understand better today than we did, say, before World War II, when the principal language of English-speaking economists was, well, English?

What about organization theory, sociology, law, political science? Has the formalist revolution generated new and valuable insights, or merely restated existing truths in new language (possibly mangling them in the process)?

I'm reminded of Ronald Coase's typically witty conjecture in his "Economics and Contiguous Disciplines":

One completely satisfying explanation [for the expansion of formal economic theory into other social sciences] would be that economists have by now solved all of the major problems posed by the economic system, and, therefore, rather than become unemployed or be forced to deal with the trivial problems which remain to be solved, have decided to employ their obviously considerable talents in achieving a similar success in the other social sciences. However, it is not possible to examine any area of economics with which I have familiarity without finding major puzzles for which we have no agreed solutions, or, indeed, questions to which we have no answers at all. The reason for this movement of economists into neighbouring fields is certainly not that we have solved the problems of the economic system; it would perhaps be more plausible to argue that economists are looking for fields in which they can have some success.

Entry filed under: - Klein -, Methods/Methodology/Theory of Science. Tags: .

Passion, Blogging, and Manuel Castells “The Train Wreck That Is Strategy” and Game Theory

8 Comments Add your own

  • 1. Ryall  |  22 May 2006 at 11:18 pm

    Let’s see … precisely stated assumptions, definitions and propositions embedded in a methodology that ensures the latter are logically consistent with the former, versus … what, exactly?

    If you need any demonstration of the need for formalism in theory-building within the social sciences, take a look at the train wreck that is Strategy. As we are discovering using formal methods, most of what passes for foundational theory in strategy is wrong.

    Conversely, consider how formalization completely transformed Finance – both in academic and practice circles.

    Progress in economics is slow because the problem domain is hard (as a physicist once pointed out, our “atoms” think). My guess is that it would have been even slower had the profession attempted to construct theories relying solely upon natural language as has been the case in other areas.

  • 2. Peter Klein  |  23 May 2006 at 9:26 am

    These are fair points. I too think the analysis of strategic interaction and its applications (including agency theory, mechanism design, contract theory, etc.) represent significant increases in useful knowledge. On the other hand, the evidence on practitioner relevance is mixed (e.g., this). And the most general and profound insights can probably be gleaned from simple PD or coordination games, which don't require much, if any, formal apparatus. To put the problem another way: Who has taught us more, Aumann or Schelling?

    Finally, Mike's conjecture — progress in economics "would have been even slower had the profession attempted to construct theories relying solely upon natural language as has been the case in other areas — is an empirical claim. How would we go about evaluating such a claim? 

  • [...] In a comment on my co-blogger's post of yesterday, a commentator argues that there is no real alternative to formalism, and then provokingly continues: If you need any demonstration of the need for formalism in theory-building within the social  sciences, take a look at the train wreck that is Strategy. As we are discovering using formal methods, most of what passes for foundational theory in strategy is wrong. [...]

  • 4. Peter Klein  |  23 May 2006 at 2:39 pm

    David Warsh suggests auction theory as the best example of useful formal neoclassical economics.

  • 5. Ryall  |  23 May 2006 at 6:54 pm

    Peter, I see that I succeeded in provoking a reaction from Nicolai … hehe. Before moving over to his thread with a reply, let me clarify couple of points.

    First, I think many of us would agree that there is a thriving market in economics for clever formalism independent of real-world relevance. This has always struck me as a colosal waste of energy.

    Second, I am not advocating any particular approach; e.g., “neoclassical economics” (whatever that means), game theory, NK models, etc. Rather, progress in social science (any science, actually) requires unambiguous claims, rigorously derived. Theoretically, one could use natural language to proceed, but practically speaking, humans aren’t very good at keeping their logic straight when working through complex arguments. (Which is clearly why mathematics was invented in the first place.) My claim is simply that, if one wishes to identify general principles using deductive theory, then formal methods, of whatever stripe, are a necessary condition for scientific progress.

    Third, this debate is somewhat pointless. I mean this is the sense that we all get to put our theories out there in the marketplace for ideas (however derived) and, at the end of the day, will see which ones are left standing. This suits me fine.

  • [...] Curiously, when asked how economics has progressed in the last half-century (previously discussed here), Blaug doesn't mention microeconomics at all, but says we've learned a lot about "how to deal with inflation, how to deal with unemployment . . . about steering the economy in a macro sense." (Who knew the guy had such a great sense of humor?) [...]

  • 7. Michael Greinecker  |  31 December 2006 at 10:58 am

    “What economic phenomena do we understand better today than we did, say, before World War II, when the principal language of English-speaking economists was, well, English?”

    I think that is the wrong question. The goal of pure mathematical economics isn’t understanding the economy better, it`s understanding economics better. I think in that respect we have learned much. There is no going back to the naivite of the old days. And I don’t know of any aspect we don’t know more now. All the insights brought by game theory came later.

    “To put the problem another way: Who has taught us more, Aumann or Schelling?”

    Well Aumann has brought us correlated equilibria, the epistemic foundations of game theory, much of the theory of repeated games, a new way to think about decision theory, the agreement-theorem with many economic applications. Economics would be much worse without the contributions of Aumann.

  • 8. Harry  |  30 May 2008 at 8:24 am

    As one make his bed, so he must lie on it,

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