If you want to learn more about the importance of model building and what it does and does not say about what we can know about the economic world, read anything by my excellent colleague Steve Landsburg. He’s got a nice chapter in his latest book, The Big Questions, on it too.

A common objection to free-trade, for example, (an article in the NYT last week about Apple and outsourcing sparked a good amount of chatter about this) is that “free-trade works on graphs and in equations” but that’s not the real world. I will not address that claim here. When you hear someone criticize an economic model/theory for not being realistic you can rest assured that the person has no idea what they are talking about. How so? Two major reasons I would suggest:

1. Many basic economic models seem to support the idea that a laissez-faire approach to economic activity tends to produce good outcomes. Have you ever heard a critic of such models argue that, “hey, that’s what the model says, but in the real world, even more laissez-faire than the models suggest would be even better?” Nope. And you never will. Generally speaking, the only criticisms I encounter are those that object to a model that suggests a smallish role for government. Seriously, how many of these same criticizers have you heard say, “gee, maybe we shouldn’t tax emitters of pollution – after all, the Pigovian tax comes from a model, not from what we actually see in the real world?” Or how many of these same criticizers have you heard say, “gee, maybe we should ignore the theory of adverse selection, after all, the idea that insurance markets unravel comes from an unrealistic model that assumes information asymmetries that don’t actually exist in the real world, and so maybe we should rethink how we regulate the health insurance industry?” And so on. I think you get my point.
2. That’s not exactly how these people behave in the real world and not how they respond to models that seem to suggest a world that they like better. Walk around today and ask people what they think about Global Warming. Ask them why we should increase taxes on carbon or perhaps scale back industrial civilization. Don’t just have them say, “because bad things may happen if we don’t.” Rather, ask them how they know this. Indeed, go one step further, ask them why global temperatures are not higher today than they are – after all, it was predicted that given the current levels and rates of emissions of carbon dioxide the planet would be hotter today than it is, and hotter in particular places than it is (such as the tropical upper troposphere). The entire global warming movement is based on totally unrealistic modeling. Note, that this does not mean I don’t believe them, I am raising a consistency point again. And the models indeed are unrealistic. We don’t even know how to model the impacts of water vapor, and we have to use calibration (and not theory) to figure out what feedback loops there are within climate systems, just to name a few of the uncertainties.

   But I’ve never heard a supporter of doing something about climate change condemn the models on the same grounds that they condemn economic models, particularly free trade. Furthermore, ask someone who favors economic stimulus in times of recession, or who wishes to argue that the 2009 stimulus should have been larger, or that we ought to do stimulus now, how they came to that decision and they’d have no choice but to say, “because our economic models tell us we ought to do so.” Seriously, there is absolutely no real world experience or evidence to confirm or deny any view on what economic stimulus actually does. Now, I like to argue from a microeconomic chain of logic about why it would be hard to believe that stimulus would be a good idea, but I have no serious real-world evidence to 100% make my case – nor do stimulus proponents. So, in the case of the proponents, their belief in stimulus has to be based on models. Never mind how utterly inconvenient that position may be given the complaint I encounter in the title of this post – I don’t think anyone who makes claims like this spends more than one iota asking themselves if they are making sense. Why? Because we are either so extraordinarily delusional, or that we so badly want to affiliate with a particular group or idea, that we just say what sounds reasonable and go no further.

To be honest, this state of affairs is perhaps the most depressing of all the aspects of having to be engaged in what people think is “serious intellectual discourse.” It’s not. Not because it’s not possible but rather because few people (myself perhaps included) really are interested in having it.

In a working paper two students and I write:

Stevans argues that, “most academic economists are concerned with studying such obscure topics as backward induction among chess players and the existence of monotone pure-strategy equilibrium in Bayesian games.” Does “most” mean more than half? Eighty-percent? Is there a right amount? He is onto something, of course. As Paul Krugman has written in many places, economic confusion comes about because modelers have little conceptual notion of what it is they are trying to model. But this does not mean modeling qua modeling is wrong, or even mindless drudgery. There is modeling for modeling’s sake – the kind that perhaps should be scrutinized. And then: there is good modeling. Models are not just neat ways of illustrating sometimes complex ideas. They are essential.

Applying formal theoretical and mathematical techniques to economic history (referred to as “cliometrics”) has revolutionized the way we understand the history of slavery, transportation, agriculture and other areas without making those topics inaccessible. In defending the formalization of economic history, Nobel Laureate Robert Fogel famously stated that, “The belief that the older economic history is solidly grounded in fact is an illusion … it is permeated with untested covert models and subliminal mathematical assumptions.” Graduate education focuses on model building because models prevent us from saying whatever it is we want to say about the world. Writing down a model of human behavior and interaction is the only way we can understand whether or not what we are saying is logical – with propositions within the models and outside of them. Perhaps the crisis in modern economics is not that we build too many models, or that the models of academic economists are unnecessarily complex, but perhaps that we have yet to discover a model to help non-economists model the world themselves.

A student came to me the other day and mentioned, sort of out of the blue, that private agencies should not deliver water to cities, and that rural and suburban water ought not be priced because it would cause the poor to suffer. I did not push the issue. But this person, if asked what model of the world he was operating under, would very likely not have been able to offer one. And that is a problem, as we’ll elaborate on in the future. But he certainly was operating under a model – and I wonder how he’d defend it. The simple model? That the elasticity of demand for water is zero. If that were indeed true, then when private agencies charged market prices for water that reflected its true social cost, we’d only see transfers from customers to firms – and no economizing on water use at all. But we know that perfectly inelastic demand curves cannot exist, and we can also ask our student what conditions would have to prevail in order to generate such a curve in the water market. And he’d have seen that those conditions are extraordinarily unlikely.

So, while I am not a huge fan of fancy, technocractic model building, that does not mean I am not a strong supporter of logical and systematic explanations of behavior. To say that you can dispassionately look at facts, examine history or understand the social, political and cultural influences on people and that means you do not need an economic model to describe behavior is implausible. The point is, when making such judgments you are still using an economic model, it’s just that you are not articulating what it is. I have taken this to heart lately. It doesn’t make sense trying to reason with people, so what I do is simply ask questions about how they came to the positions they are taking.

In the world we typically live in, the kind of precaution we exercise is to not act (at least not consciously and collectively). Indeed, this should be attractive to those folks who understand the complex ordering of modern societies precludes perfect outcomes from being achieved. The precautionary principle is invoked to change the default order for society to being “act, and act collectively.” If you take such propositions seriously, how come they are not applied consistently? Think about global warming. We are being told to reduce carbon emissions by 80% below 1990- levels by 2050 or else … something bad might happen. Fine, let me accept that argument, despite it being a physical impossibility right now. Where are folks out there advocating that we “do something” about other serious threats? Wouldn’t consistency require that we invade Iran right now, or send an atomic bomb over there to flatten every molecule within their borders? Sure, that is costly, but there is a possibility that they will unleash nuclear weapons and bioterrorism on us and Israel. There is no scientific way to prove that they will or they won’t and surely the possibility that they will bomb us is out there, so I say let’s launch our missiles.

If you wish to argue we ought not preemptively nuke the Iranians, why not? Rolling back modern civilization to get an 80% emissions reduction may kill as many people, albeit unidentifiable at the outset, so I am not convinced by the “we are killing people in one case and not the other” arguments. What other threats are out there? I submit that we should eliminate the use of ALL anti-biotics today. Why? Because our overuse of them has encouraged bacteria to evolve to become more powerful and we may end up creating the Superbug of Superbugs – the mother of all infections, that will wipe out far more of the human race than global warming could ever do in the worst scenarios. On what grounds should we not exercise caution in the use of antibiotics yet use caution when it comes to global warming?

Or finally, what if I offer up the suggestion that, “we ought to subsidize the building of millions of churches so that we can all go and pray that global warming will not doom us” as the “do something” response to the global warming crisis. Would you object to such a plea? I’d guess that you’d say yes. On what grounds would you say yes? I submit that you’d say that “praying for less serious consequences will not affect whether we get less serious or more serious consequences.” And I’d ask you, “how do you know?” I suspect you’d have to invoke science. In other words, you’d have to rely on the very axiom you are trying not to rely on in order to justify your preferred conclusion. You can’t do that, at least not if you are interested in being taken seriously. But I don’t suspect many of us really want to be. Well, that’s not quite right. I just think many of us are delusional — including yours truly.

Remember however that there are many other ways for humans to coordinate their activities – including religious organizations, extended familial relationships, community organizations, governments, and so on. That government is the other major institution in society today is also telling – we stumbled upon that too as a way to help overcome other classes of coordination problems.

That said, it is very easy to imagine that a market setting (given current culture, technology and property rights institutions) may not easily overcome certain classes of coordination problems. For example, allowing the free and open buying and selling of ocean fish may result in rapid depletion of open fisheries. But from that observation (empirically verifiable too!) it certainly does not follow that having the government own and operate ocean fisheries will make the problem any better.

The only way that the latter observation follows is by assuming a natural state of perfection when governments operate. Of course, if transactions costs within government were zero, and information costs within government were zero, monitoring government was cheap and easy and incentives within government were aligned perfectly with the objectives of citizens, then yes, sure, government management of the commons would solve the fishery problem. But that is not the world we live in. It never was and never will be. You cannot under any reasonable operational model of human behavior compare the inability of people to coordinate their activities under market institutions as they actually exist on earth today, with the ability of people to coordinate their activities under political institutions that only exist in the land of unicorns. But that is precisely what we do. It’s a pretty unsophisticated and uncharitable approach to doing comparative institutional analysis.

We can do better than that. And that’s true for those of us that appreciate how well market institutions work. Extra credit to anyone who can figure out why the post is titled what it is.

1. Mr. Stern needs a statistics refresher. What is the right probability here?  Is it really to look at a growing command economy and imply that command –> growth? Actually no. What matters is, what is the probability that an economy run like China’s will see growth. And China is one case out of … 50? 70? 90? What is the probability? On the contrary, what is the chance that a country moving in a free-market fundamentalist direction achieves good results? I’d venture a polite guess that it is a wee-bit higher.
2. Signapore, second only to Qatar, had the world’s second fastest growth rate in real GDP last year, it grew 50% more rapidly than China. Does Andy recommend the US follow Singapore’s model? After all, it is ranked second in economic freedom. It must be the case, right, that it is growing only because of its free-market fundamentalism. In any case, here’s a list of the top 20 growing countries from last year. What about the other 19? What makes China so special? Is it really because it’s big?
   

   1	Qatar	16.272
   2	Singapore	15.270
   3	Paraguay	14.400
   4	India	11.1
   5	Republic of China (Taiwan)	10.823
   6	People’s Republic of China	10.300
   7	Turkmenistan	9.222
   8	Argentina	9.161
   9	Sri Lanka	9.134
   10	Congo, Republic of	9.090
   11	Zimbabwe	9.006
   12	Peru	8.795
   13	Botswana	8.562
   14	Uzbekistan	8.500
   15	Uruguay	8.468
   16	Nigeria	8.394
   17	Afghanistan	8.227
   18	Turkey	8.200
   19	Yemen	8.016
   20	Ethiopia	8.008

3. There are lots of countries doing lots of great planning like China too, do we just get to forget Guinea, Bolivia, Cameroon, Venezuela, etc.?
4. Mr. Stern is making a pretty bold assertion that China is growing because of its central plan. That may be true. But China had central planning for three decades before the 1980s, and it was one of the most horrific human rights and economic horror stories that the planet has ever seen. Do we conveniently get to ignore that “misstep?” Furthermore, China has been growing incredibly freer over the last 30 years – did you even see a single mention of this in his article? That the concept of private property now has meaning in China. That unlike the United States, not a single dollar of foreign capital has been expropriated by the Chinese government in 50 years. Would it be any less correct to argue, “China has been learning from the free-market fundamentalism of the western world and has made rapid movements in that direction, which is why it is growing. Therefore the U.S. should pay attention to what’s happening over there and step on the free-market fundamentalist gas pedal?” I’ll be long dead before he utters anything resembling that.
5. So what?  I don’t care if China grows faster than us. I hope they do. It will make me richer. It will give me more friends. It will be a source of more medicines. It will be a source of more entertainment. It will be a source of more trading partners. What’s this insane obsession with being like anyone else anyway? If someone in China is better at building a bridge or better at making a faster microchip than someone in America, why the heck should I care? After all, I currently suck at building bridges and making microchips, and I don’t care since I can trade teaching services in order to access someone who has those skills. Tell me again why I would be worried that I’d have more and richer people to trade with? Or is Andy worried that if China goes and gets all rich on us that we’d lose a war with them? Fine. I’m not particularly interested in seeing America at war with anyone.
6. So what? Suppose Andy is right. I still don’t care. Or does Andy not respect the core values of a certain class of people who prefer to have their rice-bowls to themselves? Being free is valuable on its own right. And being free has delivered unmeasurable wealth to mankind already. If being free in the 21st century means I’d have to forego some more of an increase in my living standards, it’s a price I’m more than willing to pay. But I suspect that those who value liberty do not matter in the world of Mr. Stern. If so, he would have mentioned that in his little polemic. And in a world of true freedom, what fear would I have of someone else’s success?
7. Does Andy Stern really believe that political actors in China or the US can be trusted to wield the awesome powers he envies in an honest, fair and transparent way? Does he propose to have only the Progressives wield the power to “partner” with the private sector? What if a far-right Christian coalition ends up taking the reins in the US? Would he be comfortable having them usurp the “free-market” ideology of the US and legislate a massive moral change in the country? Would he agree with the mobilization of massive resources to build more churches and community centers that agree with established teachings? Would he agree with an expansion of government-corporate farming, you know, to benefit the people?
8. Does Andy even know that more roads and more high rises are good things? You’ll find an eerie emptiness in his article about whether any of the things China is doing make long term sense. Furthermore, you’ll find an eerie emptiness regarding the rapid pace of American growth 200 years ago and how that growth happened haphazardly and without a plan.
9. And while we are on the topic of navel-gazing, you’ll notice that Andy leaves out some pretty famous navels. How about Lincoln Steffens and the rest of the Gulag-a-goggers that visited the USSR in the late 2os and early 30s (as detailed in Amity Shlaes’ excellent The Forgotten Man) indicating, “I’ve seen the future and it works?“  Even as late as the late 1960s Paul Samuelson oohed and aahed at the rapid industrialization of the USSR and even had a chart in his best-selling textbook that showed Soviet living standards leaving America behind in the near future. Oops. Or, as one of the other commentators here pointed out, what about the oohs and aahs about Japan taking over the world in the 1980s? Oops.

Oh, so much more to say, but I must go alas.

UPDATE: Here is Scott Sumner.

Date: Sat, 10 Feb 2001 21:47:57 +1100
From: “John L. Daly”
To: Chick Keller
CC: “P. Dietze”, mmaccrac, Michael E Mann, rbradley, wallace, Thomas Crowley, Phil Jones, McKitrick, Nigel Calder, John Christy, Jim Goodridge, Fred Singer, k.briffa
Subject: Re: Hockey Sticks again
Dear Chick & all

[I think Chick Keller wrote:]

the first is Keith Briffa’s rather comprehensive treatment of getting climate variations from tree rings: Annual climate variability in the Holocene: “interpreting the message of ancient trees”, Quaternary Science Reviews, 19 (2000) 87-105. It should deal with many of the questions people raise about using them to determine temperatures.

Take this from first principles.

A tree only grows on land. That excludes 70% of the earth covered by water. A tree does no grow on ice. A tree does not grow in a desert. A tree does not grow on grassland-savannahs. A tree does not grow in alpine areas. A tree does not grow in the tundra We are left with perhaps 15% of the planet upon which forests grow/grew. That does not make any studies from tree rings global, or even hemispheric.

The width and density of tree rings is dependent upon the following variables which cannot be reliably separated from each other. sunlight – if the sun varies, the ring will vary. But not at night of course.

cloudiness – more clouds, less sun, less ring.

pests/disease – a caterpillar or locust plague will reduce photosynthesis

access to sunlight – competition within a forest can disadvantage or advantage some trees.

moisture/rainfall – a key variable. Trees do not prosper in a droughteven if there’s a heat wave.

snow packing in spring around the base of the trees retards growth temperature – finally!

The tree ring is a composite of all these variables, not merely of temperature. Therefore on the 15% of the planet covered by trees, their rings do not and cannot accurately record temperature in isolation from the other environmental variables.

In my article on Greening Earth Society on the Hockey Stick, I point to other evidence which contradicts Mann’s theory. The Idso’s have produced more of that evidence, and a new article on Greening Earth has `unearthed’ even more.

Mann’s theory simply does not stack up. But that was not the key issue. Anyone can put up a dud theory from time to time. What is at issue is the uncritical zeal with which the industry siezed on the theory before its scientific value had been properly tested. In one go, they tossed aside dozens of studies which confirmed the existence of the MWE and LIA as global events, and all on the basis of tree rings – a proxy which has all the deficiencies I have stated above.

The worst thing I can say about any paper such as his is that it is `bad science’. Legal restraint prevents me going further. But in his case, only those restraints prevent me going *much* further.

Cheers
John Daly