Hard Obscurantism and Unrealistic Models in Economics

The philosopher and social scientist Jon Elster is well-known for his critical and insightful views about the (ir)relevance of rational choice theory (RCT) in the social sciences. Among his recent writings on the subject, Elster has published last year a paper in the philosophy journal Synthese concerning what he calls “hard obscurantism” in economic modeling (gated version here). By hard obscurantism, Elster essentially refers to a practice where “ends and procedures become ends in themselves, dissociated form their explanatory functions” (p. 2163). This includes many rational choice models, but also a part of agent-based modeling, behavioral economics and statistical analysis in economics.

Elster’s paper focuses on the case of rational choice models and builds on several “case studies” that are thought to illustrate the practice of hard obscurantism. These case studies include Akerlof & Dickens’s and Rabin’s use of cognitive dissonance theory, Becker and Mulligan’s accounts of altruism as well as Acemoglu & Robinson’s theory of political transitions. Beyond these examples, Elster underlines two general problems with rational choice models and more generally with RAT: first, theory is indeterminate, second it ignores the irrationality of the agents. Indetermination is indeed a well-known problem that is partly (though not equivalent) related to the existence of multiple equilibria in many rational choice models. According to Elster, it has three sources: (i) the fact that the determination of the optimal amount of information leads to an infinite regress (i.e. to compute the marginal utility of information requires to collect the information but whether or not to collect the information necessitates to know its marginal utility), (ii) brute and strategic uncertainty (the latter is of course closely related to the existence of multiple equilibria) and (iii) the agents’ cognitive limitations. The latter is regarded by Elster as the most important source and is somewhat related to the irrationality problem. In Elster’s words,

“How can we impute to real-life agents the capacity to make in real time the calculations that occupy many pages of mathematical appendixes in the leading journals and that can be acquired only through years of professional training?” (p. 2166)

Elster’s objection is hardly new and many different responses have been developed. It is not my intention to survey them. I shall rather on one issue that follows from Elster’s critique: can we learn anything with unrealistic models and how? There is an empirical disagreement among economists regarding the degree at which individual agents are truly irrational. Against the behavioral economists’ claim that individuals’ behavior and reasoning exhibit a long list of biases, other economists claim that this depends on the institutional setting in which individuals’ choices take place (for instance, it is probably not true that hyperbolic discounting is dominant in many market and many biases seem to diminish in importance if agents have the opportunity to learn). It is a fact however that individuals’ behaviors do not have the consistency properties that most rational choice models assume they have. Moreover, most rational choice models are unrealistic beyond their “behavioral” assumptions about agents’ reasoning abilities. They also make rather unrealistic “structural” assumptions such as for instance the number of players, the homogeneity of their preferences, the fact that features of the game are common knowledge, and so on. A good example among the case discussed by Elster is Acemoglu & Robinson’s theory of political transitions. The latter builds on a game-theoretic model with only two players which are thought to be representative of two groups of actors, the elites and the citizens. The preferences of the members of each group are assumed to be homogenous and, for the citizens group, to correspond to the median voter’s preferences. The model also makes several strong assumptions regarding what the players are knowing.

So, can we learn anything about real world mechanisms from such unrealistic models? The philosopher of social science Harold Kincaid has recently made an interesting suggestion for a (partially) positive answer. Kincaid rightly starts by indicating that it is vain to search for a general defense of unrealistic models in the social sciences and that each evaluation must be made on a case-by-case basis. Regarding perfect competition and game-theoretic models, Kincaid argues that may offer relevant explanations in spite of the fact that they build on highly unrealistic assumptions:

“The insight is that assumptions of the perfect competition and game theory models may just be assumptions the analyst – the economist or political scientist – uses to identify equilibria. However, in certain empirical applications, the explanations are equilibrium explanations that make no commitment to what process leads individuals to find equilibrium”

In my view, this account of the relevance of unrealistic models particularly works well in the case of mechanism design which is at the same time a highly theoretical but also applied branch of microeconomics. A typical approach in mechanism design is to consider that the right institutional design will entail equilibrium play from the players, even if the designer ignores the players’ actual preferences. The modeler does not make any commitment regarding how the players will find their way to the equilibrium. The model simply indicates that if the institutional set up has such or such characteristics (e.g. a continuous double bid auction), then the outcome will have such or such characteristics (e.g. allocative efficiency). It is then possible to check for this conjecture through experiments.

On this account, the model is thus merely a device to identify the equilibrium but has no use for explaining the mechanism through which the equilibrium is reached. It is not sure however that this account applies to rational choice models used in other settings, especially if experiments are impossible. For instance, Acemoglu & Robinson’s model highlight the importance of commitment to explain political transitions. Indeed, their theory aims at accounting for the change from a dictatorial equilibrium toward a democratic equilibrium. The elites’ ability to commit not to raise taxes in the future is the key feature that determines whether or not the political transition will occur. The model thus suggests that a highly general mechanism is at play but it is unsure which level of confidence we can have in this explanation given the highly unrealistic assumptions on which it builds. An alternative defense would be that the model’s value comes from the fact that it highlights a mechanism that may possibly partially explain political transitions. Thanks to the model, we perfectly understand how this mechanism works, even though we cannot be sure that this mechanism is actually responsible for the relevant phenomenon to be explained. In other words, the relevance of the model comes from the fact that it depicts a possible world which we are able to fully explore and that this world bears some (even remote) resemblance with the actual world. As I have argued elsewhere, many models in economics seem to be valued for this reason.

The problem with this last account is that, while it may explain why economists give credence to rational choice models, it is highly unlikely to convince skeptics like Elster that they are explanatory relevant. Indeed, as Elster has argued elsewhere, the academic value given to these models may itself result from the fact that the economic profession is trapped in a bad equilibrium.

Recent Working Papers

You will find below several working papers I have written recently on different (but somewhat related) topics. Comments are welcome!

A Bayesian Conundrum: From Pragmatism to Mentalism in Bayesian Decision and Game Theory

Abstract: This paper discusses the implications for Bayesian game theory of the behaviorism-versus-mentalism debate regarding the understanding of foundational notions of decision theory. I argue that actually the dominant view among decision theorists and economists is neither mentalism nor behaviorism, but rather pragmatism. Pragmatism takes preferences as primitives and builds on three claims: i) preferences and choices are analytically distinguishable, ii) qualitative attitudes have priority over quantitative attitudes and iii) practical reason has priority over theoretical reason. Crucially, the plausibility of pragmatism depends on the availability of the representation theorems of Bayesian decision theory. As an extension of decision-theoretic principles to the study of strategic interactions, Bayesian game theory also essentially endorses the pragmatist view. However, I claim that the fact that representation theorems are not available in games makes this view implausible. Moreover, I argue that pragmatism cannot properly account for the the generation of belief hierarchies in games. If the epistemic program in game theory is to be pursued, this should probably be along mentalistic lines.

Keywords: Bayesian synthesis – Bayesian game theory – Pragmatism – Mentalism – Preferences

 

Neo-Samuelsonian Welfare Economics: From Economic to Normative Agency

Abstract: This paper explores possible foundations and directions for “Neo-Samuelsonian Welfare Economics” (NSWE). I argue that neo-Samuelsonian economics entails a reconciliation problem between positive and normative economics due to the fact that it cuts the relationship between economic agency (i.e. what and who the economic agent is) and normative agency (i.e. what should be the locus of welfare analysis). Developing a NSWE thus implies to find a way to articulate economic and normative agency. I explore two possibilities and argue that both are attractive but have radically different implications for the status of normative economics. The first possibility consists in fully endorsing a normative approach in terms of “formal welfarism” which is completely neutral regarding both the locus and the unit measure of welfare analysis. The main implication is then to make welfare economics a branch of positive economics. The second possibility is to consider that human persons should be regarded as axiologically relevant because while they are not prototypical economic agents, they have the ability to represent them both to themselves and to others as reasonable and reliable beings through narrative construction processes. This gives a justification for viewing well-being as being constituted by the persons’ preferences, but only because these preferences are grounded on reasons and values defining the identity of the persons. This view is somehow compatible with recent accounts of well-being in terms of value-based life satisfaction and implies a sensible reconsideration of the foundations of welfare economics.

Keywords: Neo-Samuelsonian economics – Welfare Economics – Revealed preference theory – Preference-satisfaction view of welfare – Economic agency

 

History, Analytic Narratives and the Rules-in-Equilibrium View of Institutions

Abstract: Analytic narratives are case studies of historical events and/or institutions that are formed by the combination of the narrative method characteristic of historical and historiographical works with analytic tools, especially game theory, traditionally used in economics and political science. The purpose of this paper is to give a philosophy-of-science view of the relevance of analytical narratives for institutional analysis. The main claim is that the AN methodology is especially appealing in the context of a non-behaviorist and non-individualist account of institutions. Such an account is fully compatible with the “rules-in-equilibrium” view of institutions. On this basis, two supporting claims are made: first, I argue that within analytical narrative game-theoretic models play a key role in the identification of institutional mechanisms as the explanans for economic phenomena, the latter being irreducible to so-called “micro-foundations”. Second, I claim that the “rules-in-equilibrium” view of institutions provides justification for the importance given to non-observables in the institutional analysis. Hence, institutional analysis building on analytical narrative typically emphasizes the role of derived (i.e. non-directly observed) intentional states (preferences, intentions, beliefs).

Keywords: Analytic narratives – Rules-in-equilibrium view of institutions – Institutional analysis – Game theory

Accounting for Choices in Economics

Economics is sometimes characterized as the “science of rational choices over the allocation of scarce resources” or even more straightforwardly as the “science of choices”. In a recent blog, Chris Dillow makes some interesting remarks about people’s economic behavior. He notes that our behavior is often partially unconscious and/or habit-based. Moreover, the set of available options is quite frequently severely restricted such that there is few room to make voluntary choices. Finally, many decisions are actually more or less random and grounded on social norms, conventions and other factors on which we barely reflect. The conclusion is then that

“when we ask “why did he do that?” we must look beyond “max U” stories about mythical individuals abstracted from society and look at the role of habit, cultural persistence and constraints.”

These are interesting and important remarks because they directly concern the scope of economics as well as the meaning of the key concept of choice. It seems that Dillow is using the choice concept according to its folk meaning. According to the latter, to properly say “she chooses x” requires at least that (a) one has several available options at her disposal to choose between and (b) she opts for one of the available option consciously and voluntarily. However, I would argue that this is not how economists generally use and understand the choice concept. They rather use a concept of choice* in a technical sense. To put it using some jargon, in economics choices* are basically behavioral patterns that correlate with changes in opportunity costs. In other words, when we say that economics is the science of choices*, what is actually meant is that it studies how some particular variable reflecting for instance the consumption level of a given good, changes as the good’s relative price or consumers’ information change. This definition of choice* has at least two noteworthy implications:

1) Economists are not interested in individual choices per se. Economists almost always work at some aggregated level and they do not aim at explaining the choices made by specific individuals or firms. They are rather interested in the properties of aggregate demand and supply.

2) Economists are agnostic regarding the specific mechanisms through which economic agents are making choices. In particular, there is no presumption that these choices are conscious and not habit-based. The U-Max framework only assumes that individual choices are responsive to change in opportunity costs, not how and why they are responsive.

These two implications work in conjunctions. Choices* need not be conscious nor based on any form of complex calculus but they are however intentional: choices (in both the folk and technical meanings) are about something and they are the product of the agents’ intentional states (desires, beliefs, wants…). As philosophers of mind have emphasized, there is nothing paradoxical in the combination of unconsciousness and intentionality. The U-Max framework, as well as decision and game theory as a whole are tools that are particularly well-fitted to study intentional behavior, whether conscious or not. These tools indeed assume that individual choices are responsive to changes in opportunity costs which, in special cases (e.g. addictive behavior), may not be true. However, this is mostly irrelevant as long as responsiveness is preserved at some market level. Gary Becker’s paper “Irrational Behavior and Economic Theory” provides an extreme example of this point. It shows how we can derive “well-behaved” demand and supply functions with individual agents (households and firms) using “irrational” decision rules. This result is by no way a necessity: there are cases where irrational behavior will lead to unconventional demand and supply functions and because of income effects even rational behavior at the individual level can generate upward-slopping demand curves. Generally speaking, institutions matter: the way exchanges are organized will determine the aggregate outcome for a given profile of preferences and production costs.

All of this depends on the claim that economists are not interested in explaining individual choices. Economists with the strongest revealed-preference stance are likely to agree with this claim. But there are many economists who are likely to disagree, considering that accounting for individual choices is necessary to understand aggregate outcomes such as a financial crisis. More generally, I would argue that attempting to explain individual choices can hardly be avoided in the numerous cases where multiple equilibria exist. The point is that to explain why a given equilibrium has been selected, it will most of the time be required to understand how individuals make choices. Here, whether choices are habit- or calculus-based, conscious or automatic, and so on, may matter. For instance, Thomas Schelling famously pointed out in The Strategy of Conflict the important of focal points to account for the way people are able to coordinate without communicating. As Schelling made it clear, focal points are not determined by the mathematical properties of the game nor by purely instrumental considerations. They depend on cultural, social and aesthetic features.

A slightly more complex example but which is even more relevant, especially in industrial organization, is the existence of multiple (Bayesian perfect) equilibria in incomplete information games. In incomplete information games, one player (the “principal”) ignores the other players’ (the “agent”) type. The agent’s choice may sometimes convey an information to the principal and helps him to identify the agent’s type. Such games typically have multiple equilibria with some of them separating and other pooling ones. Which equilibrium is implemented is partially determined by the way the principal interprets the agent’s choice. Under a separating equilibrium, the principal interprets the agent’s choice in such a way that it provides him with an information about the agent’s type. This is not the case under a pooling equilibrium. Of course, since under a pooling equilibrium all agents behave the same way whatever their type, observed behavior cannot serve as a basis to infer agents’ type. But the fact that all agents behave the same is itself a rational response to their own understanding of the way the principal will interpret their choice at the equilibrium.

My point is thus that in strategic interactions where players have to think about how other players are thinking, it is less clear that economists can safely ignore how people make choices. Given the same set of “fundamentals” (preferences, technology, information distribution), different behavioral patterns may arise and these differences are likely to be due to the way individual agents are choosing.