Why economics is case-based

Economic Models as Analogies, by Itzhak Gilboay, Andrew Postlewaitez, Larry Samuelson, and David Schmeidler, is, perhaps,* the best paper about the discipline of economics I’ve ever read. My copy is densely highlighted.

This gets to something important:

We argue that viewing economists as generating knowledge that is partly case-based explains the puzzles raised in Section 2. First, one need not wonder why economists feel that they gain insights and understand economics better using models whose assumptions are wrong. In the case-based approach, models cannot be wrong. As long as the mathematical analysis is correct, a theoretical case is valid, the same way that an empirical or experimental case is valid as long as it is reported honestly and accurately. Cases do not make any claim to generality, and therefore they cannot be wrong. […]

Finally, using the case-based view, one can also understand why economists and psychologists view their models differently. True to the standard, rule based model of science, psychologists try to avoid refutations by being very explicit about the domain of applicability of their models. Economists, on the other hand, often offer models that are merely theoretical cases. These models cannot be refuted, and hence there is nothing to be lost by trying to draw analogies between them and new, remotely connected problems. On the contrary, every problem that may end up being similar to the model increases the model’s popularity. As a result, economists have an incentive to view more real life cases as examples of their models, without risking their theory’s reputation in so doing. [Bold added.]

I recall an aha moment when I was reading The Theory of Industrial Organization, by Jean Tirole, years ago. You see, I had no formal economics training. My background is physics, a rule-based, not case-based, discipline. I was accustomed to “theory” meaning something that is thought to be true within a specified domain. Then it is tested. If enough credible evidence refutes it, revisions are necessary and, eventually, some are embraced. Without explicitly trying to, Tirole disabused me of the notion that economics worked this way.

Gilboay and colleagues say economics is clearly not physics, despite the math. It’s not even psychology, usually. Its connection to the real world is much more tenuous. Why? Because in economics, theory is case-based. And case-based models “cannot be refuted!” That one’s model can’t be wrong is likely of some comfort to some practitioners, even if only implicitly.

Many models are constructed under certain assumptions generally known to be false. (Their sentence, “That the assumptions of economics are false is one of the most poorly kept secrets in science,” is perfect.) As such, in general, they are developed in a way that makes it far less likely for them to be true (or reasonably true-ish) of the world or some clearly articulated sub-domain of it.

That’s very confusing, because economists do take their models — and the ideas motivated by them — to the world. Then all manner of claims are made about human behavior and ideal policy. Things happen, some of them not good, others just fine.

When I read Tirole, I learned that you can’t point to anything like “the theory of industrial organization (IO),” despite the title. There’s no Maxwell’s equations of IO. That would be rule-based. Maybe it’s too hard. But do economists even try? Are they, on the whole, sufficiently honest in the discipline’s limitations? Or are they just trying to increase the popularity of this model, or that one? (Not all economists are the same. There is heterogeneity, of course.)

In IO there are lots of different models of firm behavior (the different cases). Likewise, there are lots of different models relating to the same phenomena in macro and other areas of economics, health economics among them. When and where does each apply? To what extent is each “true”? These things are rarely answered. Indeed, they’re sometimes unanswerable because model assumptions are often so grossly violated and that’s not even the point. Everybody knows it, but engaging that is, to large degree, not what economics is about.

Needless to say, this was a huge eye opener. The paper by Gilboay and colleagues deserves a full read.

* “Perhaps” only because I read and forget so much.

@afrakt

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