Debunking Economics Part 5: Not all assumptions are created equal

It’s a cornerstone of heterodox economics to criticize the  methodology of neoclassical economics and Chapter 8 of Steve Keen’s Debunking Economics holds true to this tradition. At one point in the history of economic thought, the majority of neoclassical economists might have agreed with Milton Friedman’s classic paper The Methodology of Positive Economics. Whether that is still the case, I’m not entirely sure. However, based on the current state of economic models, I would not be entirely surprised if a majority of neoclassical economists today were at least sympathetic to Friedman’s views.

In this paper, Friedman claims that a theory should judged by its predictive power:

Viewed as a body of substantive hypotheses, theory is to be judged by its predictive power for the class of phenomena which it is intended to “explain.” Only factual evidence can show whether it is “right” or “wrong” or, better, tentatively “accepted” as valid or “rejected.” As I shall argue at greater length below, the only relevant test of the validity of a hypothesis is comparison I of its predictions with experience. The hypothesis is rejected if its predictions are contradicted (“frequently” or more often than predictions from an alternative hypothesis); it is accepted if its predictions are not contradicted; great confidence is attached to it if it has survived many opportunities for contradiction. Factual evidence can never “prove” a hypothesis; it can only fail to disprove it, which is what we generally mean when we say, somewhat inexactly, that the hypothesis has been “confirmed” by experience.

A theory should be judged by its “fruitfulness” , i.e. the precision of its predictions and how wide its implications are within a particular field, not by its realism. Friedman took this idea a step further by claiming that all important and significant theories are filled with unrealistic assumptions:

In so far as a theory can be said to have “assumptions” at all, and in so far as their “realism” can be judged independently of the validity of predictions, the relation between the significance of a theory and the “realism” of its “assumptions” is almost the opposite of that suggested by the view under criticism. Truly important and significant hypotheses will be found to have “assumptions” that are wildly inaccurate descriptive representations of reality, and, in general, the more significant the theory, the more unrealistic the assumptions (in this sense). The reason is simple. A hypothesis is important if it “explains” much by little, that is, if it abstracts the common and crucial elements from the mass of complex and detailed circumstances surrounding the phenomena to be explained and permits valid predictions on the basis of them alone. To be important, therefore, a hypothesis must be descriptively false in its assumptions; it takes account of, and accounts for, none of the many other attendant circumstances, since its very success shows them to be irrelevant for the phenomena to be explained.

To put this point less paradoxically, the relevant question to ask about the “assumptions” of a theory is not whether they are descriptively “realistic,” for they never are, but whether they are sufficiently good approximations for the purpose in hand. And this question can be answered only by seeing whether the theory works, which means whether it yields sufficiently accurate predictions. The two supposedly independent tests thus reduce to one test.

According to Friedman, the assumptions of any theory cannot possibly be thoroughly “realistic” in any descriptive sense. Any realistic theory of the market would have to include a multitude of seemingly relevant details. Any attempt to achieve this type of realism would render a theory useless. Even if we were to take a less logical extreme and assert that the assumptions of a particular theory are “too” unrealistic, there is no basis or criterion for this:

What is the criterion by which to judge whether a particular departure from realism is or is not acceptable? Why is it more “unrealistic” in analyzing business behavior to neglect the magnitude of businessmen’s costs than the color of their eyes? The obvious answer is because the first makes more difference to business behavior than the second; but there is no way of knowing that this is so simply by observing that businessmen do have costs of different magnitudes and eyes of different color. Clearly it can only be known by comparing the effect on the discrepancy between actual and predicted behavior of taking the one factor or the other into account. Even the most extreme proponents of realistic assumptions are thus necessarily driven to reject their own criterion and to accept the test by prediction when they classify alternative assumptions as more or less realistic.

While this argument for instrumentalism might seem very plausible, it suffers from several flaws. In his paper, ‘Unreal Assumptions’ in Economic Theory: The F-Twist UntwistedAlan Musgrave discusses these flaws. By distinguishing between 3 different types of assumptions, negligibility, domain, and heuristic, Musgrave shows the lack of clarity surrounding Friedman’s paper and his use of the word “assumption”.

Negligibility Assumptions:

According to Musgrave, negligibility assumptions state that certain aspects of reality have little to no effect on the topic at hand. For example, when Galileo investigated the motion of falling bodies, he assumed that air resistance had no detectable effect on these motions. So when Friedman is talking about these types of assumptions, he is correct to say that a theory containing negligibility assumptions can only be evaluated through empirical corroboration. However, he is wrong to conclude that these assumptions are “unrealistic”. Rather than asserting that specific factors are absent, these assumptions claim that these factors are “irrelevant for the phenomena to be explained” (Friedman’s claim about eye color in the paragraph above would fit under this description).

Domain Assumptions: 

When a theory is tested and fails to make accurate predictions, it may be because of a certain negligibility assumption. The particular factor that was thought to be negligible does in fact have a significant effect after all. It might be concluded that the theory will only work when this factor is absent. From this, we specify the domain of applicability of a the theory. These types of assumptions are called domain assumptions. Let’s say an economic theory assumes that the government has a balanced budget. Given such an assumption, we may conclude that any budget imbalance has negligible effects. However, we can also conclude that opposite. A budget imbalance will have a significant effect and this economic theory will only apply under conditions where this imbalance does not exist.

The switch from negligibility assumptions to domain assumptions is very important and it’s something that Friedman ignores. This switch is an ad hoc modification that replaces a stronger or more testable theory with a weaker or less testable one. As a result, some domain assumptions can render a theory untestable. If we assume that a theory only holds under a balanced budget, but the government never has a balanced budget, then this theory cannot be tested. So if we value testability (which Friedman does), we should hope that the domain assumptions in a particular theory are not always false or “unrealistic”. This is in complete contrast to Friedman’s claim that “to be important, therefore, a hypothesis must be descriptively false in its assumptions.

Heuristic Assumptions:

Heuristic assumptions are assumptions that are known to be false, but are used as stepping stones towards a more general theory. As Musgrave elaborate, “the ‘assumption’ that factor F is negligible is merely a heuristic device, a way of simplifying the logical development of the theory.” Newton’s assumption of a one planet solar system when trying to prove that planets followed elliptical orbits was a heuristic assumption. This was not a negligibility assumption, as Newton knew that planets would sometimes have detectable and meaningful gravitational effects on one another. Nor was this a domain assumptions, as Newton was not saying that his theory only applied to one planet solar systems. Newton used this assumption as a stepping stone, which was eventually used by Henri Poincaré and others to create more precise predictions and better theories on planetary behavior:

The modern theory of planetary behavior now recognizes that the stable orbits of our solar system can only have evolved – over an enormous period of time – from far less stable orbits, which must have led to collisions between proto-planets. It is now accepted that the moon, for example, was the product of a collision between another proto-planet and the early earth. (Keen 2011: 162)

So contrary to Friedman’s paper, not all assumptions are created equal and an “important” theory is not filled with unrealistic assumptions.

Links:

Assumptions, Assumption, Assumptions 

References:

1. Keen, Steve. Debunking Economics: The Naked Emperor Dethroned? London: Zed Book, 2011. Print.

2. Friedman, Milton (1953). The Methodology of Positive Economics. Essays in Positive Economics. University of Chicago Press. 3-43.

3. Musgrave, Alan. “Unreal Assumptions In Economic Theory: The F-Twist Untwisted.” Kyklos 34.3 (1981): 377-87. Print.

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  1. Pingback: Seven reasons economics has failed - zwilo

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