The State of Modern Economics

Herbert Gintis

Economist Herbert Gintis has an excellent piece over at Evonomics on the current state of economics, including developments in behavioral and evolutionary economics and their relationship to traditional economic theory. Gintis has done some fine interdisciplinary work and I’m greatly anticipating his forthcoming book Individuality and Entanglement: The Moral and Material Bases of Social Life. For Gintis, “The most creative behavioral and evolutionary economists remain inspired by the successes of, and consider their work as extensions of traditional economic theory. The most creative supporters of traditional economic theory, in turn, embrace behavioral and evolutionary perspectives and build on its insights.” Gintis walks the reader through a helpful analysis of general equilibrium, comparative statics, economic dynamics, and economic policy. He notes, “Traditional microeconomic economic theory is at its best in analyzing general equilibrium and comparative statics. Behavioral and evolutionary economics have as yet neither altered nor added to our understanding of general equilibrium and comparative statics.” It is in the case of dynamics “that traditional economic theory has the least to offer. Microeconomic theory has virtually nothing to say about market dynamics when there is more than a single good.” He claims that macroeconomics was a framework “economists invented wholecloth…for dealing with economic dynamics that has nothing to do with the microeconomic model of general equilibrium.” While macroeconomics is “widely taught in economics departments and policy makers pay attention to it faute de mieux…it is frankly virtually worthless, except in the very short run, where the near future can be reliably forecast from the recent past.” Gintis recognizes that “the economy is a complex dynamical system and nobody, not even the experts who spend all their time studying the economy, can predict even the direction of the long-term effects of most regulatory changes on the position of individual economic actors.” It is here that he bridges evolutionary economics with traditional, providing much-needed feedback to both the right and left of the political divide:

Evolutionary models of economic dynamics invariably assume adaptive expectations rather than rational expectations. Adaptive expectations assume individuals tend to copy the most successful behavior of others whom they observe in the market, with innovation taking place through random variation.

In the popular press, free market lovers blame financial crises on government intervention, and intervention lovers blame financial crises on insufficient regulation. Neither view is correct. The recent financial crisis was due to improper regulation of the financial sector. The notion that the financial sector of a market economy is robust in the absence of extensive regulation is simply an article of faith unsupported by theory or experience. Evolutionary economists are working on a theory of the financial sector that fits synergistically with our models of generalized market exchange and technological change, but no general model has yet been developed.

He continues by dissecting both market and state failures, which should be an eye-opening discussion for both free-marketers and those favoring more state intervention. In conclusion, he writes,

It is a serious error to reject standard economic theory on the grounds that it supports a free-market ideology. It does nothing of the kind. Correctly deployed, it carefully explains where, how, and when to intervene in the regulation of market exchange. Evolutionary and behavioral game theory are wonderful additions to the economist’s repertoire, but they complement rather than undermine traditional public sector economic theory. The most serious defect in traditional economic theory is its treatment of economic dynamics, and it is here that behavioral and evolutionary theory has the most to contribute.

Some criticize standard economic theory for failing to take into account that reliance on markets promotes selfishness and greed. The evidence from behavioral economics is quite the contrary. Even hunter-gatherers and members of other small-scale societies act more fairly if their society has significant contact with the larger market economy. And we must never forget that virtually every powerful pro-democratic, anti-racist and anti-sexist movement for social change in the world has taken place in market economies with democratic political institutions. Milton Friedman noticed this in his famous Capitalism and Freedom, and it remains valid even more a half-century later.

Check out the full article. It’s one I’ll be continually revisiting.