12.10.16

TRUTH ACCOMPANIED BY PRECISION.

This year's economics Nobel went to contract theorists Oliver Hart and Bengt Holmström.  In Bloomberg View, Tyler Cowen explains the significance of the results, and notes the importance of the researchers taking the time to understand the refractory empirical phenomena being theorized about.

Not everybody is cheering.  Start with Arnold Kling.
Think of their work as consisting of three steps.

1. Identifying some real-world complexities that affect how businesses operate. For example, output may result from both effort and luck. Output may be joint. A worker’s job description may include more than one objective.

2. Construct a mathematical optimization model that incorporates such complexities.

3. Offer insights into designing appropriate compensation systems, including when to outsource an activity altogether.

A big question is: how important is step 2?

In the eyes of the mainstream economics profession, it is extremely important. Without it, you either do not get to step 3, or your claims in step 3 lack reliability and credibility. Step 2 is why Hart and Holmström earned the Nobel Prize.

In my view, step 2 is unnecessary. If anything, it tends to get in the way, often creating a barrier to doing step 1 properly, because economists limit themselves to what is mathematically tractable. I think that Hart and Holmström sometimes (often?) made good choices in step 1, and that is what accounts for the value of where they arrived at in step 3.
Mr Kling's contention is a common one in economics: it's sometimes possible to conceive of something in general terms using words, but being able to produce a more careful delineation of conditions under which it is present using mathematics is hard. I have boxes of scribblings yet dealing with problems I thought I could make some headway against and yet fell short.  And veteran theorist Hal Varian once wrote an essay on doing research wherein he noted, in response to a workshop comment from a colleague who was attempting something more challenging, that his first attempts were more challenging (and failed.)  There's an element of complaint present, as well, in his observation that the late Alchian Allen and the still-living Harold Demsetz had worked on similar contracting problems, using a more literary form of price theory.  But the prize goes to the work that more precisely delineates the conditions under which the phenomenon is present.

Peter Boettke extends the argument.
So is there a sort of miscarriage of scholarly justice in the passing over of Armen Alchian during his lifetime, and the continuing overlooking of the aging Harold Demsetz by the Nobel committee right now?

Of course there is, but rather than express outrage, I want to offer an explanation that I hope gives pause to some within the broadly speaking coalition of property rights economists, law-and-economics scholars, public choice political economists and market process and entrepreneurship theorists.  If this coalition of intellectual traditions is going to have the impact it should have, in my opinion, then it is going to have to reconceptualize the way it is going to engage the scientific community of economists and social scientists.  There must be a serious re-engagement with the Buchanan type question of "What Should Economists Do?" and perhaps an even deeper exploration into the insights on the nature of economic science as laid out by Mises, Knight, and Hayek.

In a very colloquial way science is said to progress in the following way: Stage 1 -- what do you think; Stage 2 -- what do you know; Stage 3 --what can you prove. In the 20th century, a strange intellectual alliance formed between Statism and Scientism (this alliance was the hallmark of the progressive era ideology and we have never fully escaped its stranglehold).  Scientism itself was based on an intimate relationship between formalism and empiricism.  Formalism argued that due to the ambiguities of natural language where the same words could mean different things and the different words could mean the same thing, science would never progress beyond Stage 1 -- what do you think.  This stage is critical for getting the intuition -- the insight -- but it will remain immature unless forced to be formally stated where it may have the possibility to reach Stage 3 and be considered a real contribution to Science.  But in translating natural language to formal language of mathematics, theorists of the social world had to abstract from a variety of nuances that only natural language can capture.  Formal statements can ensure syntactic clarity, not necessarily semantic clarity (this point is something to stress for another time).  The full on adoption of the formal language of mathematical economics has costs as well as some perceived benefits that we must bring out into the open in our professional discourse.  What happens in economic theory by mid-century due to the formalist revolution is a complete disregard for logical soundness in our theoretical derivations, and instead an exclusive striving for logical validity in the models being developed.  What ties these models down and prevents them from being merely arbitrary and free floating abstractions, is that simultaneously with this move there was the advancement in sophisticated techniques of statistical testing in economics.  Economics was transformed from a branch of moral philosophy and the field of political economy to a science of "model and measure" and a form of expert guided engineering of economic systems.  This self-image fit well with both desire to manage macroeconomics and regulate microeconomics, and of course it fit well with the more ambitious efforts of nationalization and planning.  But the main point I want to stress is the need, and more importantly the ability, to tie down the logically valid models to reality through some reliable procedure of sorting through the unlimited array of possible 'model worlds' to select out only those that were empirically significant for this world in which we occupy as human beings.
That complaint raises two separate points: the use of mathematical methods in economics, and the strands of inquiry in economics that look a lot like the operator's manual for the Welfare State.  But the mathematical approach does allow the researcher to identify, more precisely, the conditions (consider the Arrow Impossibility Theorem as high-concept) under which the operator of the Welfare State will be disappointed.

David Warsh, the economics columnist for Boston's Globe, explains the way in which the patient accumulation of small advantages eventually pays off.
Contract theory promises a better scorecard, with which to tell apart the interests of players and their agents. It has barely begun to be put to work.  The prize to Hart and Holmström demonstrates the power of patient, painstaking social science.  It’s not the first word that we honor but the last.
It's not clear that there ever is a last word -- that's why we call it re-search -- and yet, making more precise the ways in which phenomena that political economists have speculated about since Adam Smith, if not before, might be what's prizeworthy.

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