What should we expect from an economic theory?
Really now ... what were you expecting?
I got into a back and forth with Srinivas T on Twitter after my comment on an Evonomics tweet. As an aside, Noah Smith has a good piece on frequent contributor at Evonomics David Sloan Wilson (my own takes are here, here, here). I'll come back to this later. Anyway, Evonomics put up a tweet quoting an economist saying "we need to behave like scientists" and abandon neoclassical economics.
My comment was that this isn't how scientists actually behave. Newton's laws are wrong, but we don't abandon them. They remain a valid approximation when the system isn't quantum or relativistic. Srinivas took exception, saying surely I don't believe neoclassical economics is wrong in the same way Newton is wrong.
I think this gets at an important issue: what should we expect of an economic theory?
I claimed that the neoclassical approximation was good to ~10% -- showing my graph of employment. Neoclassical economics predicts 100% employment; the current value is 95%. That's a pretty good first order estimate. While Newton has much better accuracy (< 1%) at nonrelativistic speeds, this is in principle no different. But what kind of error should we expect of a social science theory? Is that 10% social science error commensurate with a < 1% "hard science" error?
I'd personally say yes, but you'd have to admit that it isn't at the "throw it out" level -- at least for a social science theory. What do you expect?
Now I imagine an argument could be made that the error isn't really 10%, but rather much, much bigger. That is hard to imagine. Supply and demand isn't completely wrong, and the neoclassical growth model (Solow) isn't completely inconsistent with the Kaldor facts. This experiment shows supply and demand functions at the micro level.
Basically, neoclassical economics hasn't really been rejected in the same way Newton is rejected for relativistic or quantum systems. Sure, there are some places where it (neoclassical economics) is wrong, but any eventual economic theory of everything is going to look just like neoclassical economics where it is right. Just like Einstein's theories reduce to Newton's for v << c (the speed of light setting the scale of the theory), the final theory of economics is going to reduce to neoclassical economics in some limit relative to some scale.
But there lies an important point, and where I sympathize with Srinivas' comment. What limit is that? Economics does not set scope conditions, so we don't know where neoclassical economics fails (like we do for Newton: v ~ c) except by trial and error.
This is where economic methodology leaves us wanting -- Paul Romer replied to a tweet of mine agreeing about this point ...
@infotranecon
Yes. I used to nod off when physicists interested in macro went on about scaling. I should have paid more attention.— Paul Romer (@paulmromer) September 24, 2016
As a theoretical physicist, I try to demonstrate by example how theoretical economics should be approached with my own information transfer framework. The ITF does in fact reduce to neoclassical economics (see my paper). But it also tells us something about scope. Neoclassical economics is at best a bound on what we should observe empirically, and holds in the market where A is traded for B as long as
I(A) ≈ I(B)
i.e. when the information entropy of the distribution of A is approximately equal to the information entropy of the distribution of B. This matches up with the neoclassical idea of no excess supply or demand (treating A as demand for B).
Now it is true that you could say I'm defending neoclassical economics because my theory matches up with it in some limit. But really causality goes the other way: I set up my theory to match up with supply and demand. Supply and demand has been shown to operate as a good first order understanding in the average case -- and even in macroeconomics the AD-AS model is a decent staring point.
Throwing neoclassical economics out is rejecting a theory because it fails to explain things that are out of scope. That is not how scientists behave. We don't throw out Newton because it fails for v ~ c.
It seems to me to be analogous to driving Keynesian economics out of macroeconomics. Keynesians did not fail to describe stagflation and e.g. the ISLM model represents a decent first order theory of macro when inflation is low. Maybe it's just that there's more appetite for criticisms of economics (per Noah Smith above):
There's a new website called Evonomics devoted to critiquing the economics discipline. ... The site appears to be attracting a ton of traffic - there's a large appetite out there for critiques of economics. ... Anyway, I like that Wilson is thinking about economics, and saying provocative, challenging things. There's really very little downside to saying provocative, challenging things, as long as you're not saying them into the ear of a credulous policymaker.
Driving out neoclassical economics seems to be politically motivated in the same way Keynesian economics was driven from macro. It's definitely not because of new data. Neoclassical economics has been just as wrong as it was in Keynes time. However, it has also been just as right.
We have to be careful about why we reject theories. We shouldn't reject 50% solutions because they aren't 100% solutions. Heck, we shouldn't reject 10% solutions because they aren't 100% solutions.
And to bring it back to my critique of David Sloan Wilson that I linked to above: we shouldn't plunge head first into completely new theories unless those theories have demonstrated themselves to be at least similarly effective as our current 50% solution. Wilson's evolutionary approach to economics hasn't even shown a single empirical success. It can't even explain why unemployment is on average between 5 and 10% in the US over the entire post-war period instead of, say, 80%. It can't explain why grocery stores work.
Neoclassical economics at least tells us that grocery stores work and unemployment is going to be closer to 0% than 100%. That's pretty good compared to anything else out there**.
** Gonna need explicit examples if you want to dispute this.