The recent financial crises has resulted in a chorus of voices claiming that we have exhausted the limited explanatory power of neoclassical economics. The leading problem with that view, most people seem to think, lies with the oversimplifications inherent to the rational actor model. As a result, there has been a wave of hype and excitement about the nascent fields of behavioral economics and neuroeconomics. That kind of out of the box thinking seemed like it could blaze the trail to a new kind of economics--an economics in which new understanding of perplexing economic and financial trends that had eluded neoclassical thinkers would finally come about.
But it wont. I think. The thing is, the primary paradigm of economic research suffices to account for many market phenomena. Of course, the original formulations of neoclassical theory left some phenomena unexplained (say, certain auction behavior). However, progress on those questions came not in the form of a true revolution, but rather a tinkering with the standard tools of rational actor theory (e.g. the development of game theory to explain auctions). To draw from Kuhn, one should distinguish between progress within a paradigm and a true scientific revolution. The development of game theory, institutional economics, and information economics were all cases of the former--the standard toolkit was expanded, but not replaced. That kind of progress has gone a long way (at least for explanatory purposes, if not forecasting). A true revolution requires a new paradigm that fully replace the old one, while providing an avenue to explain new phenomena.
Right now, behavioral economics constitutes a series of experiments that show that individuals behave in "predictably irrational" ways contrary to many predictions of standard economic theory. However, what's lacking is a consistent grounds for a new understanding of economies. What effort has been made to create a conceptual frameworks in which to place experimental findings has been akin to earlier efforts to tweak the existing paradigm--the goal is to find concrete rules which economic actors follow, be it rational maximization or some other heuristic--either way the mode of research stays the same.
Nonetheless, I do think that economic research is reaching a stasis point. Most papers these days are pained to find some setting of interest which lends itself to economic analysis--be it auctions of oil wells, regulation of a certain kind of forest, or new tax breaks in Swaziland--but the pace of progress in our understanding is slowing under the current framework. The aftermath of the financial crisis and the recession has made this clear, and the failure of neoliberal development policy has done so as well.
So I've been thinking: if there were a revolution in economics, what would it look like? What about the standard toolkit is holding economics back? It's worth mentioning that Kuhn found that most ideas that became revolutions were not new--in fact, they often were as old as the previous paradigm, but were never really necessary enough to be fleshed out. So it's probably something already out there.
My bet: endogenous preferences.
What do I mean by that? What unites all economic theory is that characteristics about the individual are treated as fixed and predetermined, or exogenous. Most importantly, our motivations are predetermined biologically (genetically, really), presumably. As if our conception of desirability and experience of satisfaction is absolute, and not materialized in our relationships with others. As if fashion is absolute. As if social psychology doesn't exist.
And that's nuts. That sort of oversight should be implicated in the failure of economic forecasting, some of the "revolutionary" findings of behavioral experiments, and, above all, the inevitable failure of economic imperialism. And it's not like people don't know that its nuts--economic anthropologists and sociologists have been screaming at the top of their lungs about this stuff for decades, begging to be heard. These ideas are definitely out there, waiting for their moment.
Tyler Cowen recently wrote a very good post on the related subject of methodological individualism (and the lessons to be learned from Foucault) a few weeks ago. In economics, everything can be reduced to the behavior of individuals, just as in physics researchers boil everything down to the behavior of basic particles. But, as Cowen notes "actual historical explanation relies on the use of broad categories, classes, and exemplars, and in a manner which is not logically reducible to statements about individual beliefs and desires." Why? One important reason is that's how people understand the world, and that informs the decision-making process. If economics really wants to go imperialist in the pursuit of better development and business cycle models, they are going to have to deal with that fact sooner or later.
Maybe I'm overselling endogenous preferences. In truth, endogeneity of key individual attributes can be brought under the individualism umbrella. With sophisticated mathematics, one could develop an economic model in which individual attributes are both a product of external factors and the primary units of analysis. It would be very difficult to tie those models to concrete cases, but I bet it could be done. Above all, those models would create a framework for better understanding the world, even if it has to remain an abstraction--much as Walrasian equilibrium theory did. Would that sort of shift constitute a true revolution, then? It's hard to tell, but I'm guessing that sort of innovation, coupled with new inputs from biology/neuroscience, would result in a new sort of understanding of socio-economic phenomenon, and a new paradigm for research at that. The result could wind up being a framework which accounts both for run-of-the mill economic phenomena and for the strange results coming out of behavioral labs. Neoclassical economicsCBO to abandon DSGE or I/O models anytime soon).
When you search for "endogenous preferences" in google scholar is this one by Samuel Bowles. Bowles is now at the Santa Fe Institute, whose researchers the WSJ's has hinted are, in fact, the best promise for a new economics.
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