Inapplicable truths.

Using models within economics or within any other social science, is especially treacherous. That’s because social science involves a higher degree of complexity than the natural sciences. The reason why social science is so complex is that the basic unit in social science, which economists call agents, are strategic, whereas the basic unit of the natural sciences are not. Economics can be thought of the physics with strategic atoms, who keep trying to foil any efforts to understand them and bring them under control. Strategic agents complicate modeling enormously; they make it impossible to have a perfect model since they increase the number of calculations one would have to make in order to solve the model beyond the calculations the fastest computer one can hypothesize could process in a finite amount of time.

While it is true that economic models are very complex it is false that the complexity of models in natural sciences such as physics are less so. Atoms are not strategic agents, but atoms are not the smallest units and in the end probability is the best that can be determined. Even that is true only of special cases since so little is known. Consider the problems of climate modelers. They know bits and pieces of the various interacting complex sub systems but are no where near useful levels of predictive modeling. Their task is no easier, and no more successful, than that of economists.

The disappointing part for me is that the weaknesses of economic models is not a novel insight.

Hayek made a similar charge in his Nobel Lecture of December 11, 1974, The Pretence of Knowledge:

… the economists are at this moment called upon to say how to extricate the free world from the serious threat of accelerating inflation which, it must be admitted, has been brought about by policies which the majority of economists recommended and even urged governments to pursue. We have indeed at the moment little cause for pride: as a profession we have made a mess of things.

Although Hayek saw the problem as stemming from an inappropriate "scientistic" attitude, he explicitly wanted “…to avoid giving the impression that I generally reject the mathematical method in economics.” Rather, his main message was that

If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible…The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men's fatal striving to control society - a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.

Economic scientists have precious little understanding of this rule governed complex order, and how to keep it on its demonstrated long term path of growth and human betterment without suffering too irreparably from the kind of unpredictable reverses that we are now mired in. Less pretence and a commitment to learn from the new data being generated as I write, will be both humbling and informative, after the inevitable human political impulse to blame one’s long standing political adversaries has run its course.

What is most impressive in the current crisis is that even those who find bubbles unsurprising, and who had warned of the housing bubble debacle, did not anticipate its ability to undermine the financial system so decisively and thereby to devastate a good performing economy. This is revealed in a fairly crisp timeline: residential home prices started their decline in 2006; mortgage market collapse in July-August, 2007 (which kick-started the Fed into taking “enhanced liquidity” measures); the fourth quarter 2008 events—the Treasury, Fed, FDIC joint announcement of crisis action, unprecedented extensions of FRB credit to holders of all varieties of underwater assets in implicit recognition that the financial system was under reserved and insolvent, not just illiquid.

Economists and policy makers have been learning as we go, and no one can be sure how long that process has yet to go.

IMV we should proceed as if the condition of ignorance is permanent, a feature rather than a bug, and design institutions and policies that take these facts into consideration. Too much harm has been done by reckless adventurers betting our farms on long shots. But know also that it isn't just that mad economists got carried away with their ungrounded theories.

FOR years now, many businesses and individuals in the United States have been relying on the power of government, rather than competition in the marketplace, to increase their wealth. This is politicization of the economy. It made the financial crisis much worse, and the trend is accelerating.

Well before the financial crisis erupted, policy makers treated homeowners as a protected political class and gave mortgage-backed securities privileged regulatory treatment. Furthermore, they allowed and encouraged high leverage and the expectation of bailouts for creditors, which had been practiced numerous times, including the precedent of Long-Term Capital Management in 1998. Without these mistakes, the economy would not have been so invested in leverage and real estate and the financial crisis would have been much milder. . .

We should stop using political favors as a means of managing an economic sector. Unfortunately, though, recent experience with health care reform shows we are moving in the opposite direction and not heeding the basic lessons of the financial crisis. Finance and health care are two separate issues, of course, but in both cases we’re making the common mistake of digging in durable political protections for special interest groups. . .

So if we’re looking for a major lesson from our banking mess, it is undoubtedly this: We have made a grave mistake in politicizing the economy so deeply, and should back away now. In health care, the Obama administration should drop its medical sector deals and try to sell a reform plan — in whatever form Mr. Obama chooses — on its own merits. That’s not only good for health care, but also good for the American polity. And in the longer run, that will be good for banking, too. If nothing else, without controlling health care costs, the American government will not stay solvent — and that will be the biggest financial crisis of them all.

In short, we should return both the financial and medical sectors and, indeed, our entire economy to greater market discipline. We should move away from the general attitude of “too big to take a pay cut,” especially when the taxpayer is on the hook for the bill. If such changes sound daunting, it is a sign of how deep we have dug ourselves in. We haven’t yet learned from the banking crisis, and we’re still moving in the wrong direction pretty much across the board.

Obama is the past, the broken unworkable past.

People who are raised in the industrial world and who get enthused about systems thinking are likely to make a terrible mistake. They are likely to assume that here, in systems analysis, in interconnection and complication, in the power of the computer, here at last, is the key to prediction and control. This mistake is likely because the mindset of the industrial world assumes that there is a key to prediction and control. . .

But self-organizing, nonlinear, feedback systems are inherently unpredictable. They are not controllable. They are understandable only in the most general way. The goal of foreseeing the future exactly and preparing for it perfectly is unrealizable. The idea of making a complex system do just what you want it to do can be achieved only temporarily, at best. We can never fully understand our world, not in the way our reductionistic science has led us to expect. Our science itself, from quantum theory to the mathematics of chaos, leads us into irreducible uncertainty. For any objective other than the most trivial, we can't optimize; we don't even know what to optimize. We can't keep track of everything. We can't find a proper, sustainable relationship to nature, each other, or the institutions we create, if we try to do it from the role of omniscient conqueror.

I've been boggling in amazement that America fell for Obama's antiquated nonsense. I'm always disappointed in politicians and governments - they are inherently shoddy - so in that sense Obama was just the next pretender. But the stars aligned and gave us exactly the wrong fellow for the times, one that seeks to double down on the mistakes that created our current woes. We could not have done worse, though he may have been suitable to a different time and problem set. Bad timing as well as bad thinking.

I'm feeling a bit old and hopeless. My whole adult life has been spent knowing the foolishness of not just our government but others as well, expecting that they would slowly wise up a bit. There was even a moment of giddiness when the Soviets imploded, as predicted by the more thoughtful, and that object lesson in scientistic arrogance was plain to see. False hope. We have gotten worse rather than better.

Update

See A story about quasiparticles, which illuminates my claim that While it is true that economic models are very complex it is false that the complexity of models in natural sciences such as physics are less so.