Real-World Economics Review, issue no. 57
The Value of Simple Models
Geoff Davies (Australian National University, Australia)
Copyright: Geoff Davies, 2011
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Neoclassical economic theory predicts equilibrium, yet the prediction is based on a string of patently absurd assumptions. Furthermore, evidence for instability is pervasive in the behaviour of real economies, implying that real economies are far from equilibrium and their behaviour potentially complex or chaotic. Therefore the neoclassical approach to understanding the behaviour of economies is futile and misleading , as many heterodox economists understand.
However the development of better theories seems to be significantly hindered by a feeling that any superseding theory has to be thoroughly quantified before it can be useful, and a feeling that the neoclassical theory has set a benchmark for sophisticated mathematics that must be matched before another theory can be respectable. Less fundamentally there seems to be a common perception that empirical insights can only be gained through elaborate statistical treatments of observations.
Here I offer some discussion from my experience as a natural scientist, and some examples regarding the Global Financial Crisis, to counter these hindrances. Useful and relatively simple models can be constructed that can immediately overcome major neoclassical limitations, for example by permitting non-equilibrium behaviour. The solution of the mathematics can be done using very standard numerical integration methods that are readily available in commercial packages. Mathematical machismo is not required. There are also situations in which the empirical lesson is obvious with no analysis, as will be noted here.
I should be clear that there are certainly many modellers who operate outside neoclassical confines, reported for example in Beinhocker’s excellent survey of “complexity economics” . The lessons offered here will not be news to them. Also some of them are constructing quite complex models that are nevertheless very instructive, such as models with many interacting adaptive agents. This article is prompted by my reading of some heterodox blog discussions, and is addressed to anyone who may have some difficulty seeing how to move beyond the neoclassical approach. Nor are the models here are offered as original investigations, though they may lead to such.
General points on quantification and mathematics
Theories do not necessarily even have to be quantified to provide important insights. I have argued that the recognition of economies as self-organising systems with many possible states already implies three important conclusions: that economies can be restored to their appropriate place serving society, that there can be a diversity of economic styles rather than a monoculture, and that economies can be compatible with the living world.