Getting the rabbit into the neoclassical hat

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Lars Pålsson Syll
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Getting the rabbit into the neoclassical hat

In public, including in the training of economists, Neoclassical economics usually reads its models backwards. This gives the illusion that they show the behaviour of individual economic units determining sets of equilibrium values for markets and for whole economies. It hides the fact that these models have been constructed not by investigating the behaviour of individual agents, but rather by analysing the requirements of achieving a certain macro state, that is, a market or general equilibrium. It is the behaviour found to be logically consistent with these hypothetical macro states that is prescribed for the individual agents, rather than the other way around.This macro-led analysis, this derivation of the micro from a macro assumption, is and always has been the standard analytical procedure of theory construction for the Neoclassical narrative. Sometimes, for pedagogical reasons, authors call attention to how the “individualist” rabbit really gets into the Neoclassical hat. For example, consider the following passage from a once widely used introduction to economics.
“For the purpose of our theory, we want the preference ranking to have certain properties, which give it a particular, useful structure. We build these properties up by making a number of assumptions, first about the preference-indifference relation itself, and then about some aspects of the preference ranking to which it gives rise” (Gravell and Rees 1981, p. 56, emphasis added).
In other words, it is not the behaviour of the individual agents that determines the model’s overall structure, nor even the structure of the preference ranking. Instead it is the macro requirement for a particular structure which dictates the behaviour attributed to the individual agents. The “purpose” of this “particular, useful structure” is to rationalize the macro “conclusion” assumed at the beginning of the exercise. The resulting model shows micro phenomena determining macro phenomena, whereas, in fact, it is the starting point of the macro structure that has determined the behaviour of the model’s micro elements. Likewise, “rationality” becomes something defined to meet the exigencies of a desired conclusion.

Yes, indeed, ‘rationality’ in mainstream neoclassical economics is defined and used​ in rather suspect ways. Take, for example, the rational expectations assumption. Rational expectations in the mainstream economists’ world imply​ that relevant distributions have to be time independent. This amounts to assuming that an economy is like a closed system with known stochastic probability distributions for all different events. In reality, ​it is straining one’s beliefs to try to represent economies as outcomes of stochastic processes. An existing economy is a single realization tout court, and hardly conceivable as one realization out of an ensemble of economy-worlds ​since an economy can hardly be conceived as being completely replicated over time. It is — to say the least — very difficult to see any similarity between these modelling assumptions and the expectations of real persons. In the world of the rational expectations hypothesis, ​we are never disappointed in any other way than as when we lose at the roulette wheels. But real life is not an urn or a roulette wheel. And that’s also the reason why allowing for cases where agents make ‘predictable errors’ in mainstream macro​ models doesn’t take us any closer to a relevant and realist depiction of actual economic decisions and behaviours. If we really want to have anything of interest to say on real economies, financial crisis and the decisions and choices real people make we have to replace the rational expectations hypothesis with more relevant and realistic assumptions concerning economic agents and their expectations than childish roulette and urn analogies.

‘Rigorous’ and ‘precise’ mainstream neoclassical models cannot be considered anything else than unsubstantiated conjectures as long as they aren’t supported by evidence from outside the theory or model. To my knowledge no in any way decisive empirical evidence has been presented.

No matter how precise and rigorous the analysis, and no matter how hard one tries to cast the argument in modern mathematical form, they do not push economic science forwards one single millimetre​ if they do not stand the acid test of relevance to the target. No matter how clear, precise, rigorous or certain the inferences delivered inside these models are, they do not say anything about real-world​ economies.