On Janeway’s Mesoeconomics

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Peter Radford
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from Peter Radford

“Economics has become irrelevant.”

PART ONE

Oh my.  Apparently Brad DeLong and I have the same problem.  He, of course, is part of the elite club.  I am decidedly not.  So it is quite a shock to share something.

What?

He set out to write an 800 word review of Dan Davies’ new book and ended up about 5,000 words later still writing.  I set out to write 1,000 words on William Janeway’s recent article on mesoeconomics, and here I am nearly 5,000 words later, still writing.  The common thread being, from my reading of DeLong, that economics sucks.

That’s a technical term.

Dan Davies seems to agree because he says this:

As long as the ideology of economics maintains its dominant position, there is always a considerable danger of the Friedman doctrine rising back up from the dead. If the highest-level decision-making mechanisms of the world are to be viable systems, they need a philosophy which can balance present against future and create self-identity…. This philosophy cannot look much like mainstream economics…. Any system which is set up to maximise a single objective has the potential to go bonkers…. You can’t have the economists in charge, not in the way they currently are…. The top level of any decision-making system that’s meant to operate autonomously can’t be a maximiser. And so, the governing philosophy of the overall economic system can’t be based on the constrained optimisation methodology that’s currently dominant in the subject of economics…

A more precise term to describe the conundrum is irrelevant.  Economics has become irrelevant.  Which is what Steve Levitt said he feared also.  Economics sets out to solve the insoluble.  Which it can do in make-believe, but not in reality.  Hence the irrelevance.

Why does economics do this?  It seems like a lot of wasted effort.  It does, however, as JK Galbraith once said, keep a lot of economists employed.  So that’s a good thing.  If keeping economists off the streets is the best we can do, at least it’s better than nothing.

But, still, why do they do it?  They’re obsessed with goals that are unachievable in the real world.  They keep banging their heads against problems that exist only in an idealized non-existent place.  I give them loads of credit, though, they are persistent.  Like Monty Python’s flying sheep: it’s worth watching.  You never know if they might succeed.

Well, we do, don’t we?  We know they won’t succeed.  Reality and make-believe don’t actually intersect.  Still, it’s fun to watch.

The entire superstructure of academic economics sets out with a number of goals for an economic system.  Maximization being top of the list.  Efficiency is right up there too.  Optimization is not far behind.  And so on.  All presume something that not only does not exist , it cannot exist: perfect information.  There is no way anywhere on planet earth that the conditions for maximization, as spoken of by economists, exist.  There is insufficient information and even if there were, there is insufficient computational power to use that information.  We are hobbled by uncertainty and bandwidth problems.

This is why economists are reduced all the time to discussing the real world as if it is some sort of failure.  It can never quite live up to the lofty ideals that economists claim to have discovered in the further reaches of their perfect worlds.  Planet economics is a fantasy.  Everyone knows knows it.  Yet it persists.

Let’s just say it:  The issue, at its deepest root, is that economists wanted to provide their capitalist sponsors at places like the University of Chicago with a set of theories supportive of the status and lifestyle requirements of those sponsors.    Which they did using the beguiling phraseology of “freedom”.  Free markets became a thing.  Naughty stuff like power and its consequences were set to one side.  The state was suitably tainted as being a problem.  Firms were forgotten.  Markets became the be-all and end-all.  The gap between textbook and reality was ignored because the goal was not knowledge of the real world, but to create a logically secure and ideologically comfortable basis to serve as a foundation for the wealthy and corporate elite to battle Soviet ideas abroad and redistributive ideas at home.

Job done.

This is not to say, naturally, that there hasn’t been a lot of effort to change the way economists pass on their knowledge.  Not at all.  There are laudable new textbooks available that begin more in the real world.  They start there and then move towards theory.   This is great progress, and as Walter Frick recently noted in an Aeon+Psyche Daily column, these reality-based introductory classes are beginning to redress the damage done by decades of pretense.  There’s a long way to go, but it’s a start.

That fantasy persists in the background, though, and still exerts a gravitational pull on the discipline.  It’s still there as the central dogma to legitimize market superiority.  Maximization.  Constrained optimization. Rational choice.  Perfect competition.  Proper economics.  No wonder the market fails.  It’s being asked to do the impossible.

You’d think that after the hapless performance of most economic models over the past few decades someone would have had the courage to toss the fantasy overboard and get on with the hard work of engaging with reality.  We don’t need new ways of teaching as much as we need new theory.

So we’re stuck with the real world being an error or failure and a constant stream of performative advice flowing in from academia as to how we could and should alter ourselves to match the automatons that inhabit their fantasy world.  If only humans weren’t … well … human.

PART TWO

I haven’t yet read the Davies book, so I will not opine on it further.  But I have read Janeway’s lament about the need for something he calls mesoeconomics.

The problem is that economics in its extreme and irrelevant form expunges from the stage any actor or artifact that doesn’t assist in the establishment of fantasy.  The actors left are carefully chosen to do precisely what economists tell them to do, and to do it instantaneously with breathtaking precision, foresight, and obedience.  Error just does not exist.  This is, of course, ridiculous, but that doesn’t stop economists from persevering.  The end result of this absurdity is then postulated as something called an equilibrium, which alternatively put, is some happy place where all is right with the world and which no one — none of those automatons at least — can improve upon.  At which point the world presumably just stops.  Nirvana having been established we can all go home.

Well, not really.  Because stuff happens.  And it is this pesky stuff happening that really irks economists.  That’s why they keep telling us that the real world is a failure.  It is riven through with inefficiencies, errors of logic, rotten feedback, and a general sense of not being perfect.

How economics arrived at this level of agitation with, and disconnection from, reality is too long a story to tell here.  Suffice to say it has something to do with the ideological necessity of ‘proving’ the superiority of something called ‘the market’ over any other form of economic coordination.  Market obsession was an outcome of the ideological confrontations of the 1920s and 1930s when state planning was a real thing in the Soviet Union and the Great Depression had besmirched free-wheeling capitalism more than a little.  Those were the heady days of great debates between economists who were actually trying to think about reality rather than fantasy.

Steadily though, and in order to bolster their market obsession with a veneer of scientific veracity, economists began to add layer upon layer of analytical gloss.  They went deep into mathematics.  They adopted the cloth of impeccable logic.  The tossed out anything tainted by collective action.  They reduced their world to a set of individuals specifically designed to achieve the preordained superiority of markets.  Things like general equilibrium, marginal analysis, and perfect information were kluged together, along with a host of other clever tricks, to erect what became part of the post war ‘synthesis’ that Samuelson became well known for launching in his iconic textbook.

In his introduction to that synthesis Samuelson argued that the success of modern economics would be that both unemployment and inflation would be substantially banished from democratic societies.  This would open the door to a return to ‘traditional’ economics which was the wise allocation of resources.

Notice that slippery word ‘wise’.  What the heck is that?

Before we get to that, please note the rather glib way in which Samuelson talks about the success of economics helping banish both unemployment and inflation from democratic societies.  That ability was the other part of the synthesis and had nothing to do with wise allocations of anything.   It was a relic of the 1930s and it seemed to work.  It was the Keynesian bit, with some help from his friends.  Then Samuelson swoops on: the real work in future was to be wise allocation of resources.

Allocation of resources.  That became the game to be played — all the other problems, don’t forget, had been solved.  Micro-logic began to outshine macro-pragmatism.  It all became very Robbinsian.

And this is where the wheels well and truly fell off.  Ideology took over.  Market obsession became the order of the day.  The hyper-logicians won.  Fantasy was in.  Realism was out.

Go back to my comment about stuff happening.  Well, it does.  And that’s a problem if you want to ‘prove’ something inside a messy, complex, and often inscrutable object like a modern economy.  So economists simplified.  They stripped away reality and reduced everything to the barest possible level.  They seem to think that they penetrated the fog and identified persistent regularities worthy of note.  The problem is that beyond the fog is nothing.  It is the fog we need to understand.

Sure, they still used words that spoke to real world-like activity.  Competition for instance.  Naturally it was perfect competition.  This was the mechanism they chose to drive their machinery towards their desired goal.  Competition.  In markets.  Because that’s where competition takes place.  No?  The end result of all that fierce competition was … roll the drums … efficiency the likes of which cannot be excelled by any other form of economic coordination.  It just can’t.

All that perfection can, however, get a bit dazzling.  We need to see through the glare.  How about a quick reference to Hayek?

When he was busy attacking central planning back in the 1930s and 1940s — a debate that he eventually lost to the likes of Lerner and Lange — he also expressed opposition to the other-worldliness of equilibrium thinking and perfect competition that had taken hold in the emerging synthesis.  When discussing the absence of reality in that paradigm, in 1948,  he said:

“Now, how many of the devices adopted in ordinary life to that end would still be open to a seller in a market in which so-called ‘perfect competition’ prevails?  I believe the answer is exactly none.  Advertising, undercutting, and improving (‘differentiating’) the goods or services produced are all excluded by definition — ‘perfect’ competition means indeed the absence of all competitive activities.”

‘Exactly none’.  Ouch.  Irrelevance foretold by one of their own.

The importance of Hayek’s statement is not so much the obvious, but the insinuation: economics talks about topics like competition and so on, but then axiomatically dismisses them in order to preserve the analytical field for its logic.  For all the talk of competition, Hayek is saying, nowhere is actual competition allowed in, because for competition to exist there have to be many points of view.  That’s the whole point of his ideas about knowledge in society: it sits around in localized pockets and varies all over the place.  Real competition requires different interpretations of risk, of possibilities, of potential action, of variations of resource options, of organization, of consumer desires, of pretty much everything.  And such variance eliminates perfection as being credible — except as an irrelevant thought experiment.

PART THREE

Perhaps nowhere is the contrast Hayek is exposing more obvious than in the paradox of business education.  Students duly attend their basic microeconomic classes where they get drilled in the perfection, and thus the superiority of, the marketplace over any sort of planning, unless, of course, they are lucky enough to be in one of those schools using a modern textbook.  Then they sit through classes on — you guessed it — planning, the gist of which is how to rig markets or how to create and then exploit niches in asymmetrical information to create rents.  Since the latter is the real world, it is the planning sessions that have the most subsequent application, leaving the micro classes as background ideology.  Which is what it is.  This is also why we see the absurdity of business leaders extolling the free market whilst doing their darnedest to build what Warren Buffet calls ‘moats’ around their investments.  No one really believes in the existence of free markets except economists.

Which leaves people like Janeway  up a creek.  That’s another technical term.

Decades of steady departure from reality have come at an enormous cost to economics.  It has nothing to say about contemporary issues like the recent spate of supply chain failures.  Which worries Janeway sufficiently that he suggests there is a need for something called mesoeconomics.  This is the missing middle between the absurdity of hyper-rational micro and the ad hoc bag of tricks deployed as policy at the aggregate or macro level.

Here’s an excerpt from Janeway’s article:

“While microeconomics deals with the behavior of individual agents (firms, consumers, workers, investors), macroeconomics addresses the behavior of statistical aggregates (as represented by GDP, national income, and so forth). But the space between has largely been neglected, particularly with respect to how it serves as the dynamic context in which economic policies play out. One source of this lacuna may be the simplistic faith that markets can be trusted to deliver the most efficient solution, or at least trusted more than corruptible politicians.”

Notice a key problem here lurking in the way Janeway describes micro.  He clumps business firms into that same bag as individuals.  That’s what economists do. They lump all ‘agents’ together in one big category and ignore all the variations between them.  This is very convenient because it means they can ignore the real world attributes of such agents and study only that extremely select few that have importance in the development of constrained optimization models.  This despite firms being collections of people.  Often quite large collections of people.  Sometimes even 100,000 people.  Or more.  They appear on the economic stage only at the point of exchange.  Anything they do before that magic moment is dismissed as existing in a black box.  It is mere industrial organization.  It is not maximization.

Those firms do, however, compete.  Despite all those moats existing in the real world, the firms inhabiting economics compete like helpless demons completely unable to influence their surroundings or, most importantly, consumers.  Sometimes they are called production functions which is simply a mix of capital and labor — whatever they are, which is never pinned down precisely.  This oddity of imprecision is allowable in the rules of economics because it takes place before the market.  The legendary rigor and logic economists are so proud of only exists, apparently, in the market.  Nowhere else.

Sometimes, though, firms are also referred to as a ’nexus of contracts’.  This strange animal was invented to allow economists to treat firms as just another contractual arrangement.  Why?  Because once production and its various processes is reduced to an assemblage of contracts the paraphernalia of standard micro can take over and  the firm is dissolved magically into the background of transacting.  Which is to say, the making and executing of contracts.

When someone like Coase pops up and asks the obvious question: if markets are so darned perfect and ever-so-the best at allocating resources optimally, why do we have firms?   He gets a contorted response.  Those transactions have costs associated with them.  Duh!  So firms only exist because of those costs.  Remove them and, hey presto, firms disappear.  This notion has the beauty of allowing the market superiority to continue at the point of sale.  It’s just that transactions cost a little during the production phase – a page that does not exist in economics.  An added advantage of this idea is that, once again, it reduces the firm to a set of things indistinguishable from the market: it is a set of transactions that for the want of being cheaper could just as well be anywhere out there in the marketplace.

There is nothing special, in any of this, about firms. To economists, firms are people too.  Apple and Google etc are just like you and me.  Exactly like you and me.  Not at all different.

Poor Janeway is really up creek.

With firms so summarily dismissed as potential agents of economic coordination how does he engage with supply chains which are transparently intentional acts of firms engaged in production?

Well, supply chains are contractual.  So that might help.  And they exude costs.  More to the point it seems that the tendril-like supply chains that Janeway fears are problems exist precisely because firms are trying to cut costs.  They are, unfortunately, inextricably linked with firm management, and the goals of business.

PART FOUR

How did we get these awful supply chains?

Because we all went bonkers.  As Davies points out in that quote above.

This is where the outsize and unwarranted influence of economics plays a key role — which is what Davies is moaning about.

Shareholder value.  Remember that?  One of the great consequences of the fantasy created by economists , hell bent as they are about maximization, is that business was driven, at the risk of being criticized as being un-modern and therefore subject to takeover by clever finance people, towards ever greater efficiency.  Which is great as far as it goes.  After all productivity is the wellspring of wealth and greater efficiency is the root of productivity.  The problem, though, is that out in the real-world-attainable efficiency is not what economists are talking about.

Don’t forget they are living in a fantasy world where everything is carefully defined and plays out according to the rational logic economists have devised to show that markets are the pinnacle of efficiency.  This is Hayek’s point above.  In the fantasy-world things like competition are introduced with an Orwellian presence.  They are there.  But they are not there.  They are there because the models include them.  They are not there because everything is pre-ordained by the attributes given to the various actors on the stage.  It’s as if words are spoken but there is no sound.  Everything moves inexorably towards the desired goal.  Hurrah.  Markets are great.

In the real world, however, there’s great deal of noise.  There is no practical hope of achieving anything optimal because of all that noise.  None.  What firms do, instead is to set goals and plans in ordered to limit the damage uncertainty can do during the time of, or across the space of, production.  To accomplish this firms set boundaries around themselves — boundaries within which they coordinate economic activity reasonably, though not totally, protected from outside influences.  Boundaries act like Buffet’s moats — they prevent information leakages into the outside world, and, more importantly constrain the problem being solved.  They are an attempt to mimic economics because they are an attempt to shut out the world beyond.  The key, though, is that they never wholly succeed.  Reality intrudes.  The best laid plans … as the saying goes …  In a nutshell the firms of economics are closed systems.  The firms of reality are open systems.  They are not the same.

But.  Shareholder value.  The pressure to achieve ever greater efficiency, and thus profit, and supported by all sorts of theories of business derived from microeconomics, businesses forgot why they exist.  They exist because that fantasy efficiency cannot be achieved.  Ever.  So, driven on by the ideology of economics, and as they pushed out further and further from the safety of the shores of reality and towards the mirage of economic efficiency, they took on ever greater risk.  That risk being the noise of the real world playing havoc with their plans.

Efficiency is the enemy of sustainability or resiliency.  It is a lesson learned over and over again in nature.  An overemphasis on efficiency exposes a system to the shock of the unexpected.  Stuff happens.  Just not in economics.  Which is why, I suppose, the real world is exogenous to theory and everything we trip over on a day-to-day basis is some sort of ‘failure’.

Only the failure is not in the real world.  It is in the absurdity of the theory.

So we arrive at Janeway’s paradox.  In the fantasy world there is no trade-off between greater efficiency and the possibility of failure due to uncertainty.  Everything in that world is known.  Efficiency can be maximized.  In the real world the possibility of disruption lurks around every corner.  So todays’ efficient solution could be tomorrow’s existential risk.  You simply cannot have the ultimate efficiency without also exposing yourself to enormous risk of loss.  There has to be balance.  And balance, as Davies says, is a foreign concept to maximizing obsessed economists.

PART FIVE

There is a straight ideological line running back from the existence of tenuous supply chains, through modern business theory, and back to the fantasy world of micro.  The danger of listening to economists as if they know anything about the real world is that the allure of their fantasy can beguile us all into believing in magic.  This is especially true of the odd way in which economists treat information.  It’s everywhere.  They talk about it incessantly.  They even discovered that it is unevenly distributed about the place — they call this ‘asymmetry’.  This discovery was worthy of great accolades and has become a feature of discussion.

This discovery is of note is, however, only within the context of the pre-existing fantasy.  The very reason humans trade, why they ‘truck and barter’, is because everything is asymmetrically spread around the place.  From raw materials to the most esoteric knowledge, everything is sitting about in clumps.  The landscape of information, is far from the flat, uninteresting, and the static perfection of fantasy.  It is more akin to the landscape of the Himalayas with great piles jealously hoarded in one place and great valleys in others.  Indeed information is another of those Orwellian moments in economics.  It too is everywhere in theory, but is in fact nowhere of importance. How can it be important if there is no difference?  Without difference there is no motion.  Without motion there is no economy.  Someone once said that information is ‘a difference that makes a difference’.  Economists must have missed that.

To quote Davies again:

“The way in which the economics profession ignored most of the work done in information theory is striking.  It ignored its own traditions relating to uncertainty and decision-making, instead ploughing ahead with a frighteningly simplistic view of the world in which everything could be reduced to a single goal of shareholder value maximization.” 

So, Janeway and Davies agree on something.  The extraordinarily simplistic, almost naive, foundations of economics.

Will a new mesoeconomics provide Janeway with what he wants?  We cannot tell.  It means getting away from the straightjacket of economic theory as it exists.

We can be doubtful justifiably.  There’s a second paragraph from Janeway that has the hallmark of naivety in it.

“The issue that has called attention to this domain has been the fragility of an economy whose structure has been optimized for efficiency. The COVID-19 pandemic exposed how the longstanding commitment to maximizing returns on capital (for the benefit of shareholders and executives) meant that minimal capital was put toward maintaining buffer stocks or redundant secondary sources that could have helped absorb supply shocks. Since the systemic benefits from these investments are positive externalities, they do not factor in individual firms’ calculations.”

Listen to that.  He is claiming that there is a fragility within economies that have been optimized for efficiency.  But they haven’t been optimized.  That’s not possible.  We can, however, edge towards a sort of pseudo efficiency by cutting costs to deliver more so-called shareholder value.  Ultimately it was this relentless cost-cutting attempt that created the fragility.  Ditch the optimization illusion and you ditch the fragility.

He is on the right trail however.  His language is clunky because he is still trying to fit the firm into his background fantasy theory.  But the thrust of the argument is correct.  You need spare capacity to weather uncertainty.  You need to hedge your bets.  This is neither novel or even that interesting.  But it shocks economists to the core.  Because, by implication, you cannot optimize.  Buffer stocks.  Secondary sources to absorb shocks.  The expression is correct.  Maximization is out.  Resiliency is in.

Anyone in business must find this dull and self-evident.  Economists, however, have no clue about business and have to adjust: they need to get back to understanding how stuff gets done in a real, rather than in fantasy economies.  Production is a real thing, not some weird precursor to exchange.

And, yes, firms do exist.  They exist to coordinate economic activity.

There’s a ton of interesting work out there on evolution, behavior, cooperation, information, and learning.  It is within that combined effort that we are likely to find mesoeconomics.  Always in motion, all process, non-static, non-market, non-individual, non-aggregate, and definitely non-optimal.

Mesoeconomics is the interesting part of the overall economy.  It’s where things are organized.  It’s where things are produced.  It’s where actual humans exist and deal with actual problems of everyday living.  It’s reality.  It’s where economists can become relevant again.  If they want.

Addendum: Three more things:

One.  Whitehead once said … “If science is not to degenerate into a medley of ad hoc hypotheses, it must become philosophical and must enter upon a thorough criticism of its own foundations”. This is true of economics as it searches for relevancy and re-invigoration.

Two.  I came across a manifesto advocating a process perspective for biology.  It is called “Everything Flows”.  It reminded me of the road not taken in economics despite Alfred Marshall’s advocacy in his “Principles of Economics”.  As a flavor of “Everything Flows”, I offer the following paragraph …

“More specifically, we propose that the living world is a hierarchy of processes, stabilized and actively maintained at different timescales. We can think of this hierarchy in broadly mereological terms: molecules, cells, organs, organisms, populations, and so on. Although the members of this hierarchy are usually thought of as things, we contend that they are more appropriately understood as processes. A question that arises for any process, as we shall discuss in more detail below, is what enables it to persist. The processes in this hierarchy not only compose one another but also provide conditions for the persistence of other members, both larger and smaller”.

What allows an economy to persist?  What brings stability?  And at what cost to potential change?

Mesoeconomists have a lot to ponder!

Three.  For evidence of the strange worlds possible when you go down the economics rabbit hole look no further than my favorite price theorist Brian Albrecht’s recent article concerning house prices.  The theory underlying the article asserts that there is ‘no such thing as supply’.  Everything is simply a version of demand.  Albrecht says: ‘Producers do not sell at just any price.  They are implicitly demanding their own good.’  Apparently the contest is not between a buyer and a seller, but between two buyers both demanding the same good.

Chew on that.  Explain how that good came into existence.  Explain how relevant that extraordinary twist of logic is.

He goes on ” …it becomes clear that what we call “supply” is an artificial construct that is just a by-product of the initial allocation … ”

Apparently production is ‘an initial allocation’.

More embarrassingly he also says: “… At a conceptual level, I like this approach because it helps us avoid the Marshallian fallacy that there is a subjective side (consumers) and an objective side (producers) of the economy. It’s all just demand; it’s all subjective.”   

In contrast, I think Marshall represents a good beginning for us to reconsider the missing middle.  At least he didn’t seem to think goods just drop out of the sky in some form of ‘initial allocation’.  They were .. ahem .. produced.  I wonder by whom?  I wonder why?  In Albrecht’s fantasy tale toothpaste manufacturers make toothpaste because they demand toothpaste.  That seems like a lot of effort.  Why not simply make enough for themselves?  Why make so much?

Oh dear.

Yes.  Economists can be very clever.  They can follow their logic wherever it leads them.  Sometimes, perhaps too often, it leads into an abyss of absurd nonsense.

And they wonder why we laugh?

Where is even a smidgeon of Samuelson’s ‘wisdom’?

Nowhere.

Sigh.