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Jonathan Schlefer's The Assumptions Economists Make

05/10/2012 01:16 pm ET | Updated Jul 10, 2012

Economics these days resemble a large family with a dark secret. Few speak of that secret to outsiders; that would be bad form, and besides, they wouldn't understand. But within the family, in whispers and asides that sometimes erupt into heated argument, tensions rise. Something is fundamentally wrong. This was not the way things were supposed to be. Appearances and reality don't align. That's roughly where Jonathan Schlefer shows up. He's not the first to suggest that many of the foundational assumptions of economics may not be correct; indeed, the shocking lack of anticipation of the financial crisis by a discipline built, as Milton Friedman confidently argued in his lecture, "The Methodology of Positive Economics," on prediction, brought forth a number of critics, both within the field and without. Schlefer himself straddles that divide. A research associate at Harvard Business School, Schlefer is a former editor in chief of MIT's Technology Review with a Ph.D. in political science from the university. He appears to be, in short, a kind of freelancer, buzzing about academia but not really a member of the guild. That inside-out perspective informs, I think, The Assumptions Economists Make.

Schlefer has seemingly set himself the task of closely examining and thinking about the models that lurk at the heart of the various schools of economics -- classical, neoclassical, Keynesian -- and asking: Do they make any sense? Are they valid, realistic, consistent, predictive, productive? What do they really mean? To do so, Schlefer must struggle with their controlling assumptions. Models are stripped-down versions of reality, and thus, beneath the jargon and technical apparatus, abstractions built upon assumptions about how people act and what people want, and how the world of money and markets function; economists regularly admit they are not "realistic" but useful. Today, these models are nearly all embodied in equations. Schlefer takes those models and -- to borrow from another academic field -- deconstructs them. He thus accomplishes two things: He argues convincingly for the importance of economic history and economics as an exercise in intellectual history, contrary to the practice of most economists who operate in a "one-dimensional present," or who reject, in the words of MIT economist Olivier Blanchard, "the trash bin of the history of thought." And Schlefer attempts -- this tells you he's outside the academy -- to resurrect a style of economic commentary (not newspaper punditry) that was last practiced at the highest level by John Maynard Keynes: That is, the economic argument not as an exercise in math but in writing.

Schlefer writes:

This book... is about what economists do in their secret lives as economists, when they aren't dashing off op-eds to tell everybody what to believe, pulling the wool over undergraduates' eyes in textbooks, or otherwise engaging in public relations. What economists do is make simplified assumptions about our world, build imaginary economies based on those assumptions -- otherwise known as models -- and use them to draw practical lessons. ... I explain the structure of models in words because nobody disputes the math, and readers of this book don't need to be dragged through it. But grasping the intuitions that good models capture still demands thought. And the real disputes arise about assumptions that underlie a model, how to interpret it (what might this abstraction legitimately be interpreted as implying?), and whether it is at least not wildly inconsistent with experience.

In roughly chronological order, Schlefer tackles everything from the Ur-metaphor, traceable to Adam Smith (if often distorted) but lurking in the more recent faith in equilibrium, of the invisible hand, to Ricardo's classical assumptions to John Bates Clark's neoclassical production function to the various flavors of Keynesian thought to the various schools of the free-market revival -- rational expectations, dynamic general stochastic equilibrium models, efficient markets -- to different "structuralist" models. Schlefer is careful to provide the historical context from which these metaphors or models emerged. This is not just historical needlepoint. A key part of his argument is how social convention and historical determinants shape thinking and then change; Schlefer accepts Keynes' core belief in uncertainty. There is no Platonic essence of truth -- no final unified model -- for a vastly complex, continually changing, social construct we call the economy. That's why it's so difficult and so elusive. Assumptions that make eminent sense in a mercantile age (and an age of mercantilism) may make less sense in an industrial age or a post-industrial global age.

There are a number of high spots here. For example, Schlefer's treatment of what he calls "The Puzzle of the Golden Age of Capitalism," that is, the postwar Keynesian economy that ended in the stagflation and oil shocks of the '70s, is particularly well done. That period is a puzzle; and it's often blithely wheeled out as a kind of lost Eden, with its broad middle class, mass industrial base and stunning economic growth that we should magically return to. Schlefer realizes quite well that that is impossible. In fact, he understands that the real question with the Golden Age is not just why it occurred, but why it ended, bringing Keynesianism down with it. His exploration of all this takes him into the thicket of productivity, inflation, unemployment and structural explanatory models. He exits as he enters: lots of questions with few definitive answers. But the trip is a revelation.

Schlefer works hard to make all this comprehensible and accessible. But it's difficult. He packs a lot in these concise essayistic chapters, which restlessly move back and forth in time and from subject to subject, requiring concentration on a sentence-by-sentence basis. This isn't heading to the bestseller lists -- but so what? Schlefer is waving a flashlight beam in a musty attic. As Alan Greenspan's public persona suggests, economics takes a perverse pride in obscurity and opacity. True, these problems can be extremely forbidding technically. The complexity of the economic system far outstrips our ability to construct models that mirror and predict behavior (thus the debate about the importance, or not, of "realistic" assumptions); and even if one could, the reality is that the actors in this continually unfolding drama at least appear to be free agents, thus making discussions of terms such as utility and "representative agents" exercises in building towers on sand. Unless we can uncover the deterministic bedrock of human behavior, the true microfoundations beneath the macroeconomy, this won't change. Economists, as many have said and Schlefer agrees, is not physics; it's more like some blend of biology, the social sciences and philosophy. Moreover, that obscurity also has a more willfully "political" or self-interested side. It masks assumptions that are often basic, reductionist or absurd. It retains what Greenspan was clearly after, a sense of authority and mystery. It allows the family to put a brave front for the outside world -- to keep its struggles within.

I suspect there's an economist somewhere who would argue with Schlefer about every single assumption he explores, and every conceptual position he assumes. Does Schlefer seem persuasive to me in many cases? Mostly, in exactly the way a literary critic writes convincingly about a given text. Schlefer speaks with a distinctive authorial voice -- sensible, mildly ironic, respectful, occasionally tart. He is not overtly political. He rejects the belief in markets naturally seeking equilibrium (he rejects "natural economic laws" generally) and accepts that markets can blow up on their own, without policy assistance. He describes, judges -- and restlessly moves on. Marx. Jevons. Marshall. The production function. The labor theory of value. A swipe at Lockean liberalism. A dive into the mysteries of productivity. A marvelous riff on "imperfection" in economics. He tilts skeptically with nearly everyone; and some of these folks are formidable, if mostly dead. But is he right? I'm not sure what right really means. You work your way through this wondering if he can declare anything absolutely true -- no invisible hand! no equilibrium! bash the right! bash the left! -- until he begins to draw the strands together into a coherent viewpoint, a kind of meta-philosophy of economics, in the final chapter, "Thinking About Economics." It's a sign of intelligent literary design, I think, on Schlefer's part that he doesn't wheel Friedman out on "Positive Economics" until the very end, by which time it's pretty clear how variable-verging-on-inadequate are the predictive powers of any of these models.

But what I really wonder about this book is if the family will acknowledge this kind of criticism from outside, or whether they will shrug it away as old news. The Assumptions Economists Make was published in March, and except for a few pieces by Schlefer himself and an interview, I could find no reviews (even on the book's Amazon page, which is really something). Perhaps they are coming; academia grinds slowly -- far more slowly even than the modern publishing business. I cannot declare Schlefer correct on any, or even most, of his many points, though the effort to work through his logic is always enlightening. But one has to applaud the effort and the guts to try to translate this most powerful, and flawed, discipline to an outside world mired in woe. He and the book deserve a better airing.

Previously published on TheDeal.com

Robert Teitelman is editor in chief of The Deal magazine.