Microfoundations? We Don't Need No Stinkin' Microfoundations

Matthew Yglesias says that economists shouldn't concern themselves with microfoundations for macro theories:

From an outside perspective, what seems to be going on is that economists have unearthed an extremely fruitful paradigm for investigation of micro issues. This has been good for them, and enhanced the prestige of the discipline. No such fruitful paradigm has actually emerged for investigation of macro issues. So the decision has been made to somewhat arbitrarily impose the view that macro models must be grounded in micro foundations. Thus, the productive progressive research program of microeconomics can “infect” the more troubled field of macro with its prestige.

Which, as a sociological matter, I think you’d have to say has worked.

But as a methodological matter, it seems deeply unsound. As a general principle for investigating the world, we normally deem it desirable, but not at all necessary, that researchers exploring a particular field of inquiry find ways to “reduce” what they’re doing to a lower level. To make that concrete, in the modern day we have achieved a decent understanding of how principles of chemistry are grounded in physics’ understanding of the behavior of atoms. But it’s just not the case that advances in chemistry were made by demanding that chemists ground all their models in subatomic physics. On the contrary, chemistry moved forward in the first instance by having chemists investigate issues in chemistry and see which models and theories held up.

A lot of these same issues creep up in political science, and especially in IR where everything we study is macro. But I think that Yglesias' analogy is horrible and leads him to the wrong conclusion. The differences between chemistry and physics are not equal to the differences between micro and macro variants of the same discipline. A more appropriate comparison is between astrophysics and particle physics. I think Yglesias would have a difficult time arguing that the micro has no bearing on the macro in that case.

So why do microfoundations matter for the social sciences? Historically, they have not been a primary concern. Theories of social relations -- whether political, economic, or sociological -- were typically deductive attempts to explain the way the world worked (or the way it should work). This tradition still continues, but as the disciplines became more and more systematized and data-driven, we've noticed something: deductive "grand" theories don't do a very good job of explaining the past, and do even worse at predicting the future. More often than not, these theories perform poorly because they make inaccurate assumptions about the micro systems on which the macro structure stands.

The move to shore up the (micro)foundations of our theories is an attempt to rectify the tendency to assume what we should be seeking to explain. And despite the imperfections which remain, this trend has had many positive benefits for both economics and political science.

There is a danger in becoming too reductionist. Indeed, social scientists give much weight to parsimony and tractable theory-building. We often ask if theories pass the "Grandmother Test". And in International Relations, if a theory doesn't travel then its worth is severely limited. So there is often a trade-off between elegance (and broad applicability) and the precision that comes from reductionism. Social science is often about balancing several levels of inquiry at once. If we eschew the micro in favor of the macro, we will get poor results.

The Power of the Quants.

Really interesting article from Newsweek on Paul Wilmott, an Oxford-trained mathematician specializing in quantitative finance. Wilmott seeks to train newly minted physics, financial engineering and math PhD's who are out working in finance that there is a hell of a lot more to finance than simply mathematical model-building and equations. Here is an excerpt, but do check out the entire article. Worth the read.

Imagine an aeronautics engineer designing a state-of-the-art jumbo jet. In order for it to fly, the engineer has to rely on the same aerodynamics equation devised by physicists 150 years ago, which is based on Newton's second law of motion: force equals mass times acceleration. Problem is, the engineer can't reconcile his elegant design with the equation. The plane has too much mass and not enough force. But rather than tweak the design to fit the equation, imagine if the engineer does the opposite, and tweaks the equation to fit the design. The plane still looks awesome, and on paper, it flies. The engineer gets paid, the plane gets built, and soon thousands just like it are packed full of people and sent out onto runways. They fly for a while, but eventually, because of that fatal tweak, they all end up crashing.

In a way, this is what's happened in quantitative finance. The planes are the complex derivatives—like collateralized debt obligations—that now lie smoldering on the balance sheets of banks. The engineers are the "quants": those math and science Ph.D.s who flocked to Wall Street over the past decade and used mathematical models to build these new investment products. These are the people Warren Buffett was talking about when he said, "Beware of geeks bearing formulas" in his letter to shareholders this year. The quants aren't entirely to blame for the financial meltdown; there's plenty of guilt to be shared by regulators, top executives and the investors who bought the instruments the quants created. Yet while aeronautical engineers who willfully designed a faulty plane might be on trial for criminal negligence, Wall Street's math gurus are, for the most part, still employed. Strangely, the banks need quants more than ever right now. If anyone's going to figure out how to price these toxic assets, it's them. Quantitative finance isn't going away, but it is in desperate need of reform. And one man—a math geek himself—thinks he knows where to start.

This is not only true of the world of finance. This can also be extended to economics and political science. Are some rising academics simply bending equations and formulas to fit the real world, implying causality and correlation where none really exists? In the face of mounting pressures to public or perish, how much of what is put out there in our scholarly journals dishonest, mathematical model building simply for the purposes of another publication and veiled by mathematical complexity and greek symbols? 

(ht: MR)

One Slice

Let me try to clarify my position by highlighting where it is that we differ. For those growing weary of this thread, I post some music .



You write:
3. ... the way I look at the concept of "bounded rationality" is as a heuristic device to measure people as they actually are rather than as automatons. In other words, nobody is perfectly rational but we all operate as if we think we are. Under that condition, people can seek new knowledge, biased people can seek to become less biased and improve their decision-making abilities over time, and "incomplete information" does not have to be equal to "private information". Remember "rational ignorance"?

If I interpret this paragraph correctly, you believe the information shortcomings that sometimes plague decision making are remediable. In contrast, I believe that they are not remediable. And to be clear, by being remediable I don't mean is it possible for one to imagine ways to make these problems disappear. I mean, do individuals have incentive to behave differently so that the problems cease to prevent good outcomes? My view differs from yours, then because I think the "policy relevance question" focuses not on can people seek more information (of course they can), but on will they seek more information? Here I believe our models tell us they will not.

Take rational ignorance: a situation in which people forgo collecting information that could produce better decisions because the cost of acquiring the info is greater than the expected benefit the info provides. My point isn't that more information isn't available, nor that decisions could not profit from its incorporation. My point is that people have no incentive to acquire it; that's what it means to be rationally ignorant. Remedying this information problem thus requires people with no incentive to collect more information to actually collect more information. I don't know why one would think that they would do so. I believe that what applies in this case applies more generally: if info problems emerge from the incentives that individuals face, then these individuals have no incentive to do the things necessary to remedy the information problem.

This is why I don't know how to understand the claim that IR scholars can help mitigate information problems. If information is important in the ways our theories suggest, then gaining policy relevance by providing information implies that IR scholars somehow can make policy makers do things they have no incentive to do. In other cases (information asymmetries) it requires us to provide information we cannot possibly possess. I agree that if we could in fact do these things that would be neat. But, I don't see how we can do these things.

I Like Cake (but prefer pie)

A clarification of my views of the "IR scholars in the public sphere" debate in response to Dr. Oatley:

1. When I reference knowledge-as-value-added, I wasn't talking about specific knowledge, of the sort acquired by area studies scholars. I was talking about more theoretical knowledge like being able to interpret signals, or being able to predict the strategies of insurgent groups, or being able to interpret the coordination difficulties in trade disputes. This is the type of research done by most IR scholars, and expertise in these areas can help an administration navigate the international system.

2. Outsiders may not have better information than insiders, but they may have better tools for making use of that information. In any case, are we sure we're getting a high bang-for-buck from our intelligence services? I think that's an open question.

3. This may be opening a can of worms, but the way I look at the concept of "bounded rationality" is as a heuristic device to measure people as they actually are rather than as automatons. In other words, nobody is perfectly rational but we all operate as if we think we are. Under that condition, people can seek new knowledge, biased people can seek to become less biased and improve their decision-making abilities over time, and "incomplete information" does not have to be equal to "private information". Remember "rational ignorance"?

Think of it this way: I know very little of particle physics, despite the fact that much information about particle physics is not held privately. However, if I were forced to make a judgment on some issue related to particle physics, I could improve my ability to make the best decision by taking the advice of experts who possess the knowledge I lack. If the issue is contentious, then the best I can do is hear both sides and make the best decision possible given the informational constraints I face.

So bounded rationality is distinct from both irrationality and true rationality, but has more in common with the latter than the former. But perhaps we should ask the Less Wrong folks about this.

4. Dr. Oatley wrote:

We seem to think that we can develop models that accurately explain politicians' choices and then use these models to encourage politicians to adopt policies other than those our models predict they are about to adopt. We seem not to recognize that the better our models explain the choices politicians make, the less they produce policy advice that differs from the policy governments plan to adopt.

This is a strange statement to make. Surely we can agree that the nature of international diplomacy has changed over time. And surely we can agree that some of these changes are due to the fact that policymakers have changed their strategies to accommodate new knowledge. We can also agree that policymakers are not infallible, and in fact make poor decisions all the time. One reason for this is that they are operating under much uncertainty. If IR scholars can reduce that uncertainty, then they can help improve decision-making.

I do not think, as Dr. Oatley apparently does, that the only advice IR scholars can give is "iterate the game, and play tit-for-tat".

It Was 20 Years Ago Today

Nostalgianomics

The piece, by Brink Lindsey, could just as well be called "Why Paul Krugman Is Wrong About Everything". The conclusion sums it up:

Paul Krugman may long for the return of selfdenying corporate workers who declined to seek better opportunities out of organizational loyalty, and thus kept wages artificially suppressed, but these are creatures of a bygone ethos—an ethos that also included uncritical acceptance of racist and sexist traditions and often brutish intolerance of deviations from mainstream lifestyles and sensibilities.

The rise in income inequality does raise issues of legitimate public concern. And reasonable people disagree hotly about what ought to be done to ensure that our prosperity is widely shared. But the caricature of postwar history put forward by Krugman and other purveyors of nostalgianomics won’t lead us anywhere. Reactionary fantasies never do.

The whole thing is worth reading if only to understand where the debate is located and what the policy choices are. I do not agree with every conclusion that Lindsey makes, but the broad lesson -- that arguments based on fond remembrances of bygone eras are usually over-romantic -- is sound.

American-style "Socialism"

This is from Conor Clarke over at the Atlantic. Pretty interesting post:

Have you heard that the United States is headed toward socialism? Jonah Goldberg says it is. Alabama Senator Richard Shelby says it is. Phyllis Schlafly says it is. Richard Viguerie says it is. The Republican National Committee says it is. We must be getting pretty close.

How close? This is what socialism looks like:The hot-pink portion of this pie chart is the percentage of listed American business assets that have recently been nationalized by the American government (ie, General Motors). Obama's version of socialism is so sneaky you can hardly see it!

(And there is some reason to think this actually overstates the portion of the corporate landscape that's been nationalized, but more on that at the end of the post.*)

There is a serious discussion to be had here, and I think Jon Henke is having it: Socialism, like farenheit, comes in degrees. Sure, a government that nationalizes GM is "more socialist" than one that does not, even if it doesn't mean we're living "under socialism." But differences of degree shouldn't obscure differences of kind, and as Tim Fernholz says, "it's clear that putting the government in charge of private production is not the Obama administration's guiding philosophy."

If it were, 99.79% of the American corporate assets that existed at the start of the Obama administration would not remain in private hands. The differences of degree are so small that they aren't worth mentioning. And yet, somehow, they keep getting mentioned.

A policy idea?

As has been discussed on this blog (here, here and here) and on many others in recent weeks, US unemployment has increased to about 9% and American families are really being affected by the recession. The job cuts are particularly affecting middle income Americans: those who prior to the crisis believed they had relatively stable jobs making good money, were out in the market buying homes and other goods and making regular contributions to their 401k's (with their employers matching these contributions) and other retirement accounts. 

Seeing as how as an aspiring IR scholar I am already irrelevant, I figure any policy proposals I toss out on this blog won't be taken seriously. Or even if what I say is taken seriously, someone can just take it and run with it since policy makers don't know that I exist. So here is my proposal and my logic. 

With the collapse in stock prices over the last year, many Americans have seen the value of their retirement accounts halved and their purchasing power eroded, postponing the planned retirement of many that were on the verge, and adding to worries about retirement options for those hoping that they would be able to retire at some point in the future. 

Not only have many Americans seen their retirement savings dwindle, many have also lost their jobs over the past several months. Unable to find a new job, many middle income earners have had to dip into their savings and eat into their 401k accounts to simply make ends meet.

Now, when these people make withdrawals from their 401k accounts, they are subject to a 10% penalty. According to 401k.com, any funds withdrawn before the age of 59½ is subject to an excise tax equal to ten percent of the amount disbursed, including withdrawals to pay expenses due to a hardship. A really simple and efficient way to get more money into the hands of middle income earners who are most likely to spend the money paying bills and covering housing and food costs, would be to suspend the 10% excise tax on all withdrawals made by any person that was unemployed during the previous and/or current fiscal year. The change in policy could be made effective for 6 months at a time and be reviewed depending on the pace of economic recovery. 

This simple change in the rules governing 401k withdrawals would provide hundreds of thousands of households with a quick, easy and inexpensive boost in income. The government would not have to pass any new legislation, would not have to print checks and spend money and time mailing them to taxpayers, and the economy would get an immediate boost (either by people taking out more money and spending it or leaving more money in their 401k accounts for use in the short run). Furthermore, this idea would simply allow people to keep their own money, without it having to be in the form of a tax break which would face resistance in Congress and would be difficult to roll back once a recovery begins. Furthermore, I'd guess (without any data whatsoever) that the multiplier effect on the extra 10% in 401k money would be as high or higher than that on tax cuts, rebate checks or other forms of fiscal stimulus.  

221.034 - 1,361.58

221.034

• According to Wolfram Alpha: 3,940 people are employed as political scientists (in 2007).
• According to the American Political Science Association: 17% of these people self-identify as IR scholars. (Actually, 17% of APSA members so identify; I assume this is representative of the profession overall (in the U.S.).
• According to the Teaching, Research, and International Policy (TRIP) project: 30-36% of American IR scholars focus on IPE.

1,361.58

• According to The TRIP project: 4,126 people teach "International Relations" in the US.*
• According to the TRIP project: 30-36% (33%) of American IR scholars focus on IPE.

*This seems a very inclusive categorization that includes many scholars political science would describe as comparative/area studies types rather than IR.

Mmmmm, Cake.

Thanks Will for responding to my musings about IR's policy relevance. You seem to accept the premise but not the conclusion; so let me respond directly to your objections. I pick on you because your objections are exactly those evident in the broader debate and reflect what I take to be the logical incoherence that generated my initial post.

"If IR research can improve the quality or amount of information that policymakers have at their disposal..."

1. This was kind of what traditional area studies did. Scholars spent careers gaining specialized factual knowledge. I think it is the passing of this model that Nye laments and which explains why fewer people jump between academy and government.
2. Outsiders cannot have more and better info than insiders. Scholars cannot collect better info (regularly) than that generated by the $47.5 billion we spend on intelligence each year. If it is knowable, and the government cares to know it, government will find it. I think this is the political version of the Efficient Markets Hypothesis. If the government can't find it, scholars sure as hell won't because it's not what we do.
   
3. Boundedly-rational people do not seek more information, biased people are not looking to become unbiased (and don't think they are biased), and problems of incomplete info cannot be resolved because the relevant info is private and cannot be made public (what "type" of nuclear state is Iran?).
4. Consequently, if we take our micro theories seriously, then there is no information that scholars can contribute that government is not better placed and more highly motivated to collect itself.

"If we can provide insight into the political incentives facing national leaders, then perhaps we can affect the way that policymakers approach diplomacy."

This is exactly the logic that motivates the broader desire for policy influence evident in the wider debate. (Frieden and Lake make a variant of this argument: "Our primary argument is that progress in the study of international politics – including in making its lessons more relevant to policy – depends on more, not less, rigorous theory and more, not less, systematic empirical testing.").

But, the belief that rigor leads to policy relevance rests uneasily (and I think is logically inconsistent) with faith in IR as a social science. We seem to think that we can develop models that accurately explain politicians' choices and then use these models to encourage politicians to adopt policies other than those our models predict they are about to adopt. We seem not to recognize that the better our models explain the choices politicians make, the less they produce policy advice that differs from the policy governments plan to adopt. And if governments are so easily encouraged to adopt different policies, then things are not as systematic as social scientific IR requires.

The simplest of all examples highlights the point. Assume that all that happens in IR can be modeled as variants of a one-shot prisoners' dilemma. So, we have the correct model. Now ask two questions. First, do we think that politicians don't know that "defect" dominates "cooperation" (no; we cannot think this without violating the assumptions that all of IR is a variant of a one-shot PD)? Second, if we tell the government how to maximize its own utility in this one-shot PD, can we give any policy advice other than "defect"? (no, we cannot).

I think people have a vision in which the job of the IR scholar cum policy advisor is to say: "hey, what you need to do is iterate the PD and then play tit-for-tat." What this perspective neglects is that if governments could iterate the game, then they wouldn't be stuck in a bunch of (sub-optimal) one-shot PDs (in which case the one-shot PD wouldn't be the correct model). So, if governments are stuck in one-shot PDs (thus this is the correct model) they lack incentive to change the game, in which case telling them to iterate the game and play tit-for-tat is to tell them to do something they have no incentive to do. You can say it, but governments are not going to find it any more useful than the suggestion that they sacrifice a lamb next time they play.

In short, I fail to see the logical basis for the belief that social scientific IR can provide useful policy advice. In order for our advice to matter, we must make assumptions about politicians that contradict fundamentally the assumptions we make in the models we build. This does not mean we are irrelevant. It means we need to rethink either what we mean by relevance or start talking about the limits of what we can achieve via social scientific IR. We can't continue to pretend that we can have our cake and eat it, too.