What if our models have gone so wrong that they are no longer useful? A book review of Economism by James Kwak.

The Pareto principle like many principles is perhaps applied too frequently and sometimes inappropriately. This ‘law of the vital few’ stipulating that 80% of the effects come from 20% of the causes in certain situations carries a seductive simplicity. One application of it that I have found valid is as an explanation of why despite my collection of quotes that I have assembled over the last 20 years now extending to over 80,000 words, I return again and again to a handful of aphorisms to explain to myself or others the patterns of organizations and the people within them. Two of those keystone quotes are aligned and they both came to mind while I was reading James Kwak’s brilliant and probing new book Economism:

“All models are wrong; some models are useful” — George E. P. Box [i]

“A map is not the territory it represents, but, if correct, it has a similar structure to the territory, which accounts for its usefulness” — Alfred Korzybski[ii]

My attraction to these quotes originally was based on how well they remind me that in our lives we adopt heuristics — maps — to allow us to navigate swiftly the many demands of deciding and acting — and those navigational aids have their limits. This adoption is not just an individual exercise: entire organizations employ models of the world both implicitly and explicitly that allow all the players to ‘be on the same page’ to coordinate, prioritize, and make sense of situations in similar ways. This reliance on models extends to national and international discourse as the economies and nation-states in which those organizations operate adopt broad frameworks by which all may communicate and act.

But as Box pointed out numerous times, the model is never capable of being fully accurate; its best possibility is high utility. As Korzybski notes, a map is only as good as its resemblance to the real thing. Human being, corporations, and countries have all shown the capacity for overextending the use of our maps and over applying our models. James Kwak in his incisive new book Economism Bad Economics and the Rise of Inequality suggests a whopper of an example of this tendency — the collage of ideas such as supply and demand, market equilibrium, and free market supremacy known as ‘Economics 101’.

Kwak is that rare writer in the world of ideas who argues forcefully but fairly for his contention that as Simon Johnson puts it in a neat introduction to this book that “the way we typically think and talk about economics is seriously incomplete.” While the author finds errors and inconsistencies in the pronouncements of influential economists, investors, and policymakers on “the magic of the marketplace”, he is also quick to always point out where the results of various studies and surveys are contradictory, where the lines of the map are blurry. In other words, Kwak even at his most incensed at what he sees as the obvious biases of others insists upon the possibility that his own views might invite disconfirmation. What seems to most aggravate his sensibility — shaped through stints in the worlds of business, law, and academia — is the cocksure readiness of extreme promoters of Economism — those “overvaluing economics by overestimating the importance of material conditions, focusing exclusively on economic metrics, applying economic methodologies when they are inappropriate, or accepting economic theory too readily”. His many examples of this tendency made me want to go back and see if the offenders even express any doubts, any chance that their opponents might be onto something? Does Alan Greenspan regret saying in 2000 that “where once more marginal applicants would simply have been denied credit, lenders are now able to quite EFFICIENTLY [emphasis added] judge the risk posed by individual applicants and to price that risk appropriately”? Maybe I do have to take a look at his memoirs to see if there’s any recantation. Is Ben Bernanke tortured by the memory of his statement in 2007 that “the increasing sophistication and depth of financial markets promote economic growth by allocating capital where it can be most productive? And the dispersion of risk more broadly across the financial system has, thus far, increased the resilience of the system and the economy to shocks”? Or does he always remind people that he did include the phrase ‘thus far’?

Kwak raises a meaningful current example of this failure to seek disconfirmation when he cites the work of David Newmark and William Wascher, “economists who have long argued against the minimum wage” who faced with meta-studies that reached different conclusions contested the approaches and results of those papers. Is the aversion to applying Karl Popper’s falsification approach in economics rational or fear-based? Again and again, Kwak uses examples were there appears to be no attempt to disconfirm findings even when the data — as is the case with minimum wage studies — suggest at least uncertainty as to what really happens when governments enact such laws.

When Kwak cites a number of “factors (that) vastly complicate the two dimensional diagram taught in Economics 101” when considering minimum wage law affects, he is also shining a light on that dark ocean of ‘things we don’t know we don’t know’, which medieval mapmakers at least had the humility and honesty to mark as ‘Here There Be Dragons’. My own favorite example in our modern cosmos is how productivity actually works in the current global economy. This problem occurs in part because inputs and outputs are much harder to measure in a world of services. My own experience suggested to me that managers don’t pay attention to increasing productivity in a systematic fashion, which then confounds efforts to determine what is possible. This failing is due to the inability of many managers to employ existing technology. I’m not even referring to more sophisticated tools such as robotics or data analytics; I think a substantial segment of American managers have no idea how to make the best use of the basic tools sitting on the desk of their reports — communication, spreadsheet, presentation. This may be a knowledge economy, but that doesn’t guarantee that its managers in every case are using software and hardware purchased at great expense to achieve possible efficiencies. If that supposition is true, the assumptions of Economism again take a hit because they don’t allow for these irrational wonders of the real world.

Whether dissecting the response to AHCA (Obamacare) in a single chapter (to which Brad Delong’s recent takedown of a prominent critic provides a very useful supplement), wondering why Warren Buffett’s insights got ignored, or revealing how pay is largely rigged at the senior executive level of American companies, Kwak carefully outlines the Economics 101 positions before pointing out their various gaps and misalignments to reality. Some of these more recently elaborated arguments don’t even fit what the original and ‘hagiographied’ evangelists of Economism believed and wrote. A little over 100 pages into his book, the author shows that those pols and policy wonks who “claim that all government spending is wasteful by definition” ignore the exceptions endorsed by Friedrich Hayek and Milton Friedman. Having gotten the map wrong, these adventurers now insist upon an orthodoxy that their own founders did not countenance. As Kwak notes, “Many of these crucial services are clearly worth more than the tax dollars necessary to pay for them; without law and order, property rights, contracts, competition, and a monetary system, there wouldn’t be much of an economy to begin with.” The inconsistency of rejecting all taxation and disputing all government spending doesn’t register with Economism adherents; I still remember bitterly Joe Lieberman fumbling in his vice presidential debate with Dick Cheney in 2000 while the latter stated that the “… the government had absolutely nothing to do with (being) better off than (he was) eight years ago” as if all of the above factors in addition to roads, airports, etc. that his company Halliburton used were inconsequential.

This insistence on advocating for principle even when both the circumstances and the original idea suggest a different reality is discouraging. Kwak’s explanation of the 2008 financial crisis is even clearer than Margot Robbie’s dissertation in The Big Short (although not as entertaining), but what difference does it make if no one is willing to admit their model has flaws? My fear is that those steering many of our large institutions will keep referencing this map filled with errata for guidance even as the signs of danger to democracy abound such as rising inequality, stalled productivity, or know-nothing populism. Slavish obsession with ideas that taxes and government are bad overwhelm any possibility of considering what might be good. As Kwak writes, “Taxes are the cost of organizing ourselves in a democracy rather than as a collection of autonomous individuals.” Perhaps that is the essential problem: the propagators of Economics 101 don’t really believe that we are all in this together; like Cheney, they attribute all success and rewards to their own efforts. Therefore, the kind of “asymmetric structure” Kwak notes that exists when “certain megabanks are too big to fail” or private markets are fetishized to the disadvantage of many provoke no discomfort among this large group at the top of the income brackets. More broadly, insistence on the Economism model/map rejects the nuances to how citizens live: ordinary families are not dots on a chart but people who struggle to cover costs of rent, doctors, and child-rearing. Perhaps the best that Kwak’s book can do is to reach the people who have not yet made up their mind and to get them to compare this map to the territory they experience, to create “a new worldview to do battle with the old”. Since “most people absorb Economism from the air of contemporary life, not from textbooks and professors”, that makes us all responsible in a democracy to be curious about the maps that guide us, our organizations, and our country, to fill the air with other ideas. And in doing so we should keep in mind George Box’s exhortation to “Remember that all models are wrong; the practical question is how wrong they have to be to not be useful.” James Kwak’s book Economism persuades me that some of our current models have crossed the line.

[i] George E. P. Box, William Hunter and Stuart Hunter, Statistics for Experimenters, second edition, 2005, page 440

[ii] A map is not the territory it represents, but, if correct, it has a similar structure to the territory, which accounts for its usefulness.

— Alfred Korzybski, Science and Sanity (1933, p. 58)[3]