Wittgenstein against scientism

This is a very good article in the NYT about Wittgenstein. It is not surprising he is not popular in current philosophy departments, the author, a Professor at NYU says, as Wittgenstein is so skeptical of standard philosophy. The article summarizes Witgenstein's position:

Philosophical problems typically arise from the clash between the inevitably idiosyncratic features of special-purpose concepts —true, good, object, person, now, necessary — and the scientistically driven insistence upon uniformity. Moreover, the various kinds of theoretical move designed to resolve such conflicts (forms of skepticism, revisionism, mysterianism and conservative systematization) are not only irrational, but unmotivated.The paradoxes to which they respond should instead be resolved merely by coming to appreciate the mistakes of perverse overgeneralization from which they arose. And the fundamental source of this irrationality is scientism.

The dream of social physics dies hard. Economics, even more than philosophy, has suffered from an overtemptation towards generalized parsimonious models.

As Wittgenstein put it in the “The Blue Book”:

"Our craving for generality has [as one] source … our preoccupation with the method of science. I mean the method of reducing the explanation of natural phenomena to the smallest possible number of primitive natural laws; and, in mathematics, of unifying the treatment of different topics by using a generalization. Philosophers constantly see the method of science before their eyes, and are irresistibly tempted to ask and answer in the way science does. This tendency is the real source of metaphysics, and leads the philosopher into complete darkness. I want to say here that it can never be our job to reduce anything to anything, or to explain anything. Philosophy really is “purely descriptive."

And so therefore the purpose of philosophy is not explanation but therapeutic.

traditional philosophy is necessarily pervaded with oversimplification; analogies are unreasonably inflated; exceptions to simple regularities are wrongly dismissed.

— Therefore — the fourth claim — a decent approach to the subject must avoid theory-construction and instead be merely “therapeutic,” confined to exposing the irrational assumptions on which theory-oriented investigations are based and the irrational conclusions to which they lead.

More signs of a renaissance in psychology

This is an interesting column from David Brooks in the NYT, mostly because he sees many of the main challenges in public policy as a matter of better psychology.

What about the big problems? How do we get people to restrain government commitments now so that debt down the road won’t be so ruinous? How do we calculate the multiplier effects of tax cuts or spending increases among different subgroups of the population, or under different emotional conditions? How do we rig the context of budget negotiations so participants can actually come to a deal? How are people in different cultures likely to react to drone strikes? How do we structure sanctions against Iran to cause the greatest psychic humiliation?

These are the big questions, and most of our policies rely on crude folk psychology from a few politicians. But there’s hope. As Brian Wansink notes in Eldar Shafir’s volume, the 20th century saw great gains in sanitation and public health. The 21st century could be a great period for behavior change.

No mention of economics at all. Of course, economics has some things to say about credibility and commitment, such as the Kydland/Presscott time inconsistency literature. But the rational actor approach appears to be yielding diminishing returns. The focus of the social sciences can shift over time. I've been seeing more and more interesting things in psychology recently.

 

From Mercantile Exchange to Railroads

We're looking at Double Entry: How the Merchants of Venice Created Modern Financeby Jane Gleeson-White, starting here.

So double-entry book-keeping served as a foundation stone of capitalist rationality and, on an individual level, business success. Luca Pacioli's advice would echo through generations of clerks laboriously maintaining ledgers.

In Pacioli’s view, three things are needed by ‘anyone who wishes to carry on business carefully. The most important of these is cash or any equivalent, according to that saying, Without this, business can hardly be carried on.’ The second thing necessary in business ‘is to be a good bookkeeper and ready mathematician’. The third ‘and last thing is to arrange all the transactions in such a systematic way that one may understand each one of them at a glance, ie, by the debit and credit method’. Not much has changed today.

Production and Decisions

Capitalism developed and changed in the eighteenth and nineteenth centuries, however. Book-keeping evolved into accounting. The medieval core of double entry proved durable for these new, much larger enterprises.

This vast new range of double-entry applications reflects the extraordinary expansion of business from the late eighteenth century to the close of the nineteenth, a period which saw the rise of the joint stock company (a business organisation which was funded by selling shares to investors who became partners in the venture), and marks the formative era of accountancy. During these decades, accountants transformed a mere system of recording exchanges into a method of managing and controlling business. The first signs that double entry would be equal to the task of monitoring and directing this new industrial world of factories, wage labour and large-scale capital investment were found in the north of England, in the pottery works of Her Majesty’s potter, Josiah Wedgwood (1730–95)—a factory called Etruria, named, by chance, after the ancient Italian region home to Pacioli’s Sansepolcro.

Wedgwood ran a large business that often did not make much money, for inscrutable reasons. So he decided to investigate.

During this period of scrutiny, Wedgwood made an important discovery—the distinction between fixed and variable costs—and he immediately understood the implications of their difference for the management of his business.

A new form of production - large factories - led to the beginnings of cost and management accounting. This was part of a much broader evolution from a system centered on mercantile exchange to one also suited for production and accountability.

The shift in outlook required to move Pacioli’s bookkeeping system beyond its mercantile origins in an exchange economy (where it recorded the exchange of goods, owing and being owed, paying and collecting debts) to manufacturing, where the emphasis is on the production of goods (the conversion of materials and labour into products) was huge.

The growth of railroads in the mid-nineteenth century brought a whole new set of issues. They required outside investment, which both meant more audit control to prevent fraud, and clearer distinctions between income and capital, so investors could be paid dividends out of actual income.

Not only did a new form of production—factories—challenge and alter double-entry bookkeeping from the 1770s, but the financing and managing of the vast investments required to build railways during the same period of industrial expansion brought new issues of accounting and accountability.

The key accounting issue in a corporation is the amount of profit available for dividends—which means that a corporation must properly distinguish between capital and income, because profits derive from income, not from capital. This new laser-like focus on profits and dividends brought two new accounting questions to centre stage: How to calculate income or profit? And how to value assets? These questions were rarely asked before 1850 but by the end of the century they had become the major preoccupations of practising accountants.

 

Double Entry and the Modern World

I read Double Entry: How the Merchants of Venice Created Modern Financeby Jane Gleeson-White last week, largely motivated by wanting to know some of the deeper reasons behind the surface apparatus of Quickbooks, which for various reasons I have to figure out soon.

It sounds like a dry subject. But the book is historically colorful, thought-provoking and well-written. Accounting numbers rule much of our lives and way of seeing the world. But they have a history and limits and flaws.

Measurement and capitalism

She tells the story of how Italian monk and mathematician Luca Pacioli in 1494 first wrote down the methods Venetian merchants had used to keep accounts, possibly for several centuries before that. The invention of double-entry clarified notions of cost and profit. According to some historians perhaps it led to capitalism itself.

In six pages Sombart set out his belief that the emergence of capitalism and the appearance of double-entry bookkeeping in the thirteenth century are causally related. He wrote: ‘It is simply impossible to imagine capitalism without double-entry bookkeeping; they are like form and content.’

Weber’s definition of a ‘capitalistic enterprise’ is derived from the concepts of double-entry bookkeeping: ‘a rational capitalistic establishment is one with capital accounting’. Like Sombart, Weber argues that double entry is significant because it makes possible an abstract measure of income and expenses—and therefore enables the calculation of profit, the key component of capitalistic business practice. Weber also believed that the formal rationality of double entry made the world a cold and disenchanted place—and, ominously, predicted that double entry would continue its rule ‘perhaps until the last ton of fossilized coal is burnt’.

The new double-entry methods caused a deeper change in perception:

He calls Pacioli’s treatise on double-entry bookkeeping ‘a major innovation in economic history’. First, because double entry provided the means of discarding all information extraneous to decision-making, leaving behind only numbers. And second, because it translated these numbers into a common measuring tool called ‘profit’, which allowed a relatively precise evaluation of actions. Double entry thus transformed business books from mere memory aids into records which allow the calculation of profit—and which can therefore be used to measure the success of each individual transaction and of a business generally.

But this did not come without a price.

We are now so familiar with this once innovative (and largely arbitrary) cost-benefit way of thinking that we take it for granted and cannot imagine it otherwise. And yet, as we shall see, this profit-driven way of thinking encouraged by double entry is not only driving managers to drink, academics to pull their hair out, politicians to short-term opportunism and most human beings to suffer in some way, but it is also destroying the world beneath our feet.

She argues that accounting is poorly suited to count environmental damage, for example. This is a problem when accounting has become central to the practice of policy and government.

National statistics

One of the main extensions of accounting is modern national income accounting. It is so familiar (at least if you have studied economics) that we forget how relatively recent it is. Keynes and Kuznets largely invented it, and both were skeptical about its use.

As a thinker of great depth and complexity who saw economics above all as a moral practice, Keynes was suspicious of statistics and considered these quantitative measures of the national economy as exceptional, emergency measures demanded by the times. In the budget speech which presented these accounts for the first time, the British Chancellor expressed the same view, stressing that the publication of official estimates of national income and expenditure should not be regarded as setting a precedent.

That did not stop a massive increase in the use of techniques which had proved useful during the war.

In 1952, very few statisticians were familiar with the theory and practice of national accounting. This would soon change irrevocably. The work done by Stone, Kuznets and others became the foundation of international accounting, and their national income statistics used to measure economic growth would soon become the key indicator of national success and government performance.

But even the main originator of much national income accounting was skeptical of its application.

But the accuracy and usefulness of national income measures have been questioned from the beginning, by Keynes and others, including Simon Kuznets himself. For example, Kuznets believed the national accounts should include the value of unpaid housework, despite the fact that including this vast contribution to the national economy would present statisticians with the difficult task of making monetary estimates of this valuable work. The US Commerce Department refused to calculate these estimates—and as a result Kuznets broke his association with the department in the late 1940s. Kuznets was also concerned about the effects on people’s lives of the modern economic growth that these statistics encourage as an end in itself.

GNP continues to be questioned as an adequate measure, most significantly recently in the Stiglitz-Sen-Fitoussi study.

Perpetual scandal

The numbers can often conceal as much as they convey, and we can mistake a false impression of precision for truth. The numbers sometimes are outright lies, for one thing. Accounting is also inseparable from scandals, she says, and always has been. People have not lost confidence in accounting despite failure to detect fraud or indications of problems on a litany of cases from Enron to Worldcom to RBS.

However, not only has no such fall ensued but it turns out that these accounting scandals are a regular feature in the landscape of accounting. They are as old as the profession itself, dating back to the earliest days of the formalised use of collective capital: the corporation. Corporations and accounting scandals go together like Gordon Gekko and greed. The nineteenth and early twentieth centuries are rife with corporate collapses of the magnitude of Enron’s and comparable in their elements. And they all stem from significant accounting misstatements orchestrated by influential senior managers. Equally, the responses of lawmakers and watchdogs have been the same over the past one hundred years: tinker around the edges of the law, found new watchdogs, proclaim a new era of greater scrutiny and let accountants and auditors out to play with the managers of vast sums of other people’s money.

We'll look at more tomorrow.

 

"Sure, Big Data Is Great. But So Is Intuition"

An NYT article is skeptical of inflated claims for Big Data:

The quest to draw useful insights from business measurements is nothing new. Big Data is a descendant of Frederick Winslow Taylor’s “scientific management” of more than a century ago. Taylor’s instrument of measurement was the stopwatch, timing and monitoring a worker’s every movement. Taylor and his acolytes used these time-and-motion studies to redesign work for maximum efficiency. The excesses of this approach would become satirical grist for Charlie Chaplin’s “Modern Times.” The enthusiasm for quantitative methods has waxed and waned ever since.

Big Data proponents point to the Internet for examples of triumphant data businesses, notably Google. But many of the Big Data techniques of math modeling, predictive algorithms and artificial intelligence software were first widely applied on Wall Street.

At the M.I.T. conference, a panel was asked to cite examples of big failures in Big Data. No one could really think of any. Soon after, though, Roberto Rigobon could barely contain himself as he took to the stage. Mr. Rigobon, a professor at M.I.T.’s Sloan School of Management, said that the financial crisis certainly humbled the data hounds. “Hedge funds failed all over the world,” he said.

The problem is that a math model, like a metaphor, is a simplification. This type of modeling came out of the sciences, where the behavior of particles in a fluid, for example, is predictable according to the laws of physics.

In so many Big Data applications, a math model attaches a crisp number to human behavior, interests and preferences. The peril of that approach, as in finance, was the subject of a recent book by Emanuel Derman, a former quant at Goldman Sachs and now a professor at Columbia University. Its title is “Models. Behaving. Badly.”

It really is a matter of proper scope, and consciousness of limits. Big Data is wonderful for finding the Higgs Boson among billions of particle paths, or tracking potential credit card fraud. It is not so good at many other tasks where the data is absent or incomplete or misleading. In those cases, it is little different from ancient farmers looking at the sky and seeing mythical animal patterns.

The Importance of Stocks and Depreciaton

 

We're looking at Double Entry: How the Merchants of Venice Created Modern Finance by Jane Gleeson-White, starting here. Book-keeping evolved into accounting as outside investors needed assurance that dividends were paid out of actual income, not capital.


Railways and factories also wore out, however, which led to another important concept: capital stock and depreciation.

The advent of the corporation raised several other key accounting issues; for example, how to calculate the declining values—due to wear and tear—of large investments in machinery, rails, rolling stock (or railway vehicles), and so on. This problem gave rise to the concept of depreciation.

It took a long time for accountants to come to terms with depreciation and properly accounting for assets. And this is still a problem, she says, when it comes to the environment since many assets are free.

This is because until recently economists have assumed that natural resources are so plentiful that any loss of them is insignificant, not worth counting. They assumed that natural resources like water, soil, forests and air were free gifts of nature.

But just as the nineteenth-century railway entrepreneurs had to learn that human-made capital—rails and machinery—wears out and must be depreciated, so some economists are beginning to understand that nature’s capital is also subject to wear and tear and depletion. Cambridge University’s Professor Sir Partha Dasgupta is one economist who is critical of the GNP and its use to judge the progress or otherwise of nations. He argues, ‘as so many economists have already done, that GNP’s main weakness lies in the fact that it is insensitive to the depreciation of capital assets’. And from an environmental point of view, this is critical.

The Modern Economy is about Stocks

This is no doubt true. But she perhaps over-emphasises environmental gaps to the exclusion of other social assets like trust or quality of life.

The larger point is we are often too focused on flows rather than stocks, including the depreciation of assets (stocks meaning an amount, like a stock of wheat, rather than an equity share like the stock exchange.) This is a basic economic distinction we often forget. As Dasgupta says, we need to be sensitive to the depreciation of capital assets.

We are much better at being conscious of flows of income rather than the valuable stock of assets which produces that income. Yet many of the great economic challenges of our era have more to do with stocks than flows of income. Many or our capital assets, such as the knowledge required to build an Intel processor or the song "Hey Jude" do not depreciate in the traditional way. They may have to be re-learned or passed on, but they do not wear out.

So what happens when the stock of our valuable assets, properly defined, gets disproportionately much larger than money income flows? In many ways, our prime objective should be to increase the stock of assets. Income and distribution are secondary factors , especially of many of the benefits flowing from those assets are free. Some of our political thought gripes towards this, especially those who think capitalism should be left unfettered to create wealth which government can then redistribute. But that often confuses income with value.

We will come back to this point another time.

Finally, Gleeson-White emphasizes again how the numbers may often conceal deeper uncertainties.

Even accounting’s most fundamental concepts and practices, such as income measurement and asset valuation, are based on uncertainties. Accountants still cannot agree on how to define income, the measurement of which remains one of the intractable problems in financial accounting theory and practice. The valuation of assets only becomes more complex and more fiercely debated as modern global corporate structures and financial instruments become increasingly labyrinthine, and income measurement, the key to determining profits and therefore dividends, is inextricably linked to this contentious, chimerical practice of asset valuation. Nor is the crucial measurement of costs an objective process: costs are also highly contestable figures and may result as much from the collusion or rivalries of firms as from any other actuality. Accrual (or corporate) accounting—the need to allocate revenues and expenses between accounting periods and to value assets and liabilities at the end of an accounting period—raises problems which have never been solved and are probably incapable of solution. Numbers can be negotiated to make management look good. In effect, ‘accounts are used to justify decisions and to excuse mistakes’.

She concludes

In an era of international capital, when our wealth is more than ever tied up in its fortunes, and at a time when corporations, governments and financial institutions are demonstrating their fallibility on a global scale, it is essential that we are aware of the somewhat arbitrary laws of account that govern them—especially because it is in the labyrinthine workings of our accounting systems that value itself is assigned. It seems that if we want to bring our infinitely voracious consumerism into line with the resources of our finite planet, we must consider giving our planet a value that the market can recognise and account for, assign a monetary value to the oceans, air, forests, rivers, wildernesses. • Delete this highlight

(My bold). In the end, we come back to the problem of economic value. There have been many major shifts in perception of costs and decisions and stocks and accountability and depreciation. Together, they make up the modern economy.

It is time for another major shift, to cope with intangibles and abundance and our reliance on those abundant stocks. Value should not be defined by arbitrary default.

 

The Art of Choosing

I read Sheena Iyengar's The Art of Choosing last week. It is a stimulating and rewarding book about recent psychological investigation, often by Iyengar herself, into choice. She is a Professor at Columbia, and her work seems another prime example of the renaissance of psychology has a discipline in the last ten-twenty years. We looked, for example, at Martin Seligman's work here, and Daniel Kahneman has had a major impact on economics.

Iyengar is more interested in choice than happiness or heuristics, however.

Our deep need for choice

First, she emphasizes the profound importance of a feeling of agency, of having some control, to almost all creatures. Even zoo animals exhbit listlessness and distress if they do not have agency. One might think of a zoo as a paradise for wild animals, with food and material needs taken care of. Instead, this "perfect hotel" is anything but.

In spite of the dedication of their human caretakers, animals in zoos may feel caught in a death trap because they exercise minimal control over their lives. .. Due to these physically and psychologically harmful effects, captivity can often result in lower life expectancies despite objectively improved living conditions. Wild African elephants, for example, have an average life span of 56 years as compared to 17 year for zoo-born elephants. p11, 13

There are other examples. Lower ranks of the British civil service have worse health and die younger than the upper ranks, according to a famous piece of research, as they have less control over their daily tasks. Giving residents of an old people's home more control over trivial things - plants, movie screening times, TV - leads to significantly better outcomes in health and happiness.

This is fascinating. We need a minimal sense of control over our surroundings and workflow to be happy. A utopia that takes care of material needs but allows us no sense of control or agency is likely to be make us miserable.

A society built on keeping people in captivity is bound to be unhappy. People need to feel they have choice, or they shrivel. Material abundance alone is not enough to make people happy. It is more likely to be an existence like a captive zoo animal.

Cultural differences

However, cultures differ quite radically in how they think about choice. Most cultures emphasize collective needs and approval over individual needs. The United States, not unexpectedly, is at the individualist extreme.

She contrasts this with the SIkh wedding of her parents in India. All choices were made by the families and tradition. The first time the groom saw the bride was when he lifted her veil after the marriage ceremony.

These cultural predisposotions affects workplace behavior too. She studied worldwide employees of Citibank, carrying out the same tasks. They differed significantly in the amount of choice they perceived they had on their jobs, and how much they preferred management to exert.

 

"Freedom from" versus "freedom to"

She traces such cultural attitudes back to a more fundamental difference over "freedom from" versus "freedom to", which she says Erich Fromm postulated in his 1941 book Escape from Freedom (which I read as a teenager). "Freedom from", said Fromm, is "freedom from the political, economic and spiritual shackles that have bound men,", especially others interfering with the pursuit of our goals. "Freedom to" is an ability, the ability to "attain certain outcomes and realize our full potential."

A system tending too far in either direction can limit people's opportunities, Iyengar says. Capitalism tends towards "freedom from", but not everyone will have access to all the choices available. Communism tends towards "freedom to", including equality of outcomes rather than opportunities. The problem is there is little incentive to work harder or produce more, and it requires a strong government which may become corrupted by power.

She found strong differences still endure between West and East Berliners in her research, for example.

.. people's long-held assumptions about fairness can't simply be swapped for another set of beleifs. I consistently found that West Berliners, like Westerners in general, understand the world through the lens of "freedom from." On the other hand, East Berliners, and in particular the older people, focused on "freedom to", even though communism was now only a memory for them. p65

The American dream is all about "freedom from".

People who see themselves and others as having high personal control tend to favor "freedom from", not only because it provides more opportunities to attain their personal goals but also on grounds of justice - those who put in the most effort will be rewarded, while those who slack off won;t be able to ride on anyone else's coattials. p68

Americans as a whole arguably believe more wholeheartedly in "freedom from" than any other nation.. The basic premise is no one can stand in the way of your highest aspirations, provided that you have the ambition and skills to realize them. p70

This matters because it might mean potentially fundamental and irreconcilable cultural differences in what people believe about the good life, which is a primary interest of this blog. The good life in the Confucian tradtion would be very different from the good life in the Jeffersonian tradition, so perhaps it is better not to think about it at all.

Freedom to what?

I don't think that's true, though. The fact of abundance, the end of the struggle for material survival, is a challenge to every culture, whether one contronts it on an individual or social level. We face "freedom from" the traditional limits of material and social scarcity. That is a massive change from the lot of humanity for all the thousands of generations before we solved the "economic problem".

Since the 1960s, many of the traditional limits in society have been lifted. What have we achieved with it? TV and the welfare office.

We have abundance. Then the question is - what do we actually want? And "Freedom from" in isolation doesn't say anything at all about that. It suffers the traditional liberal blindspot about where preferences and tastes and wants and desires and pleasure actually come from.

How do people find what they want, especially when older cultural institutions like the churches are in decline? What cultural influences or standards influence what people want to do with their lives after it becomes genuinely a matter of choice? Iyengar doesn't go into this.

For example, we looked some time ago at economist Tibor Scitovsky's work. People want the right level of stimulation, he argues, but it has to be genuinely novel stimulation, not simply quantitatively more. How do we achieve a system where there is more genuine choice, rather than people running faster and faster on hamster wheels for more of the same?


But at the same time, simply accepting traditional or collective notions of what "freedom to" means seems alien to our tradition in the West, and at risk from technological and cultural change. There is an impoverished group of choices for "freedom to".

In the past, "freedom to" has often meant spoilt aristocrats fighting futile dramas of status and prestige and honor, or rich trust fund kids subsiding into drugs and nihilism. It has meant religious extremism and monastric austerity and self-denial. At present, it often means crystal meth in small towns and people thinking of the office cubicle as a second home. In practice, it can lead to alcoholism and divorce and loneliness and pursuit of celebrity. As John Stuart Mill once pointed out, much rests on the quality of what we want.


There is, in fact, a longer history to these ideas. "Freedom from" is analagous to "liberty", whereas "freedom to" is more consonant with older ideas of "freedom", where being free has a positive meaning. (This reminds me of one of David Hackett Fisher's books, Liberty and Freedom: A Visual History of America's Founding Ideas (America: A Cultural History)which I must look at again. ) America was at the forefront of liberty in the eighteenth century, with lingering social consequences. It ought to be at the forefront of what freedom means now.

Everyone has to answer the question of "what next?". Perhaps the Woodstock Festival or the ABC Fall Line-up or the Google free snackbar in their Silicon Valley offices is the highest point people will ever achieve. Perhaps not. We do not discuss what we should aspire to any more, beyond egailtarianism.

 

"Freedom to" is not necessarily egalitarian or traditionalist

Iyengar's conception - and the traditional view - of "freedom to" is too limited. "Freedom to" is not necessarily socialist or egalitarian. It is not necessarily about minimal provision for all, or Rawlsian maximin welfarism. After all, we've seen that Aristotle's account of the good life has been criticized since for being so unconcerned with equality.

Instead, I think this is an example of where we have taken such a wrong turn. As soon as any suggestion of material sufficiency or abundance has appeared, the first response has been equal distribution. It seems to set off an egalitarian mania, in terms of welfarism and rights and taxation. Yet egalitarianism is not the only vision of the good life, or indeed, a particularly inspiring or just one.

There are deep potential problems with "freedom to", particulalty if people are coerced into a state vision of what it means. But once "freedom from" has been achieved, the only alternative to more discussion of "freedom to" is an unthinking default socialism or nihilism. We need a new conception of "freedom to" that will also correspond to an answer to the conundrum of "value" in economics which we were discussing recently.

I think that has to be centered on people developing their skills and capacitiies to their full potential, and that has to be connected to a conception of virtue and the good life.

We'll look at more of the book tomorrow.

 

 

 

"More Heat than Light": the failure of modern economics

I'm going to turn now to Philip Mirowski's More Heat than Light: Economics as Social Physics, Physics as Nature's Economics, which is a quite devastating critique of mainstream neoclassical economics.

The heart of modern economics, he argues persuasively, was lifted wholesale from physics in the late nineteenth century. The trouble was that the main figures of the marginalist revolution, such as Walras, Jevons and Marshall, didn't quite understand all the math they imported into political economy.

The neoclassical founders almost all came from an engineering or natural science background. But they had a limited grasp of the state of the art of physics even at the time. Above all, says Mirowski, they failed to understand the importance of conservation principles in the math. To accurately measure change, something must stay the same. That means most of the edifice of neoclassical economics is based on stale physics contaminated by basic errors.

 

Substance and fields

What happened was basically this. Natural scientists struggled in the early nineteenth century with ideas of heat and motion, imagining fluids or ethers or substances. By the 1870s, that had given way to a unified view centered on energy, and the conservation of energy as it was transformed from one kind to another. Instead of fluids or other kinds of substance, physicists now thought of fields and forces, and worked out the vector math of kinetic and potential energy.

The heart of neoclassical economics, says Mirowski, is that economists replaced energy with utility in the same equations, and lifted the framework wholesale. The marginalist revoluton paralled the revolution in physics in preceding decades. Classical economists saw Value as a substance, such as the equivalent of wheat for the physiocrats or the labor theory of value for Ricardo and Marx. But for neoclassicals, Value was a field, like electromagnetism in physics. Kinetic energy was essentially spending and income; potential energy was utility.

He quotes several of the major marginalists who explicitly acknowledged that this is how they thought. But later economists mostly forgot these origins. The discipline has never been that historically self-conscious.

There were two main problems with all this, however. First, without a conservation principle, the math didn't work. Conserving energy implied income and utility were a constant - so essentially the same thing. That would mean utility would be superfluous as a separate measure to money, which was not at all desirable. The point was often lost in a technical debate about "integrability". Leading physicists tried to explain the point to economists, who appeared to have been mostly baffled and nonplussed at the argument.

Secondly, physics moved on from its 1870-vintage "proto-energetics" state, as Mirowski termed it. The second law of thermodynamics implied entropy was always increasing, so interactions were not easily reversible. Special relativity, general relativity and quantum theory all upset the mechanical "Laplacian dream" of 1870s physics, bringing frames of reference, probability, indeterminacy and the role of the observer into the picture. Symmetries and conservation principles could be broken. Matter could decay. Particles could pop in and out of existence. In contrast to notions of inherent "scarcity", the whole universe might be a "free lunch", something which came from a temporary variation in nothing.

None of these could easily be incorporated into the neoclassical framework. However, economists insisted all the more stridently that they were pursuing disciplined science, in contrast to sociologists or anthropologists, while actual scientists were increasingly doing something quite different.

As long as the Laplacian Dream was their dream, they clutched neurotically at their portrait of persons as irrotational mental fields suffusing an independent commodity space, as science ebbed ever further away toward a world subject to change, diversity and indeterminacy, and at one with the observer. P275

And the outcome?

In brief, the practical dissolution of the energy concept in advanced twentieth-century physics has painted neoclassical economics into a corner. p388

Mirowski wrote the book in 1989. Of course, the metaphor of utility as (potential) energy looks even more strained today. We now know that the visible universe of 1870s physics is only 4% of the universe. The rest is dark matter and dark energy that we cannot as yet observe and don't understand.

So what? Some mainstream economists concede to his argument about the origin of the neoclassical model, notes Mirowski, but they claim it is not relevant to the subsequent evolution of the discipline.

But it is. They still want the appearance of science, while being stuck with a model which is increasingly divergent from science in reality, he claims. To talk about analogies to entropy, said Samuelson, for example, is always the mark of a crank. But Mirowski points out that Samuelson frequently published articles with tenuous links to physics himself. Indeed, the key to Samuelson's career was maintaining the appearance of scientism.

Economists have produced various ad-hoc conservation principles in the twentieth century, according to Mirowski, "but in the final analysis this is all one big shell game, with the offending conservation principles passed from one assumption to another." p274

 

Production

The metaphor of utility as an energy field is too embedded to be given up by neoclassical economics, he says The trouble is it is also a metaphor of instantaneous exchange, and as such it has proved consistently difficult to reconcile with production, which had been the focus of classical economics. Classical economics thought that value was created in production, circulated in trade, and consumed in consumption. Neoclassical economics was focused on exchange, and found it hard to explain production at all.

That inconsistency explains a proliferation of production functions in postwar economics, and difficulties with temporarily and the existence of firms through time.

Economists have effectively tried to reinvent a substance theory when it comes to production, says Mirowksi. But this is bound to be inconsistent with utility as a potential energy field. So the profession has not been able to settle on a satisfactory answer.

The situation was embarrassing, but no neoclassical was willing to come right out and say that production was superfluous or irrelevant in their scheme of things. (Lionel Robbins came the closest). p272

Scarcity

There are also implications for scarcity. The idea of scarcity as the heart of the economic (and human) condition was largely an artifact of the neoclassical approach, he says.

Prior to that time, scarcity as some sort of primordial state of mankind did not play any signficant role in the value theory of classical political economy. Only with the dominant impression that Nature enforced a general state of dearth, say, rather than the physiocratic notion of Nature's bounty, could it become possible to even think of economic equilbrium as a state of psychological counterpoise, hemmed in by the urgent necessity to clear markets in a state of stringent limitations. p240

This caused obvious problems.

The metaphor of utility as potential energy was predicated upon a Weltanschauung of a closed, bounded system that exemplified the natural state of mankind as enduring ineluctable scarcity. If and when production was to be introduced into this morality play, it had to be done in such a way as to prevent the contravention of the scarcity principle, all the while maintaining the field theory of value. p293

Of course, I think this is fascinating given I think one of our main challenges now is thinking through the implications of abundance.

Keynes, he says. succeeded in introducing a kind of value substance in the guise of "national income". That allowed the idea of an economic process to be reintroduced. There has been an immense effort in recent decades to link macro with rational choice "microfoundations." But this is doomed to failure, says Mirowski.

Keynes generated a theory of an unstable economic process by the instrumentality of his reversion to a substance theory of value, a tactic that allowed the joint conceptualization of production, growth and the passage of time in (relatively) internally consistent manner. In contrast, it is the avowed intention of the microfoundations school to renounce all value substances and to recast all macroeconomic analysis in the format of production and utility fields. It is precisely this choice that prohibits the logical modeling of process in priduction, in growth, and in exchange, as explained earlier in this chapter. The field metaphor cannot represent a circular economy where outputs become inputs and so on, ad infinitum. It cannot specify precisely what it is that grows in an economy. p346

Fields are just not suitable when time is involved.

.. the formalism of the field is useful only in cases where one can safely abstract away all considerations of process and the passage of time. p346

Utility

Mid-twentieth century neoclassical economics would have found an alternative to utility if it could, he says. The mainstream forgot how widespread concern about utility had become in the profession before the second world war. Mirowski quoted Viner as saying economists' understanding of utility was comparable to "the knowledge of heat prior to the discovery of the thermometer." It could not be satisfactorily measured. There had always been concern at how locating value in a purely mental framework came close to idealism or solipsism.

The development of the indifference curve approach and Samuelson's theory of revealed preference were not durable responses, either, and only served to obscure the origin of the utility metaphor. Revealed preference was not empirically tractable, for one thing, and confused preferences and behavior.

In the absence of the metaphor of utility as nineteenth-century potential energy, there is no alternative theory of value, no heuristic guide to research, no principle on which to base mathematical formalism, no causal invariant in the Meyersonian sense, and most threatneing, no basis for the claim that economics has finally become scientific. p368

So what does this lead to? There is, Mirowski says, no scientific method that can guarantee economics' scientific status.

This lesson is the legacy of the decline of positivist philosophies of science in the late twentieth century. Juxtapose this fact with the hypothesis that economic research has always met with the greatest difficulties in establishing the credibiliy of its results and fending off charges of charlatanism and quackery. p357

It is hard to revise the neoclassical framework without undermining it. New approaches do not have that problem. This means, he says, neoclassical economics will be vulnerable to new contenders for the role of social physics.

Theories of Value

And is there an alternative theory of value? Mirowski says there are two main alternatives. One is to deny any separate value, rarely advocated, but as represented by someone called Samuel Bailey (who I have never heard of).

This position argues that no economic phenomenon is conserved through time, and therefore scientific analysis is impossible. Whatever one might think of the truth of this option, it should be clear than the nihilism inherent in the program assures that in this instance there can be no legitimate research program called economics. p400

The other alternative is a "social theory of value", he says, based not on scientific or social metaphors , but in social institutions such as accounting conventions or property rights.

I doubt myself whether this is true. I imagine evolution is the main contender for an alternative scientifc framework, together with the notion of adaptability and "fitness" of some kind or another.

Conclusions

Overall, it is a very bracing read. It seems, at least to me, highly persuasive - but I would want to read some reviews and responses to make sure I am not overlooking flaws in Mirowski's own analysis. .

What it underlines is that utility and scarcity were chosen not so much because of their psychological or social accuracy, but because the math "worked". And if the math worked there was more scientific respectability. I have always had the firm impression that this was the driving force of major parts of the discipline, which is likely the main reason I did not become an academic economist. It did not ring true. It was about the aesthetics of models rather than genuine insight. It was about a particular quasi-religious view of rationality rather than solving problems.

The book is also highly illuminating , not to say shocking, about the origins of utility in modern economics. I've often talked before about how ethical theory went off the rails in the eighteenth and nineteenth centuries, dropping the older tradition of the virtues and the good life for a more utilitarian, neutral and welfarist approach. Mirowski excavates a much deeper layer of intellectual history underlying current economics. It was not a matter of an import from Bentham. It was an import from physics, and just more or less happened to be called utility.

The metaphor of potential energy as a utility field locked economics into an increasingly less productive path for a century - and to a large extent still does. I knew most of the arguments about indifference curves, production functions and revealed preference, of course, but I was much less familiar with the intellectual history of the arguments. It is fascinating. And disturbing.


Perhaps most of all, it shows how value theory is the great unsolved problem at the heart of economics. That is what I have been grasping toward in my own terms on this blog. To understand the future of the economy , we have to be back up into ethics and the question of the good life and human flourishing. That, after all, is the only place a valid notion of value can come from.

 

Companies which lose good ideas

I subscribed a month ago to a wonderful daily e-mail, delanceyplace, which provides excerpts from current non-fiction books, with links to Amazon which benefit a children's literacy project. Today's excerpt is from a book called Advocacy by John A. Daly, with remarkable examples of how people with good ideas could not get them accepted in their original companies. Check it out on the delanceyplace site. An excerpt from the excerpt:

"Business history is dotted with stories of opportunities lost because people within companies were unsuccessful in pitching their ideas. And those neglected opportunities were consequential. Competitors seized market share that could have been kept and increased if the good idea had been adopted. Take the minivan. Who came up with that idea -- Chrysler? No. Ford engineers came up with that idea -- they called it the van-wagon -- but they couldn't convince management that customers would buy it. In fact, one executive who endorsed it, Hal Sperlich, was fired and went on to lead the effort at Chrysler, which then dominated the minivan world for many years. Ford lost out. ...

"Sam Walton, the founder of Walmart, started his career as a franchisee in the Ben Franklin chain of stores. Walton tried to convince the Ben Franklin executives that his model of buying directly from manufacturers and offering deep discounts would lead to incredible opportunities. They didn't listen, Walton implemented the idea himself, and Walmart became an international phenomenon. ...

The same applies to Intel, and many other companies. But the best example is Apple.

"Steve Wozniak, a cofounder of Apple Computers, was working at Hewlett Packard when he and Steve Jobs designed their first personal computer. Wozniak had signed a document at HP saying that whatever he designed as an employee belonged to HP. He said, 'I loved [HP]. That was my company for life. So I approached HP .... Boy, did I make a pitch. I wanted them to do it. I had the Apple I, and I had a description of what the Apple II could do. I spoke of color. I described an $800 machine that ran BASIC (an early computer language), came out of the box fully built and talked to your home TV: And Hewlett-Packard found some reasons it couldn't be a Hewlett-Packard product.'

"Later, when HP began work on a computer, Wozniak approached the project managers and asked to work on it. 'I really wanted to work on computers. And they turned me down for the job. To this day I don't know why. I said, 'I don't have to run anything,' even though I'd done all these things and they knew it. I said, 'I'll do a printer interface. I'll do the lowliest engineering job there is.' I wanted to work on a computer at my company and they turned me down.' Think how different the computer industry would be if Wozniak had successfully pitched his ideas to HP. ...

I read a good book about pitching ideas and overcoming objections a while back, Buy-In: Saving Your Good Idea from Getting Shot Down by John Kotter. I've had good ideas shot down nonetheless. Sometimes no amount of persuasion will work. 

The reason capitalism works better as a system is not because it's efficient or elegant - I was talking about this concerning General Electric the other day - but because in the medium term, in aggregate, fewer good ideas are shot down. So it is more adaptable and innovative.


 

 

Kant and Universalism

We've encountered plenty of criticism of Immanuel Kant on this blog before, and some support for the "escalator of reason" in which enlightenment ethics played a major part.

Clearly he is the axial figure, the pivot around which our modern conception of ethics shifted. We can trace much of the modem preoccupation with impartiality and universal rules as the bedrock of morality straight to him.

Looking at Kantian ethics hardly guarantees much readership for a blog - quite the opposite. But I keep finding on this blog that looking at the future path of the economy requires rethinking many of our ethical concepts. If we no longer have to worry about food, shelter and basic survival as our main preoccupations in life, then issues of the common good, the good life, happiness and flourishing all come to the fore.

And that means ethical philosophy becomes much more prominent in the discussion, rather than simply utility or macroeconomics. And that means we have to look, among other things, at Kant rather than the Kardashians.

I had read the classic Stephen Korner book on Kant years ago, but I noted a major recent biography in Deirdre McCloskey's references. So I read Manfred Kuehn's Kant: A Biography the other week ( while exiled to a place in Queens by the hurricane). It is well-written, tractable, and gives a deep evocation of Kant's times and context.

Of course, it does not break new ground in examining his philosophy itself, although it very much helps to get more sense of his evolution.

What really struck me is how much of Kant's early life and education was rooted in Lutheran theology and Pietist religious doctrine. Even in the eighteenth century, theology could have major consequences. Prussia tended to allow free intellectual speculation on metaphysics, although normal life was circumscribed. The relationship between reason and faith was a major issue of the age.

The limits of reason

I will leave most of the issues in the Critique of Pure Reason aside and focus on the ethics. But before I do, it is striking that Kant's metaphysics is all about demonstrating the boundaries and limits that apply to reason and experience; his ethics is all about entrenching pure reason with little regard to experience.

The driving force is certainty, and its limits.

Kant's critical philosophy can be viewed as an attempt to answer three fundamental questions of enduring philosophical significance: "What can I know", "What ought I to do?" and "What may I hope for". He may be said to address the first of these questions in the Critique of Pure Reason, but he does not answer the question. He seems to be primarily interested not in the general question of what we can know, but in the narrower question of what can be known with absolute certainty and without any qualification. In his terminology, this question is "What can we know a priori and in complete isolation from experience?" p242

He wants to demonstrate that absolute skepticism does not make sense. Experience must presuppose some a priori categories. As Kuehn puts it,

Science allows of continuous progress. This is not so for metaphysics. It has both limits and boundaries. In fact, Kant believes that metaphysics leads us necessarily towards boundaries. p260

In a sense, his aim was to save a place for moral certainty based on a priori reason, in the face of rationalist skepticism.

Kant's ultimate concerns were moral, and perhaps even religious. Accepting the validity of the empiricist approach to science and to the growth of knowledge, Kant wanted to save morality from becoming too naturalistic and too relativistic. He wanted to show that even in the absence of knowledge of absolute reality, morality has a claim on us that is itself absolute and incontrovertible. It is this moral claim that elevates us above the beasts. p 265

He wanted to use reason to save morality from reason, in effect. It is a defense of morality against the corrosion of skepticism, on the one hand, and dogmatic Pietist religious claims on the other, but it leaves a very thin morality. Too much territory is conceded.

Kant's Groundwork

Kuehn emphasis that Kant saw a good will as the only moral thing.

Indeed, a good will is the only thing that is good without any qualification. In order to explain what he means by a good will, Kant introduces a distinction between acting from duty and acting in accordance with duty. He apparently thought that duty is what a good will would will. p284

And it is wholly distinct from self interest or specific ends.

Thus, actions have moral worth only when done from duty. But this moral worth is not to be found in the purpose or goal that they are meant to attain. They have their moral worth only in the subjective principle of volition that they express. Kant calls this practical principle of volition the "maxim". As we have seen, maxims are general principles of action. p284

So here already we have the contemporary notion that intention matters to the exclusion of anything else, and strict separation from self-interest.

A pure moral philosophy deals with a pure will, that is, a will that has motives "that are represented completely a priori by reason alone" and not with human volition, which is characterized by empirically based motives. p285

Morality is a matter of pure reason, rather than the more concrete issues that lay in the domain of anthropology.

Kant, in other words, does not intend to deal with the everyday situations of moral agents. He deals, rather with an ideal of pure reason that is entirely a priori. This ideal, which he calls the categorical imperative, is not given in experience. p285-286

This requirement of disinterestedness is also at the root of his aesthetic theory.

.."the beautiful is what pleases in the mere estimate formed of it (consequently not by the intervention of any feeling of sense in accordance with a concept of the understanding). From this it follows immediately that it must please apart from all interest. p347

Indeed, one cannot help but naturally think there are parallels between Kant's purely rational autonomous agent and our more recent conception of homo economicus in economics.

 

Residual elements

He sees there are difficulties with this notion, however:

Indeed, Kant ends his book by emphasizing that " we do not.. comprehend the practical unconditional necessity of the moral imperative." We only "comprehend its incomprehensibility"... So morality for Kant is an enigma. .. That the "mere dignity of humanity as rational nature, without any other end or advantage to be attained from it - hence respect for a mere idea - is yet to serve as an inflexible precept of the will", is , Kant openly acknowledges, a paradox. True morality is an ideal yet to be instantiated in the world, but it is the only ideal worth striving for. This is in the end what his idealism amounts to. p 286

Interestingly, immediately after the Groundwork he wrote the Idea for a Universal History, which does of course have teleological elements.

So Kant argues for a teleological view of Nature by arguing that such a view is required for the progress of humanity. .. Such a regular progression would not be due to any rational process of humanity, but would have to be ascribed to Nature itself. [.]

To this end, Kant formulates in somewhat dogmatic fashion and with little defense nine propositions. The first maintains that all natural capacities of a creature are 'destined" to be fully developed sooner or later. If nature has a plan, then the plan must be fulfilled. In the second proposition, he claims that our reason is such that it can be developed only in the species, not in an individual. Our lives are too short to allow the latter ... Fourth, nature brings about the full development of our natural faculties by an antagonism within society. In the long run, this antagonism leads to a law-governed social order. Kant calls this the "unsocial sociability." Though people may not be able to bear one another many a time, they still seek the approval and respect of others.

This is a feature of his approach in general. Kant has not abandoned completely the older ideas of purpose, or, as we shall see, virtue. But he pushes them to the periphery of his system. They are ad-hoc add-ons. And as such they soon fall from sight altogether.

Whereas much of his theoretical work was concerned with showing that reason has much less power than had been assumed by his rationalistic predecessors, Kant's moral philosophy may be seen as an attempt to show that morality is the exclusive domain of reason. p312

In a similar displacement, morality requires us to believe in the existence of God, or so Kuehn summarizes Kant's view:

Without morality and God, we would be condemned to moral despair. Moral action should lead to greater good in this world, but it usually does not. Happiness and worthiness to be happy do not usually go together in this world. If we want to establish a connection between the two, we must assume they will be made to coincide by God in the long run. In this way, the notion of "God" and "immortaility" as prerequisites for the realization of the summum bonum or the highest good, make possible the moral enterprise for Kant, and therefore we must believe in their reality. p313

But God is a consequence of morality, not the other way around.

It is our autononomy that is the basis of the moral law, not God's commands or demands on us. p313

God, like purpose, still forms part of his system, but at the periphery. The trouble is these other elements - God, a belief in progress and teleology, a belief in the paradox of inflexible striving for a pure idea - are needed, even on his arguments, to make his theory join up and make sense in practice.

Kant and Virtue

One thing I found particularly interesting was Kuehn's account of how Kant saw the virtues. He was very influenced by Cicero.

There are large areas of agreement between Kant and Cicero. They both thought that ethics is based on reason and is opposed to impulse, and they both rejected hedonism. Cicero used such phrases as "conquered by pleasure" and "broken by desires" to describe actions that fall short of virtue and moral character, while Kant argued that only actions done from duty alone were moral, while any action motivated by pleasure was nonmoral. Both Cicero and Kant offer a duty-based theory of morality.

But, says Kuehn,

Though Cicero, like Kant, considered duty and virtue to be the fundamental concepts of morality, Cicero opted for a form of eudaimonism, which held that whatever is in accordance with duty will also turn out to be ultimately more pleasant than what is in contradiction to virtue.

Kant rejected Ciceronian notions of ethos or honor or the duties particular to a role or social position, although he was very familiar with it from his father's participation in Koenigsberg guilds. "Without honor, a member of a guild was nothing."

The grounds of moral obligation, Kant thinks, must not be found

in the nature of man nor in the circumstances in which a man is placed, but must be sought a priori in the concepts of pure reason... Ciceronian ethics that remain founded on common life, expressed by such concepts of honor (honestas) , faithfulness (fides) , fellowship (societas) and seemliness (decorum) is too superficial and unphilosophical for Kant. For this reason, Kant rejected not just Cicero but all those who were trying to derive a Ciceronian ethics. Moral duties cannot be derived from honor or honorableness in any way. p281

Honor, he thought, always involves an element of self-interest. He still allowed a role for character and virtue in his system, but largely in terms of strength of will in carrying out the claims of disinterested duty.

Kuehn quotes a very late Kant work, the Doctrine of Virtue.

(objectively), there is only one virtue (as moral strength of one's maxims); but in fact (subjectively) there is a multitude of virtues.. our self-knowledge can never adequately tell us whether it is complete [in being virtuous] or deficient. p401

Kant also believed duty was a clearer principle than happiness.

The concept of duty is "simpler, clearer, more comprehensible, and more natural" than any motive drawn from happiness. Maxims drawn from happiness are notoriously difficult to formulate and act on. Yet moral education had been based on such maxims until now. Kant went on to argue that this is what impeded moral progress, and this did not prove the old saw that moral theory could not work in practice. It would work, if only it were tried. p374

Kuehn summarizes, and then quotes Kant again :

The complete system of duties that Kant finally presents to us is a doctrine of virtue; what he ultimately aims at is a virtue-based ethics, one in which character plays a central role, and not some kind of constructivist moral system. The categorical imperative is intimately bound up with virtue.

Virtue is the strength of a human being's maxims in fulfilling his duty. Strength of any kind can be recognized only by the obstacles only by the obstacles it can overcome, and in this case the obstacles are natural inclinations.. and since it is man himself who puts these obstacles in the way of his maxims, virtue is not merely self-constraint.. but also a self-constraint in accordance with a principle of inner freedom, and so through the mere representation of one's duty in accordance with the moral law. p402

So virtue and character are boiled down to determination to pursue the one true principle of adhererence to univeral maxims. The plurality of life and multiplicity of different virtues are reduced down to one demand of reason. The shadow of other doctrines is still there, but only a shadow.

I think in the end Kant's aim is to defend morality against the possibility of radical doubt, which was seeping into the European consciousness. But is this really a sensible aim? In a plural world, with competing values and situations and contexts, there will always be some grounds for doubt or exceptions to universal moral principles. That is not to justify relativism. It is to say that no moral principles can be universal. Rules must sometimes be honored in the breach. Experience and knowledge of human nature must be a major part of our moral outlook. Things should not be neater than they can be.

Perhaps it is just an inherent inclination in many people that they crave clear principles to the detriment of reality, just as quant modellers prefer their econometrics to the messy business of qualitative reality.

 

Destroying the village in order to save it

So, in the end, Kant rejected social roles and position as a foundation for morality, including the elevation of the aristocracy, which was brave for his time. He believed he had retained character and virtue as central parts of his system. But they were relegated to just supporting roles for the central actor: universal rules dictated to us by our autonomous reason. There is no role for flourishing or happiness: only duty is moral. And nature has her own purposes which may be inscrutable to us.

He defended morality by ignoring most of the content and inherent judgement that underlies it. Impartiality replaced substance.

Kant spent many years lecturing on anthropology, i.e the more concrete elements of human nature, and devoted much effort to practical reason as well as pure reason in the Critiques. But he severed morality from forms of life, and human nature.

It is a magnificent system for hedgehogs, people who believe in explaining things in terms of one principle or model. It provides more determinate principles of action, stripped from particular circumstances.

But the dictates of reason themselves may allow little room for restraint or temperance or prudence or compassion or good judgment. In releasing ourselves from the circumstances of human life, we also release ourselves from the constraints and possibilities of humanity.

 

 

 

 

Futility and stock-picking

Active managers have had another bad year, says CNBC. Traditional stock-picking and bottom-up analysis doesn't work any more.

 

Just as in 2011, only about 1 in 5 active managers are beating their benchmarks in a year marked by the same type of headline volatility caused by events in Europe and fiscal concerns closer to home.

While the advantage of passive over active is nothing new, the near-record level of futility is, and the cracks are beginning to show.

[...]

"The market is being driven by macro factors," Flam said. "So most professional advisors have a background in evaluating companies, industries, economies. It's not in politics, and politics is what dominating the markets over the last couple of years."

Political factors are about decisions and perception, not ratios.

Aristotle: Citizenship and Constitutions

We're talking about Aristotle's The Politics , starting here, because it's useful to go back to first principles and get a long view of our political and economic problems.

Citizenship

One matter which has attracted attention in social democratic circles in the last few years is the notion of citizenship. (I have a recollection of a long discussion in David Held's Models of Democracy, but haven't read it in a while.)

In general, however, our conception of citizenship is now very confused and unclear. It mostly tends towards simply residence, or miminal civic inclusion, rather than any common ethnicity or values or beliefs. Multiculturalism has become the ideal on the left, as well as sectional rather than national identity. We have had an immense shift in the last fifty years from ideas of national self-determination and decolonization to purely civic membership, with no obligations except to obey the law and pay taxes.

Aristotle ( who spent much of his life as a foreign resident in Athens) is adamant that citizenship is not just residence. Instead,

What effectively distinguhes the citizen proper from all others is his participation in giving judgment and in holding office. p169

A citizen must be capable of meaningfully participating in deliberation. So is the good man and the good citizen the same thing? Not quite. For one thing, it will depend on the kind of consitution a citizen lives under.

Not that good ruling and good obedience are the same virtue - only that the good citizen must have the knowledge and ability both to rule and to be ruled. That is what we mean by the virtue of a citizen - understanding the governing of free men from both points of view. p182

You cannot, on this perspective , really be a citizen by simply asserting rights or claims against the whole, rather than also seeing the perspective of those who must meet those rights and claims and comsequences.

And the virtue of the ruler and the citizen are not the same. The virtue of the ruler is mostly practical wisdom, or phronesis, which is neither theoretical nor technocratic, but skilled ability to judge particular situations. The virtues of the private citizen are wider.

Strikingly from our perspective, as a rule he also believed anyone who works as skilled craftsman or works for wages for others cannot be a citizen...

for it is quite impossible, while living the life of a mechanic or hireling, to occupy oneself as virtue demands. p184

That perhaps vanished as a sensible view with the increased scale of organizations with the industrial revolution. But the notion that one must have time and energy to reflect still stands, perhaps.

The common good

He then separates good from bad constitutions. The notion of a good constitution is very clear:

It is clear that those constitutions which aim at the common good are right, as being in accord with absolute justice; while those which aim only at the good of the rulers are wrong. p189

Looking to simpy private advantage, "be it of the one or the few or the mass" is a deviation, when the interests of one section of the community take precedence over the others.

This has contemporary relevance as well. Seeing politics as simply a matter of demographics, of sectional interest and redistribution and faction, obscures and denies the common good. I think this is where the Democrats, as a coalition of minority and special interest groups, usually go wrong, and where the GOP is joining them with its increasingly libertarian tone. Assembling enough sectional coalition elements to get to 50.1% is not the same as advocating for a view of the common good.

It also prefigures much contemporary analysis, such as the notion of "inclusion" in Why Nations Fail. Small groups often focus on dividing a small collective pie to their own advantage, instead of making the pie bigger.


Of course, there can be different views of the common good. But you need some conception of the good. And you need to go beyond the shallow Pareto optimality of welfare economics to have any real insight into the common good. We will come back to this later.

So Aristotle distinguishes six kinds of rule: monarchy, and its deviant twin tyranny; aristocracy (in the old sense of rule by the aristoi, or the best and most virtuous men, not traditional European landed upper classes) and its deviation, oligarchy, typically the rule of the few or the wealthy; and polity, which is "political control exercised by the mass of the populace in the common interest" versus its somewhat deviant twin, democracy, which is rule only "for the benefit of the men without means." , ie the poor. p190

 

Expert Judgement

Although he is against giving power to those with little or no time to reflect or use their reason, he is nonethless very supportive of wider participation. Almost 2300 years before the rise of the middle classes in Europe, Aristotle emphasizes wide deliberation and the importance of the middle sort. For one thing, a wider group often makes better decisions.

For it is possible that the many, no one of whom taken singly is a sound man, may yet, taken all together, be better than the few, not individually but collectively, in the same way that a feast to which all contribute is better than one supplied at one man's expense. p202

Interestingly, this is a little different from 'many chefs spoil the broth' or the cult of leadership. This too prefigures what we find today, such as the greater accuracy of aggregate economic forecasts that we were looking at the other day.

He has a dietary analogy: it is actually preferable to include "rougher" classes in discussion with the powerful:

By thus mixing with the better sort, they render good service in their states, in something like the way that a combination of coarse foods with refined renders the whole diet more nutrtious than a small amount of the latter. p204

So, says Aristotle, democracy is "the most moderate of the deviations" p239. And polity, the ideal, " is a mixture of oligarchy and democracy." p259

Similar comsiderations apply to experts, according to this author who spent twenty years in the original Academy. There are some things in which they should be judged by their peers. But in others, users are much better judges than expert producers.

.. that provided the mass of the people is not too slave-like, each indiviudal will indeed be a worse judge than the experts, but collectively they will be better, or at any rate no worse. Secondly, there are tasks of which the actual doer will be neither the best nor the only judge, cases in which even those who do not posses the skill form an opinion on the fnished product. .. So too the user of a rudder , the helmsman, is a better judge of it than the carpenters who made itl and it is the diner not the cook that pronounces upon the merits of a dinner. p205

This reminds me of William F. Buckley's assertion that "I'd rather entrust the government of the United States to the first 400 people listed in the Boston telephone directory than to the faculty of Harvard University ."

Expert judgement has its limits, according to one of the first experts.

 

Rationality and Sustainability

I happened to come across an earlier discussion on this blog as I was talking about "data-driven rationality" and consistency the other day.We looked at Nobel Laureate in Economics Amartya Sen.

He says:

Rationality of choice.. Is primarily a matter of basing our choices - explicitly or by implication - on reasoning we can reflectively sustain if we subject them to critical scrutiny. (p179-180)

That is a much better way to look at things than narrow internal homo economicus consistency. Instead, there ought to be some reflection and an ability to sustain an argument against external argument.

 

Mind blindness & Unknown unknowns

I'm now going to conclude an extensive series of posts on Nate Silver's The Signal and the Noise: Why So Many Predictions Fail-but Some Don't, starting here. The extra attention is justified by how well-written and fruitful the book is.

I've naturally come across (Nobel Economics Laureate)Thomas Schelling before, especially his ground-breaking The Strategy of Conflict. But Silver uncovers some writings of his I hadn't come across, in a preface to the book Pearl Harbor: Warning and Decisionby Roberta Wohlstetter.

Schelling writes of our propensity to mistake the unfamiliar for the improbable: There is a tendency in our planning to confuse the unfamiliar with the improbable. The contingency we have not considered seriously looks strange; what looks strange is thought improbable; what is improbable need not be considered seriously.

But at least this flawed type of thinking would have involved some thinking. If we had gone through the thought process, perhaps we could have recognized how loose our assumptions were. Schelling suggests that our problems instead run deeper. When a possibility is unfamiliar to us, we do not even think about it. Instead we develop a sort of mind-blindness to it. In medicine this is called anosognosia:part of the physiology of the condition prevents a patient from recognizing that they have the condition. Some Alzheimer’s patients present in this way.

We have an inherent tendency as human beings to develop kinds of mind-blindness. I love that term.

And perhaps the biggest flaw of all is to believe the future is more predicable or controllable than it really is.

There is reason to suspect that of the various cognitive biases that investors suffer from, overconfidence is the most pernicious. Perhaps the central finding of behavioral economics is that most of us are overconfident when we make predictions. The stock market is no exception; a Duke University survey of corporate CFOs,whom you might expect to be fairly sophisticated investors, found that they radically overestimated their ability to forecast the price of the S&P 500.

Heuristics

So what can we do? What we need is heuristics:

We can think of these simplifications as “models,” but heuristics is the preferred term in the study of computer programming and human decision making. It comes from the same Greek root word from which we derive eureka.A heuristic approach to problem solving consists of employing rules of thumb when a deterministic solution to a problem is beyond our practical capacities.

In a complex an confusing world, I think good heuristics may be the best we can hope for.

It really is a very thoughtful and insightful book covering a wide range of issues. Silver clearly has deep talent far beyond baseball statistics and election forecasting.

 

Prediction and Bayesian testing

I still have a little more to say about Nate Silver's The Signal and the Noise: Why So Many Predictions Fail-but Some Don't, which I have been looking at starting here.

I argued in this post the other day that what we need for predictive success is not so much big data as self-awareness. Hypothesis testing ought to help us revise our point of view.

Silver rightly emphasizes prediction is largely a means to an end:

The philosophy of this book is that prediction is as much a means as an end. Prediction serves a very central role in hypothesis testing, for instance, and therefore in all of science.As the statistician George E. P. Box wrote, “All models are wrong, but some models are useful.” What he meant by that is that all models are simplifications of the universe, as they must necessarily be. As another mathematician said, “The best model of a cat is a cat.”Everything else is leaving out some sort of detail. How pertinent that detail might be will depend on exactly what problem we’re trying to solve and on how precise an answer we require.

I keep talking about the importance of purpose, for example here about the difference between maps and models.

The potential pitfalls mean we have to know ourselves, says Silver:

This is why it is so crucial to develop a better understanding of ourselves, and the way we distort and interpret the signals we receive, if we want to make better predictions.

Frequentism

However, much recent statistics has run well and truly off the rails by assuming that error arises from our measurements rather than our perception or judgement. Silver criticizes simple-minded statistical "frequentism", which he says mostly stems from nineteenth century English statistician Ronald Fisher.

The idea behind frequentism is that uncertainty in a statistical problem results exclusively from collecting data among just a sample of the population rather than the whole population.

The idea is you can act as if you can repeat an experiment innumerable times. The more random experiments you do, the more accurate the outcome.

Essentially, the frequentist approach toward statistics seeks to wash its hands of the reason that predictions most often go wrong: human error. It views uncertainty as something intrinsic to the experiment rather than something intrinsic to our ability to understand the real world. The frequentist method also implies that, as you collect more data, your error will eventually approach zero: this will be both necessary and sufficient to solve any problems. Many of the more problematic areas of prediction in this book come from fields in which useful data is sparse, and it is indeed usually valuable to collect more of it. However, it is hardly a golden road to statistical perfection if you are not using it in a sensible way. As Ioannidis noted, the era of Big Data only seems to be worsening the problems of false positive findings in the research literature.

 

Frequentism dominated statistics in the twentieth century. Fisher criticized Bayesian statistics (which we will come to in a moment) for beng insufficiently objective. But, says Silver,

Nor is the frequentist method particularly objective, either in theory or in practice. Instead, it relies on a whole host of assumptions. It usually presumes that the underlying uncertainty in a measurement follows a bell-curve or normal distribution. This is often a good assumption, but not in the case of something like the variation in the stock market. The frequentist approach requires defining a sample population, something that is straightforward in the case of a political poll but which is largely arbitrary in many other practical applications. What “sample population” was the September 11 attack drawn from? The bigger problem, however, is that the frequentist methods—in striving for immaculate statistical procedures that can’t be contaminated by the researcher’s bias—keep him hermetically sealed off from the real world. These methods discourage the researcher from considering the underlying context or plausibility of his hypothesis, something that the Bayesian method demands in the form of a prior probability. Thus, you will see apparently serious papers published on how toads can predict earthquakes, or how big-box stores like Target beget racial hate groups,which apply frequentist tests to produce “statistically significant” (but manifestly ridiculous) findings.

Plenty of investors have lost their shirts by having risk models which assume that market events follow a neat normal ( or similar ) distribution.

Bayesian Probability

Instead, Silver strongly advocates the older Bayesian statistics. In essence, one must specify a prior probability of an outcome , based on one's current beliefs. Bayes' formula then specifies how you should alter that probability in response to incoming data and events, which produces a posterior probability. It is about recognizing your current expectations and beliefs, amd learning from new evidence.

The Bayesian viewpoint, instead, regards rationality as a probabilistic matter. In essence, Bayes and Price are telling Hume, don’t blame nature because you are too daft to understand it: if you step out of your skeptical shell and make some predictions about its behavior, perhaps you will get a little closer to the truth.

We took a step backwards when frequentism arose.

As we will see, science may have stumbled later when a different statistical paradigm, which deemphasized the role of prediction and tried to recast uncertainty as resulting from the errors of our measurements rather than the imperfections in our judgments, came to dominate in the twentieth century.

For me, the point about Bayesian probability ( which I haven't ever used professionally) is not so much the math but a procedure which requires you to test and revise your beliefs in response to evidence. I think Silver overdoes Bayesian probability as THE answer, but his main target in his own intellectual world is likely very much the frequentists. He is a statistician. So we can understand his emphasis on an alternative statistical tradition.

Incidentally, I am no statistician, but I have been intrigued in the past by Keynes' arguments in his A Treatise on Probability (Classic Reprint), but I'll leave that for another time.