Academic journal article Review of Social Economy

The Methodology of Economics and the Survival Principle Revisited and Revised: Some Welfare and Public Policy Implications of Modeling the Economic Agent

Academic journal article Review of Social Economy

The Methodology of Economics and the Survival Principle Revisited and Revised: Some Welfare and Public Policy Implications of Modeling the Economic Agent

Article excerpt

Abstract The focus of this paper is on the survival principle, as articulated by Milton Friedman, that dominates the methodology of the conventional wisdom either explicitly or implicitly. The survival principle is revised applying the behavioral approach to economics, which differs fundamentally with Friedman's methodology. This discussion is contextualized by a comparison of the different approaches to the modeling of economic agents and the substantive implications of this for theory and public policy and thereby for economic welfare and economic justice.

Keywords: Survivor principle, x-efficiency, behavioral economics, assumptions, welfare

Following the publication of Milton Friedman's classic work on the methodology of economics in 1953, few economists have challenged the assertion that the realism of assumptions is of little analytical consequence to economic theory and, therefore, to the formation of economic policy. This paper looks at the potential substantive significance of the realism of assumptions for economic welfare and economic justice by way of its effect on the analytical predictions of economic models, on the policy implications of these predictions, as well as the effect it might have on the scope and breadth of economic analysis. [1]

Economic analysis and policy flow from economic models either explicitly or implicitly. Economic models establish the roadmap and the signposts for economic discourse. As Friedman put it (1953: 34), "A theory is the way we perceive 'facts,' and we cannot perceive 'facts' without a theory." Theory is an engine designed to analyze the world as it is (Friedman, 1953: 35). Moreover, as Thomas Kuhn (Coase 1994: 27) writes: "The road from scientific law to scientific measurement can rarely be traveled in the reverse direction. To discover quantitative regularity one must normally know what regularity one is seeking and one's instruments must be designed accordingly; even then nature may not yield consistent or generalizable results without a struggle." Kuhn adds that: "Anomalous observations ... cannot tempt [a scientist] to abandon his theory until another one is suggested to replace it ... In scientific practice the real confirmation questions always involve the comparison of two theories with each other and wit h the world, not the comparison of a single theory with the world." The construction of economic theory is, therefore, of fundamental analytical importance to the design of public policy as well as in garnering an understanding of the costs and benefits of choosing one policy over another.

In this paper, it is argued that to the extent to which economic models are misspecified as a result of inappropriate behavioral assumptions:

1 the analytical predictions generated by the models will be incorrect;

2 even if the predictions are reasonable with respect to the stylized facts, causality will be misspecified;

3 moreover, the roadmap or frame of reference provided by the models will be inaccurate thereby directing attention away from true causality.

By assuming away the possibility that the realism of assumptions might be of substantive importance these potential analytical problems are, in turn, assumed away. This is not a costless process. The opportunity cost of building models upon rocky foundations, constructed on false behavioral premises, can be measured by the economic cost of the policy errors derived from such theories as compared to what could have been generated by more "realistic" theories.

My focus is on one particular set of behavioral assumptions underlying much of the conventional wisdom and their implications for modeling the economy and for constructing public policy. The conventional wisdom assumes that economic agents tend to work as well and as hard as they can and that work effort is set or determined independently from the wage rate and the industrial relations system of which the rate of labor compensation is but one component. …

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