Economics and a unified method of justification of scientific theories

Economics and a unified method of justification of scientific theories.

                             A. Voin
                                                            10.4.11

     A few days ago I received from the Institute of New Economic Thinking (INET), founded by George Soros, the following letter:

     Hi Alexander!

In a recent highly publicized game of Jeopardy, two of the game’s greatest past champions were beat by Watson, an IBM computer whose intelligence was based on algorithms. It was hailed as the latest example of how software could outperform human beings.

In the latest INET interview, Amar Bhidé, the author of the new book A Call for Judgment, counters that argument with a strong defense of the primacy of human judgment – at least when it comes to overseeing the economy and navigating the world of finance.

The Professor of International Business at the Fletcher School of Law and Diplomacy criticizes the tendency in many quarters to rely on mathematical models to inform investment decisions. It’s that overreliance on models that tend to generalize and simplify that helped drive the world into the global financial crash of 2008 and the ensuing Great Recession. Bhidé makes a strong case that human actors need to immerse in the details of individual cases and weigh many different factors to come up with tailored decisions that more closely apply to the complexities of the real world.

Bhidé also argues that regulators need to take a similarly human-centered approach. Unfortunately, many of today’s regulators came up through the same academic economic departments that stressed the mathematical model approach and so they were drawn into the same mistaken analysis that led to the crisis.

You can watch a full version of the interview on video or watch individual segments on different ideas. We also invite you to go to the Q&A Forum and give your own answers or rate those of others to our question:

What is the right balance between using human judgment and relying on mathematical models in regulating finance and the economy?

bj_0 Sincerely,

BJ Greenspan
Deputy Executive Director

And here is my answer to this question that I posted on the above forum:

Human judgment and mathematical models

                     A Voin
                                                     9.4.11

    The question: «What is the right balance between using human judgment and relying on mathematical models in regulating finance and the economy?» is not correct, and shows a deep misunderstanding of not only the essence of the mathematical model, but the essence of a scientific theory at all, its connection with reality and in particular the limits of applicability of the theory or model. Between the mathematical model and human judgment is no fundamental difference. Mathematical model is nothing but a generalized and formalized human judgment. "Generalized" means that it refers not to a particular case, but to a certain type or class of cases. Using mathematical models can lead to errors such as those, that were the cause of the 2008 financial crisis, not because the mathematical models is worse than the human judgment, but because in this case, these models are applied outside of their applicability field, i.e., for cases in which circumstances do not conform, do not coincide with the type of cases for which these models were created.
    Why Watson IBM computer won the champions? Because the rules of the game Jeopardy (like chess) and other circumstances of these games are unchanged and, consequently, the algorithm by which works Watson, composed especially for these rules and circumstances, there will always be applied correctly and give the correct result. But the rules of the economic game and its circumstances (as well as in the case of other problems of real life) are continuously changing. Therefore, the using of mathematical models in non trivial cases really can lead to errors.
     But can we conclude from this that we should abandon the mathematical models and rely only on human judgment? After all, human judgment can also lead to errors and in any case, relating not to an individual, but many, we always have a lot of different and even opposing each other human judgments. How do we know on which of them to rely? This is especially important when it comes to macroeconomics rather than on private investment.
     The solution to this problem can be only one thing: to learn to determine the limits of applicability of scientific theory, mathematical model or algorithm. This solution provides a unified method justification of scientific theories, developed by me, whose application in the economy has been the subject of my application for a grant of INET. Paradoxically, the proposal to answer the question: «What is the right balance between using human judgment and relying on mathematical models in regulating finance and the economy?», I got together with the refusal to me in getting the grant.

Now some explanations to the answer. Firstly, regarding the grant. INET provides grants for research in the field of macroeconomics, which put forward new ideas, develop new approaches, etc. I applied for a grant and this is the text content of the application:

Modern macroeconomics has a number of basic theories and schools, developing these theories, which have more or less equal status in it: Keynesianism, monetarism and etc. This distinguishes it from the natural sciences and brings together the humanitarian, in particular with the philosophy and psychology. In natural sciences, at a certain stage in a particular area a number of hypotheses can compete each other, but with the knowledge and recognition that "God is one and the truth is one”, and that sooner or later one from all hypotheses will be adopted or synthesized, and this one will be recognised as a theory that adequately describes this area of reality. And so it happens. Of course, it is possible that in time a new fundamental theory changes the previous already recognized one, which describe the same domain of reality, such as a change of the Newtonian mechanics by Einstein's theory of relativity. But in this case there is no competition between these two theories. No question, any theory we must follow in deciding in a particular situation. Clearly, if we are in reality, where speeds are far from the speed of light, you can use each of these theories. The both will result close enough to the truth. And if the speed close to the speed of light, acceptable results can only give Einstein's theory. But in the economy, solving the problem like how we emerge from the crisis or how we do not fall into it and so forth, we have a number of competing on equal recipes that we have to do, from different schools, in the absence of criteria of preference between them and with no guarantee that following one of them, we fell into a crisis worse than the previous one. To this we must add that the situation that occurs in the natural sciences by changing the fundamental theories (Newton - Einstein), even to the natural sciences is not ideal, because we do not know in advance when we go beyond the applicability of previous theory and need to built new one. But in the natural sciences this drawback, at least so far, did not lead to serious consequences for society, especially for humanity as a whole. (Although in the future, such impacts can not be excluded and more are expected). In economics, the application of the theory beyond borders of its applicability usually leads to rather serious consequences for society and even humanity as a whole (I mean, of course, on macroeconomic theories).

Besides the economics differs from the natural sciences, because the natural sciences study objectively existing, not created by us reality. Therefore, here we go beyond the limits of applicability of the fundamental theory only when we expand area of research. (From the macrocosm to a microcosm, or go into space, etc.). And this happens very rarely. In the case of economy (macroeconomics), we study the reality that we ourselves create and which therefore varies almost continuously. Whether we accept the new tax and other laws or budget, whether there appear new forms of industrial, financial, credit, etc. relations: the transnational campaign, offshore companies, futures, etc., all of this changes the economic reality. And because these changes occur with greater speed, the application of theory beyond the limits of its applicability is happening in the economy much more frequently than, say, in physics. The whole history of the economy gives it proof. During the period of reign of the classical theory of Adam Smith and David Ricardo (that in the early stages of capitalism quite well "worked") the belief that this theory has no limits of its applicability, and its application will always give a positive, acceptable results was adopted among economists. To lose faith in this belief, and understand the fallacy, humanity have been through quite a number of painful crises, ending the Great Depression of the 1932-37. After the Great Depression the Keynesianism become the dominant theory in macroeconomics and now the faith in its truth in unlimited range appears. In particular, now economists belived that, thanks to the theory of Keynes, more crises will not happen. However, the crises, as we know, have continued, and the last scale has surpassed all previous ones. Known American economist Francis Fukuyama in his article in Newsweek writes about the causes of this crisis (I quote from memory): "Big ideas are born in the context of a particular historical epoch. They rarely survive the radical changes in the environment. ... For its time, Reaganism fit perfectly. Since the "New Deal" of Franklin Roosevelt in the 1930 state apparatuses around the world has been steadily expanded and grew. By the 1970's large welfare state and economic systems, shackled by bureaucratic constraints, proved to be a huge dysfunctional ... .. Thanks to the revolution that carried Reagan and Thatcher, has become easier to hire and fire workers .... This paved the way for almost thirty years of economic growth and the emergence of new sectors such as information technology and genetic engineering. .... Like all movements, transforming society, the Reagan revolution lost its way ... ", that led to the recent crisis. In fact, Fukuyama says here's what I wrote above, namely that the cause of crises is the application of economic models outside of their applicability, when economic reality has changed.

And we are talking about models that at the beginning of their application were working successfully. But Fukuyama reached such conclusion already after the crisis occurred. And neither he nor anyone else did not mention, but how do we know even before the crisis there, it's time to change the economic model and policy. No one suggested method of how to determine the limits of applicability of the theory, before we get them and on experience (sadly) we see that we are already passed. Moreover, nobody knows how to do that not only in economics but also in the natural sciences, physics in particular. In Michelson's experiment physicists saw that Newton's theory has reached the limits of its applicability, and then created a theory of Einstein, fit reality into the larger area. However, the method of how to determine in advance the borders of applicability of the theory before it met its limits in the experiment, are not offered even by phisicists. Likewise, in physics and other natural sciences, there is still no method or criteria by which one could clearly distinguish hypothesis from the proven, grounded theory, which guarantees the truth of its inputs at least in some areas. Moreover, today in the physics the prevailing view is that a theory - it's just not disproved hypothesis. A clear boundary between science and pseudoscience also is absent today even in the natural sciences, and as criteria for distinguishing between them the subjective evaluation, such as the number of publications in reputable journals, is using. Finally, the method of justification of scientific theories, even though it worked out during the development of natural sciences, physics, primarily, not yet explicitly represented, and exists only at the level of stereotype of natural scientific thinking. But in the humanities, philosophy and economics, he did not known at all. Moreover, in philosophy, epistemology and theory of knowledge

prevails today a post positivist school (Quine, Kuhn, Feyerabend, Popper, Lakatos), which denies the existence of a unified method of justification of scientific theories.

This situation much more have place in the economy (macroeconomics). Only here, in view of the role that economics plays in society, the harm of this is much bigger. In particular, the government, instead of relying on the conclusions of grounded economic theory adopted by all, based on expert opinion, which, as is well known, is different to the extreme for different groups of experts.

Based on my theory of cognition («Неорационализм», Kiev, 1992, Part 1) I have refuted the arguments of post positivist and

developed a unified method of justification of scientific theories (Философские исследования, № 3,2000; № 1, 2001; № 2, 2002, Философия физики. Актуальные проблемы, M. :ЛЕНАНД, 2010 and others). It remains unchanged for all shifts of the fundamental theories, in which changing the basic concepts and conclusions. This method gives to science its special epistemological status, and from it follows the criteria that distinguish science from non-science, pseudoscience, etc. As mentioned above,

this method is elaborated in the development of natural sciences, physics, first of all, but until now has existed only at the level of stereotype of natural science thinking. I have formulated it, and presented explicitly and showed that a scientific theory, grounded on this method, guarantees the validity of its conclusions (with a given precision and probability) in field of reality, for which there is binding of its concepts to experience. Also, basing on this method I clarified the difference between theory and hypothesis, which is important for physics, but it is particularly important for the economy, where this difference was completely washed away. And this vagueness has important consequences for society and humanity, as often referring to the theory, which is actually only a hypothesis, somebody assure us in the security of a development or project and the society has not a tool to check out the truth of the relevant arguments. The unified method of grounding can also set the boundaries of reliable application of the theory that, as shown above, is particularly important for the economy. I also showed that the unified method of grounding can be used not only in field of natural science but also with appropriate adaptations in the humanities and in philosophy, where he still has not been guided even at the level of stereotype. Also it can be used in the economy.

The purpose of the proposed project is using of the unified method of grounding in macroeconomics, in particular, to establish limits of the applicability of macroeconomic models.

I think, this project should be funded by INET, as opposed to other granting institutions, because it suggests an entirely new approach to the problems of macroeconomics, based on the established by me a unified method of justification of scientific theories.

    Like I said, my grant application was rejected and a notification of this I got on the same day as the above cited letter with the question. Under any pretext was it rejected? Under very simple: there were many applications in field of macroeconomics and my nomination this time has not passed. What picture do we see here?
     It turns out that in the global economy there is a paramount problem, and the leadership of INET perceives it. What could be more important! They themselves write that the last global financial crisis happened because of investors (well, and banks and governments, I note) used mathematical models. And not they alone write about it. By the way, mathematical model – it is mathematically formalized theory. And yet, by the way, nobody would universally apply these theories (because there are many competing), if they had not previously been tested experience. That is, these theories - models worked and worked successfully, then they have been used widely and then bam - the global financial crisis, just because of their use. And as Bhidé wrote, the crisis hapened because these models do not take into account the specific circumstances. It turns out that before that, when successfully implemented, they take into account the circumstances, and now for no reason, all of a sudden stop to consider. Can this be explained except by the fact that the circumstances were changed. And that those who have applied these models, they did not know that they have limits of applicability, and even more about where exactly are these boundaries. I was just writing about it in my application for a grant and writing that to allow you to set those boundaries I have developed a unified method of justification of scientific theories, and I propose to apply it in the economy. And what happened? They say: your application can wait, we have more important one’s (I'd like to know what is more important). And then, on the same day, they sent me another letter, asking if I knew how to solve this very problem, the solution of which I proposed to them in the application for a grant that directly in front of this was rejected by them.
    This story with the INET fits well into the overall picture of my attempts to reach a broad discussion and recognition of the unified method of justification (and in general my philosophy and macroeconomics). I wrote many articles on these attempts, here is the only list the main ones.

    The cycle of my articles on the unified method, that editor of main Russian philosophical journal «Вопросы философии» V. Lektorsky was going to publish even 15 years ago, never went there because of resistence of director the Moscow Institute of Philosophy V. Stepin. He is the author of the theory of three periods in the development of physics (classical, not classic, and post not classic), each with its own method of justification, (what contradicts the unified method of justification) and instead to argue with me publicly (or to publicly recognize that I am right) he preferred to resort to administrative methods. (See the article «Полемика с профессором Смирновым»).
     In the Kiev Institute of Philosophy, I was not able to make presentations on the unified method of justification (although before I did here three presentations on various other issues). Not even helped my treatment of this subject neither to the Academy of Sciences nor to the President. In particular from the administration of President my letter was sent to the Academy of Sciences, and from there to all the same Institute of Philosophy, where I received a derisive response signed by the Deputy Director of the Institute A. Kolodny. The essence of the answer was: we have a democracy and the President can not decree to us. (And I did not ask the President to decree to adopt a unified method, ask only to assist its discussion). And in general, "write, publish and wait until you will be noticed. Incidentally, we are following with interest your writings”.
     I must note that in the philosophical journals of Ukraine I have published nothing either before or after this case (although in Moscow I published a number of philosophical articles, despite the resistance of Stepin). But before that, I published a lot of journalistic articles (with philosophical overtones) in the most intelligent Ukrainian newspapers ("Зеркало недели", "День", etc.). After that I could not since then publish a single article in Ukrainian newspapers, despite numerous attempts. Here is a "write, Alex, we are following with interest your writings!”
     In October last year I took part in the World Philosophical Forum under the auspices of UNESCO in Athens and was a member of program committee of the Forum. On the Forum website (http://wpf.unesko-tlee.org) represented 5 of my work, more than any other member of the Forum. The Forum was devoted to the global crisis of humanity and to the search for ways out of it and, above all, for great new philosophical ideas. At the Forum clearly was displayed lack of a common language among contemporary philosophers, not allowing them to agree to anything but empty appeals for freedom, justice, morality, etc., with the full uncertainty of these concepts, what gives possibility to each to understand them as he wishes. The fact that it is the situation in contemporary philosophy, I think, is well known to anyone even slightly versed in what's happening in it. To those who are not very focused, I can offer just read the articles on the website of the Forum and, finally, two of my articles ("Коментарий к статье Л. Баевой" and "Comment on P. Nikolopolus"), in which I analyse two works among, incidentally, the best represented at the Forum.
     In my speeches at the Forum, I repeatedly stressed this problem and explained that it’s solution gives only developed by me the unified method of justification of scientific theories, part of which is my theory and concepts which gives it the most common language of philosophy, too. I was listened, applauded, but there was no substantive response on my speeches. Despite my suggestion and insistence that the mention of a unified method of justification was included in the resolution of Forum, the direction of Forum did not do that. I wrote a letter about that to two heads of relevant departments of UNESCO, repeated three times to send it, got no answer. Turned it into the "Open Letter to UNESCO”, posted it on the Internet, the reaction - zero.
     There are a number of problems of exceptional importance widely discussed today in an scientific, philosophical and traditional media, whose solution is impossible without using a unified method of justification of scientific theories. Lack of common language is characterized not only philosophy, but also other human sciences, in particular theoretical sociology, psychology, etc. The lack of clear criteria for separating science from pseudoscience even more exacerbates the problem by reducing the effectiveness of science in general, not just humanitarian. According humanitarian same science, especially philosophy and theoretical sociology, lack of a common language, coupled with the lack of scientific criteria simply turns it into the endless empty chatter. This is despite the fact that the solution of many problems which confront mankind today, lies exactly in this plane, but not in the plane of scientific – technological development (see my article "New Enlightenment"). The lack of clear criteria, which devide science from non-science, reduces also the effectiveness of education, especially university. And again, only unified method of justification of scientific theories gives these criteria.
     A number of venerable scientists, politicians and public figures make a career in the chatter about these problems without having to move their solution at least a step. But when I speak to them, explaining that the solution to these problems is impossible without the recognition and application of a unfied method of justification, they bend head down, silent. Let the reader judge of who of us is right, for my articles such as "Наука академическая, альтернативная, лженаука и эпистемология" "Проблема науки – лженауки на примере социологии", "Открытое письмо участникам круглого стола "Кризис университетского обазования в России" and others. None of the venerable, making a career for allegedly solving these problems, to whom I spoke on this occasion, did not answer, and none of these articles had never been published (just Internet).
    Summed resume. One gets the impression that science, especially the humanitarian and philosophy in particular, has long ceased to be a church service to truth and the good of mankind (so much so that even to use such terms is something seriously inconvenient), and turned into a "wonderland in the country of fools", where the corporation cynical and greedy "cats" and "foxes" of science earns his daily bread by dishonest means, and spit on the truth and to humanity. And those who can shed light on this "dark kingdom", the corporation is considering as it’s mortal enemy and takes up arms against them with all it’s might. The unified method of justification causes a furious resistance, just because it gives clear criteria for separating real science from pseudo one, and thus sheds light on the "dark kingdom".