The Failure of Economists to Account for Complexity
Using models within economics or within any other social science, is especially treacherous. That’s because social science involves a higher degree of complexity than the natural sciences. The reason why social science is so complex is that the basic unit in social science, which economists call agents, are strategic, whereas the basic unit of the natural sciences are not. Economics can be thought of the physics with strategic atoms, who keep trying to foil any efforts to understand them and bring them under control. Strategic agents complicate modeling enormously; they make it impossible to have a perfect model since they increase the number of calculations one would have to make in order to solve the model beyond the calculations the fastest computer one can hypothesize could process in a finite amount of time. Put simply, the formal study of complex systems is really, really, hard. Inevitably, complex systems exhibit path dependence, nested systems, multiple speed variables, sensitive dependence on initial conditions, and other non-linear dynamical properties. This means that at any moment in time, right when you thought you had a result, all hell can break loose. Formally studying complex systems requires rigorous training in the cutting edge of mathematics and statistics. It’s not for neophytes.
Let me be a bit more specific. The dominant model in macroeconomics is the dynamic stochastic general equilibrium (DSGE) model. This is a model that assumes there is a single globally rational representative agent with complete knowledge who is maximizing over the infinite future. In this model, by definition, there can be no strategic coordination problem—the most likely cause of the recent crisis—such problems are simply assumed away.
Colander introduces complexity by allowing for strategic behaviour that arises as soon as all sellers and all buyers do not face perfect outside options. Why do we know this? Because of general equilibrium theory, the use of which Colander however declines. I don't like this part:
As opposed to viewing the supply/demand model and its macroeconomic counterpart, the Walrasian general equilibrium model, as interesting models relevant for a few limited phenomena, but at best a stepping stone for a formal understanding of the economy, it enshrined both models, and acted as if it explained everything. Complexities were just assumed away not because it made sense to assume them away, but for tractability reasons. The result was a set of models that would not even pass a perfunctory common sense smell test being studied ad nauseam.
While all this is true for the reduced-form models Colander has in mind, it does not apply to general equilibrium theory as such. Certainly, Walrasian general equilibrium theory does not reduce complexity. Quite to the opposite, it is the major tool of stating complex interdependencies. It is the only apparatus in economic analysis that highlights the economy as a global system. If one goes beyond first-order conditions and local stability analysis, Walrasian stability analysis leaves enough room for all kinds “non-linear dynamical properties”. There is no need to dispense structural models per se.
