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I think I can sympathise with people being distrustful of economics and finance (I say this as someone who works in the industry). When I read what economists h

I think I can sympathise with people being distrustful of economics and finance (I say this as someone who works in the industry). When I read what economists have to say about free trade, for example, it makes me incredibly skeptical. I admit I'm not up to date with the latest graduate-level economic models. But I have read about Ricardian comparative advantage. When I looked into the assumptions behind that model, I realised they were utter nonsense. In turn, that made me reluctant to believe anything else that economists wrote on the subject. The same thing happened with banking. The standard macro model where banks lend out central bank reserves with the overall constraint on credit creation being 1/(reserve requirement) is kinda-sorta what happens, but the details are all wrong. As far as I can tell, economists don't want to change the details of this story because then they have to re-write another part of their theory (IS/LM), and that forms the keystone of a lot of standard theory. To summarise, I haven't seen much from academic economics that inspires confidence. So why should I trust them?

lmm 10y ago
> But I have read about Ricardian comparative advantage. When I looked into the assumptions behind that model, I realised they were utter nonsense. In turn, that made me reluctant to believe anything else that economists wrote on the subject. Could you be more specific? It's a simplistic model sure, but just about every field of study or industry uses simplified models. As a first-order approximation it seems reasonable.
- crdoconnor 10y ago
  The theory of comparative advantage assumes comparative advantage is static. Either you have a rich industrial base or you don't. Either you have gold deposits or you don't. Either you have cheap labor or you don't. It falls to pieces once you consider that comparative advantage is dynamic. While gold deposits are either there or not, an industrial base can be built using judicious application of tariffs and subsidies. As with most assumptions in economics (e.g. perfect information), it serves a purpose, although that purpose isn't to simplify the models - but to aid in the creation of politically useful models.
- krona 10y ago
  General models the produce approximations are all well and good. The problem arises when economists pick a model to make a precise prediction, without nuance, about some event in the future or some trend over time; that's when people switch off. I think people in general people have learnt to be skeptical about economic forecasts, and that is only a good thing in my view. "About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know. Nevertheless, the necessity for action and for decision compels us as practical men to do our best to overlook this awkward fact.." -- Maynard Keynes
- soVeryTired 10y ago
  Sure. (as an aside if anyone can point out how to do proper bullet points I'll edit). Here's a non-exhaustive list of concerns that occur to me when I read e.g. the wikipedia page on comparative advantage. I'll happily admit my ignorance in this field. 1/ What is the nature of comparative advantage? Where does it come from? The standard explanations point to things like weather, but surely location-dependent industries are only a tiny fraction of modern economic output. 2/ Is comparative advantage fixed? To the best of my limited knowledge, heavy industry in the US civil war era was only able to grow because of trade barriers. If comparative advantage can vary over time, surely that implies a very different course of action to "specialise in what you're best at right now". 3/ How does a country automatically know what it is best at producing? 4/ What about cross-pollination of ideas between industries? 5/ What about diversification? Surely putting all your eggs in one industrial basket is a bad idea? Holland (and now Saudi Arabia, Nigeria, and others) specialised in oil production, which ultimately had nasty side effects on its economy. This is known as the Dutch disease. 6/ The usual claim is that "in the long run", everyone benefits. How long is the long run? How much suffering takes place in the short run? I mean, look what happened to Detroit. To address your "simple model" point: yes, many people do argue that "all models are wrong, but some are useful". If you're going to make that argument, you need a mechanisim for differentiating between bad and good models. I don't know of any such mechanism in economics. I'd be a whole lot happier with a series of detailed ethnographies than with a mathematical model. Some things are just too complicated for mathematics to handle.
  - lmm 10y ago
    > 3/ How does a country automatically know what it is best at producing? I know the standard answer to this one: they don't, but they allow the free market to handle it. Industries which have an advantage in that country will flourish, those that don't will go bankrupt.
    - soVeryTired 10y ago
      That's a fair point. I can partly get behind that argument, but it does make some assumptions - for example, that barriers to entry for most industries are low, and that other industrial players won't attempt to drive out new entrants.
marcosdumay 10y ago
> But I have read about Ricardian comparative advantage. When I looked into the assumptions behind that model, I realised they were utter nonsense. I don't think I've ever seen anybody criticize Ricardian comparative advantage before. What assumptions did you find to be nonsense? Personally, I've always thought the model to be too simplistic (in the real world, there are often unrelated issues that have greater effects), but never could find a systematic flaw on the model itself.
- soVeryTired 10y ago
  I went into it a little bit in a reply to lmm
tpeo 10y ago
As far as I know, IS/LM hasn't been the keystone of anything since the 1970s. They've been mostly replaced by DSGE models for the purposes of macroeconomic policy. So I'm curious about what "standard macro models" you're referring to.
- soVeryTired 10y ago
  DSGE models tend not to be covered until the graduate level. When I said 'standard theory' I meant introductory macro rather than cutting-edge policy formulation. I'm open to correction though.
  - tpeo 10y ago
    Personally, I don't think something as old and as widespread as DSGE can be called "cutting-edge". Introductory macro, like any other introductory course, is always at least twenty years lagging behind standard theory, as used by large economic organizations (e.g. central banks, international agencies), and at least some twenty five to thirty behind the cutting-edge stuff. At least, that's the rule of thumb that I was taught. It's unfortunate for undergraduate students, who really don't get a taste of the hardcore econ. But I guess that's just how it is. But about Ricardian comparative advantage: it's a bad model. It's a gem of economic thinking, just like Ricardo's differential theory of rent. But as model, it just ignores so many things (pretty much all that you've pointed out) that it really isn't useful beyond a "first-order approximation" (much like IS/LM models). Ironically, it's a fine short-run model. You've asked about what the long-run is. Well, the long-run is when all inputs can be changed by the firms, whereas the short-run is when they can only change some of the inputs (e.g. labor and raw materials, as opposed to machinery). It doesn't really have a direct relationship with time, but the idea behind is that the varible inputs can be changed in a shorter time scale than the fixed inputs. But when everything but labor is fixed, that's just when comparative advantages kick in. On the other hand, comparative advantage simply can't handle stuff like technological advance, resource exhaustion, or pretty much anything which might change the productivity in any of the countries we're looking at. It wasn't conceived to deal with any of that, either. It was pretty much Ricardo's counter-example to the issue of whether trade would be profitable in the presence of absolute advantage, and one of his pet arguments against the Corn Laws.

lmm 10y ago

> But I have read about Ricardian comparative advantage. When I looked into the assumptions behind that model, I realised they were utter nonsense. In turn, that made me reluctant to believe anything else that economists wrote on the subject. Could you be more specific? It's a simplistic model sure, but just about every field of study or industry uses simplified models. As a first-order approximation it seems reasonable.

crdoconnor 10y ago
The theory of comparative advantage assumes comparative advantage is static. Either you have a rich industrial base or you don't. Either you have gold deposits or you don't. Either you have cheap labor or you don't. It falls to pieces once you consider that comparative advantage is dynamic. While gold deposits are either there or not, an industrial base can be built using judicious application of tariffs and subsidies. As with most assumptions in economics (e.g. perfect information), it serves a purpose, although that purpose isn't to simplify the models - but to aid in the creation of politically useful models.
krona 10y ago
General models the produce approximations are all well and good. The problem arises when economists pick a model to make a precise prediction, without nuance, about some event in the future or some trend over time; that's when people switch off. I think people in general people have learnt to be skeptical about economic forecasts, and that is only a good thing in my view. "About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know. Nevertheless, the necessity for action and for decision compels us as practical men to do our best to overlook this awkward fact.." -- Maynard Keynes
soVeryTired 10y ago
Sure. (as an aside if anyone can point out how to do proper bullet points I'll edit). Here's a non-exhaustive list of concerns that occur to me when I read e.g. the wikipedia page on comparative advantage. I'll happily admit my ignorance in this field. 1/ What is the nature of comparative advantage? Where does it come from? The standard explanations point to things like weather, but surely location-dependent industries are only a tiny fraction of modern economic output. 2/ Is comparative advantage fixed? To the best of my limited knowledge, heavy industry in the US civil war era was only able to grow because of trade barriers. If comparative advantage can vary over time, surely that implies a very different course of action to "specialise in what you're best at right now". 3/ How does a country automatically know what it is best at producing? 4/ What about cross-pollination of ideas between industries? 5/ What about diversification? Surely putting all your eggs in one industrial basket is a bad idea? Holland (and now Saudi Arabia, Nigeria, and others) specialised in oil production, which ultimately had nasty side effects on its economy. This is known as the Dutch disease. 6/ The usual claim is that "in the long run", everyone benefits. How long is the long run? How much suffering takes place in the short run? I mean, look what happened to Detroit. To address your "simple model" point: yes, many people do argue that "all models are wrong, but some are useful". If you're going to make that argument, you need a mechanisim for differentiating between bad and good models. I don't know of any such mechanism in economics. I'd be a whole lot happier with a series of detailed ethnographies than with a mathematical model. Some things are just too complicated for mathematics to handle.
- lmm 10y ago
  > 3/ How does a country automatically know what it is best at producing? I know the standard answer to this one: they don't, but they allow the free market to handle it. Industries which have an advantage in that country will flourish, those that don't will go bankrupt.
  - soVeryTired 10y ago
    That's a fair point. I can partly get behind that argument, but it does make some assumptions - for example, that barriers to entry for most industries are low, and that other industrial players won't attempt to drive out new entrants.

marcosdumay 10y ago

> But I have read about Ricardian comparative advantage. When I looked into the assumptions behind that model, I realised they were utter nonsense. I don't think I've ever seen anybody criticize Ricardian comparative advantage before. What assumptions did you find to be nonsense? Personally, I've always thought the model to be too simplistic (in the real world, there are often unrelated issues that have greater effects), but never could find a systematic flaw on the model itself.

soVeryTired 10y ago
I went into it a little bit in a reply to lmm

tpeo 10y ago

As far as I know, IS/LM hasn't been the keystone of anything since the 1970s. They've been mostly replaced by DSGE models for the purposes of macroeconomic policy. So I'm curious about what "standard macro models" you're referring to.

soVeryTired 10y ago
DSGE models tend not to be covered until the graduate level. When I said 'standard theory' I meant introductory macro rather than cutting-edge policy formulation. I'm open to correction though.
- tpeo 10y ago
  Personally, I don't think something as old and as widespread as DSGE can be called "cutting-edge". Introductory macro, like any other introductory course, is always at least twenty years lagging behind standard theory, as used by large economic organizations (e.g. central banks, international agencies), and at least some twenty five to thirty behind the cutting-edge stuff. At least, that's the rule of thumb that I was taught. It's unfortunate for undergraduate students, who really don't get a taste of the hardcore econ. But I guess that's just how it is. But about Ricardian comparative advantage: it's a bad model. It's a gem of economic thinking, just like Ricardo's differential theory of rent. But as model, it just ignores so many things (pretty much all that you've pointed out) that it really isn't useful beyond a "first-order approximation" (much like IS/LM models). Ironically, it's a fine short-run model. You've asked about what the long-run is. Well, the long-run is when all inputs can be changed by the firms, whereas the short-run is when they can only change some of the inputs (e.g. labor and raw materials, as opposed to machinery). It doesn't really have a direct relationship with time, but the idea behind is that the varible inputs can be changed in a shorter time scale than the fixed inputs. But when everything but labor is fixed, that's just when comparative advantages kick in. On the other hand, comparative advantage simply can't handle stuff like technological advance, resource exhaustion, or pretty much anything which might change the productivity in any of the countries we're looking at. It wasn't conceived to deal with any of that, either. It was pretty much Ricardo's counter-example to the issue of whether trade would be profitable in the presence of absolute advantage, and one of his pet arguments against the Corn Laws.