What Economists Knew About Knowing

In his excellent book, Knowledge and the Wealth of Nations, economics journalist David Warsh lays out the fascinating back story (in a broad sense) of a single important economics paper – “Romer 1990”. In this paper, titled “Endogenous Technological Change”, Paul Romer lays out a new model for understanding the growth of a nation which finally brought knowledge – in the form of improvements in technology – into the model. Previous growth models (such as the famous Solow model) had left such improvements to the ‘residual’, and thus failed to explain a great deal of the changes that occurred in 20th century economies.

(Warning – this post is rather lengthy!)

According to Warsh, Romer was not by any means the first Economist to take up the story of technological change and place it at the center of explanations for growth. Warsh refers to an “underground river” of thought that actually rises to the surface. Until Romer, however, none of these moments and places where that river of thought came into light did it take hold of mainstream economics. Warsh argues that, before Romer, none of the proponents of a knowledge-led growth theory were at the mathematical forefront, and given economics ever rising mathematical demands on its theorists, none of these proponents were taken seriously. Indeed, the underground river goes back as far as Adam Smith, in some readings. Smith’s famous pin factory story (which argues that the division of labor in a pin factory, say, achieves dramatic gains in productivity) is in some sense a story about knowledge. Workers in the pin factory are more efficient than a solo blacksmith in part because they develop better methods for doing the same task over and over. Everyday innovation thus produces the economies of scale often discussed (though apparently less often modeled until the modern era).

One example of this underground river might be this lovely lecture “The Economics of Knowledge and the Knowledge of Economics” given by economist and social thinker (for lack of a better term) Kenneth Boulding. Boulding was an early proponent of an evolutionary, as opposed to equilibrium, model of economics, an approach that emphasizes change over stability. Here’s a nice quote on the evolutionary as opposed to equilibrium perspective (yanked from wikipedia, excuse any errors):

Prediction of the future is possible only in systems that have stable parameters like celestial mechanics. The only reason why prediction is so successful in celestial mechanics is that the evolution of the solar system has ground to a halt in what is essentially a dynamic equilibrium with stable parameters. Evolutionary systems, however, by their very nature have unstable parameters. They are disequilibrium systems and in such systems our power of prediction, though not zero, is very limited because of the unpredictability of the parameters themselves. If, of course, it were possible to predict the change in the parameters, then there would be other parameters which were unchanged, but the search for ultimately stable parameters in evolutionary systems is futile, for they probably do not exist…. Social systems have Heisenberg principles all over the place, for we cannot predict the future without changing it. (1981, p. 44)

The problem then, for Boulding, is that the inputs to our social scientific models are not stable like the inputs to models in physics. There is no particular reason to believe in a stable relationship between labor and capital inputs in auto manufacturing, say, unlike between the mass of two planets and the force exerted on them by gravity. I believe this observation extends well beyond the economic sphere. Race, class and gender, to cite the other holy trinity in sociology*, are not stable quantities (as we sociologists have been saying for decades), but rather fluid, socially constructed realities. In the parlance of our times, they are not “things” in the same way that asteroids and stars are “things”. Thus, we should have no expectation that they would play the same roles in the same proportions over time, making the assumptions underlying our mathematical models tenuous at best, and counterproductive at worst.

In the lecture on “The Economics of Knowledge and the Knowledge of Economics”, Boulding highlights how knowledge (meaning ideas or mental “images”, not necessarily truths) is like and unlike other commodities studied by economists**:

Another difficulty is that only things which are clearly capable of being appropriated are subject to being exchanged, and if a thing cannot be property, it obviously cannot be a commodity. While knowledge has many of the aspects of property, its capacity for reproduction in many minds and its accessibility in the form of the published word make it a very peculiar form of property. Thus as Major John Wesley Powell said to a congressional committee in 1886: “Possession of property is exclusive; possession of knowledge is not exclusive, for the knowledge which one man has may also be the possession of another.” In spite of Major Powell’s dictum, some knowledge, of course, is exclusive, such as trade secrets and patents, and thereby becomes property. What is perhaps even more important, knowledge which has the capacity of generating more knowledge in a single head is also exclusive and becomes property to the individual possessing it.

I do not know the history of the debates over intellectual property as well as I would like to, or hope to in the future, but this strikes me as an excellent foray into that field, although one aimed squarely at the economics profession rather than the political world.

Boulding goes on to divide knowledge work into two processes, “printing” and “organizing”. Printing refers to the reproduction of knowledge or structure as if by rote learning. Printing is incapable of producing new thoughts, but simply puts old ones into new heads. Boulding considers mass production a form of this printing – an idea is reproduced over and over again in physical form. The second process, organizing, involves the creation of new structures, or “the way in which an idea creates an organization, or an image of the future governs an individual life.” When economics professor Dani Rodrik teaches his model for development to his graduate students at Harvard, that’s printing. When those students go and run non-profit organizations and governments and attempt to implement his ideas (we can hope!), that’s organizing. Oddly, this twofold model of printing and organizing places little emphasis on truly new ideas, and the reader is left to wonder where (for example) Rodrik’s theory came from in the first place. Are all ideas merely the descendents of early ones, newly formed in a process of organizing? This evolutionary model makes sense for some kinds of science, which exhibits at least a bit of linearity in its progression, but might not make sense for literature, say. Authors have influences, but I do not think we want to call them mere organizers drawing forming earlier ideas into new structures. Then again, maybe we do, if the adages concerning the lack of original plots are to be believed anyway.

In any event, Boulding’s model of knowledge is an interesting and productive one, in my mind. Boulding also uses this emphasis on knowledge to recast traditional economic models of behaviors, in a manner anticipating somewhat the approach of psychologists Kahneman and Tversky***:

The study of decision, therefore, must concentrate on how these images of the future are derived from the information inputs of the past, as this is the only place from which they can come. That is, we have to think of our images of the future as essentially learned out of our inputs from the past, and the nature of this learning process is therefore of overwhelming importance. Similarly, the utility or welfare function, which we impose over these images of the future, is likewise learned, though economists have been surprisingly unwilling to recognize this fact, perhaps because it was called to their attention in such strident tones by Veblen, who argued most convincingly, to my mind, that if we wanted to have a dynamic economics, we could not simply take preferences for granted but had to regard them as essentially learned.

Here Boulding draws on the early 20th century ‘heterodox’ economist Thorstein Veblen, famous for his book “The Theory of the Leisure Class” who, amongst other things, coined the term “conspicuous consumption” and emphasized the importance of status as a motivator of consumption. Boulding does not propound this specific view of consumption, but rather seeks to motivate a prolonged discussion within economics about where preferences do come from and how they work. I believe that this assumption of exogenous preferences remains one of economics great limitations, though it may be fortunate for those critics in places like Sociology or cultural studies who wish to gain traction in a world increasing dominated by economistic thinking. If economists cannot explain where preferences come from, and indeed on some level admit that those preferences are highly mutable, then we are led to question those theorems which naively seek to satisfy those preferences.

For example, in a paper that I will probably give an entire post to at some point because I simply love it, game theorist Thomas Schelling, famous for his work on the cold war arms race, argues in a 1984 lecture “Self-Command in Practice, in Policy, and in a Theory of Rational Choice” that people exhibit a great many strange behaviors of a similar type: acting strategically against their future self. For example, Schelling might ask his friends to deny him a cigarette should he request one as he is trying rather hard to quit. Here we have an example of an actor’s current set of preferences directly conflicting with his future ones, to the extent that the actor goes out of his way to deny himself his future desire. And indeed, this behavior is quite common, from dieting to quitting smoking to asking an OB/GYN to deny painkillers during birth.

Taken together, Veblen, Boulding and Schelling all point towards a problem in the economic model. When applied to the actions most associated with it – firms maximizing profits, individuals trading off income and leisure, the economic models seem to make a great deal of sense, at least as first approximations. But when broadened out into an entire theory of human behavior, the models fall woefully short. Without an understanding of where preferences come from (be it psychological, like Kahneman and Tversky, or sociological, like Bourdieu’s understanding of habitus), economics ends up making some silly predictions and not being too useful when applied to a number of problems.

And indeed, Boulding notes this problem in economics, and in particular, the problems of taking the assumption of rationality too far.

The general movement towards the rationalization of decision-making processes in both private and public life through the use of optimizing procedures applied to complex masses of information may have some other costs lurking among the benefits, particularly in regard to political decision making. For one thing, these elaborate procedures may easily produce a sense of subjective certainty, which is quite unwarranted by the uncertainties of the actual system. One worries about this particularly in the international system, where the principle that “he who hesitates is saved” is usually very sound, and an illusion of certainty can be quite disastrous. The use of political war games and of computer simulation in the Department of Defense is a genuine cause for alarm on this score, and one would very much like to see some studies of the effect of gaming, for instance, on business behavior. It could easily be that the euphoria produced by these exercises resulted in some disastrous decisions, though I have not been able to document this hypothesis. The great danger of rationality is of course suboptimization; that is, finding and choosing the best position of part of the system which is not the best for the whole. Too many people, indeed, and especially too many experts, devote their lives to finding the best way of doing something that should not be done at all. Decision making by instinct, gossip, visceral feeling, and political savvy may stand pretty low on the scale of total rationality, but it may have the virtue of being able to take in very large systems in a crude and vague way, whereas the rationalized processes can only take subsystems in their more exact fashion, and being rational about subsystems may be worse than being not very rational about the system as a whole. I would not argue, of course, that rationality about the system as a whole is impossible. On the other hand, the economist has a certain mind-set in favor of his own skills, and it is easy for him to leave out essential variables with which he is not familiar. Here, indeed, a little learning may be a dangerous thing, or even a little rationality.

Boulding presents one excellent and important example of the dangers of thinking you know more than you do in the terms of the GNP statistics:

Our great gift to the world is national income statistics and the percentage rate of growth of GNP. In fact, as every economist knows, calculations of GNP, especially in the poor countries, are largely exercises in the statistical imagination, and even if they were accurate, the GNP itself can be a very poor measure of welfare. The GNP can rise because of arms races, because of stupid dam-building, or even through the building of presidential palaces. It can be rising because a small proportion of a population is getting better off while the vast majority remain in stagnant misery. Valuable as the GNP is, therefore, as a rough overall measure of economic success, it can easily become a fetish and a quite misleading statistic.

It is this certainty that worries me, and motivates in many ways my study of economics and economists. Given that economic knowledge is often acted upon and made real (creating a “Heisenberg Principle” effect in the social world, perhaps analogous to the “looping effects” discussed by philosopher Ian Hacking but not only at the level of the individual), perhaps we need a bit more skepticism and a bit less faith when it comes to that knowledge. Boulding called for that in 1966, and I echo that call now.

*The first being, of course, Marx, Weber and Durkheim.

**Interestingly, like earlier political economists and later economic sociologists (and Karl Polanyi, amongst others), Boulding rejects the notion of a separate economic sphere which is to be the province solely of economists. He defines the econosphere as “that subset of the sociosphere, or the sphere of all human activity, relationships, and institutions, which is particularly characterized by the phenomenon of exchange.” I like this notion of subset as a strong form of the ’embeddedness’ discussed so frequently by contemporary economic sociologists. This contemporary usage of the embeddedness concept has been critiqued by Greta Krippner, amongst others, for letting the economic sphere off easy, in a sense, by still thinking of the market as a separate sphere that touches on the political and social, rather than one that is completely dependent on the rest of the social sphere for its functioning at every level. Markets are not made imperfect because they exist in the social world but rather depend entirely on the social world, and not easily separable for it.

***K&T won the Nobel Prize in economics for showing how people predictably deviate from ‘rationality’, in particular due to ‘framing effects’ and risk and loss aversion.