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Chapter 13
Economic Explanations
Paul Thagard
This chapter discusses explanation in a particular field, economics, and approaches
reflexivity in order to try to understand it in terms of psychological mechanisms, which
enables some interesting things to be said about economic change. It will also draw out
some of the implications for economics and also for more general questions regarding
explanations of social complexity.
Howard Raiffa, a famous decision theorist, and Ernest Nagel, a famous philosopher
of science, were both teaching at Columbia. One day Nagel encountered Raiffa in the
hallway. Raiffa was pacing up and down muttering to himself, “What should I do? What
should I do?” Nagel said, “Howard, what’s the problem?” Raiffa replied, “Oh, it’s really
difficult. I got a job offer and I just can’t decide whether to accept it or not.” Nagel, who did
a lot of work on probability theory, said, “Well, Howard, you’re one of the world’s greatest
experts on decision theory, so why don’t you draw out the decision tree? Why don’t you
plug in the probabilities and utilities, calculate how to maximize your expected utility, and
decide?” Raiffa looked back at him and said, “Ernest, this is serious.”
All of us have encountered serious problems in our lives: what job to take, whether
to go to graduate school, whether to get married, whether to get divorced, whether to have a
baby. If you have ever tried to use mathematical methods for this, you have encountered the
same problem that Raiffa did in this situation. This is relevant to economics because most of
economics for the last few decades, at least since the 1940s when von Neumann and
Morgenstern had a huge influence, has assumed something like rational choice theory: that
what individual consumers do and should do is to maximize their expected utility. This
operates at the microeconomic level of individuals, but what happens at the level of whole
societies in macroeconomics is also assumed to be an aggregate of that, so if you work out
the microeconomics, everything else will follow. The problem with this theory is that it is
not true. Some philosophers have worried about economics being unfalsifiable. Well,
rational choice theory is clearly falsifiable because it has been falsified.
I would say the same about creationism. It is not unfalsifiable, it is false. In the case
of creationism, there are alternative theories that provide much better explanations of the
evidence. That is unfortunately one of the big lacks in economics. Nevertheless, empirically,
economic theory has been shown to be false at the microeconomic level by a whole series of
experiments in behavioral economics and behavioral game theory.
At the macroeconomic level, the standard economic theory is also clearly false. The
problem is not just that the economists failed to predict collapses such as in 1999 and 2008,
it is that they predicted the opposite assumption. If people are being rational, and if there is
perfect information in society, then you simply cannot have a collapse, but you did, so that
is a falsification.