Keen on Collusion (3)

This is the third part of a (apparently getting more and more open ended) short series on Steve Keen's alleged debunking of the notion that under perfect competition you get higher quantities at lower prices compared to a monopoly situation. I say "alleged", because (a) his debunking is vigorously disputed, and (b) Keen is not to be the first to have discovered the flaw in the theory (see this comment on Worthwhile Canadian Initiative, for example).

In this episode of the saga I'd like to discuss this comment on the blog Unlearning Economics where the commenter tries to explain the flaws in the logic and math of the Keen/Standish[PDF] paper. In it they admit a few errors but otherwise defend their claims. As I wrote earlier, the logic and math is not what makes Keen's (re)discovery remarkable but the results of his computer simulation. After all, software doesn't have a bias unless it's actively programmed in, whereas "economist" and "bias" appear to be synonymous, at least if Moshe Adler is to be believed. Anyway, I take issue in particular with the following paragraph in the comment:

Then the [Keen/Standish] paper shows some simulations which are meant to support the claim that it is “optimal” for firms to choose collusion. Since the firms are not optimizing, just adjusting their quantities [in] some ad-hoc way in response to changes in their profits, it’s hard to tell what is driving the results. Then we see some attempt to refute Cournot result, but instead of going through standard Nash equilibrium computation (which doesn’t contain any mathematical mistakes – I’ve solved enough homeworks to be confident about this), Keen presents some convoluted model where firms respond to other firms choices in fixed proportion, and derives that optimal level of strategic interaction is zero. Only problem is that he again assumes that optimum = maximizing joint profits.

There's a problem in almost every sentence of this paragraph, so I try to address them one by one.

1. [It] is“optimal” for firms to choose collusion.
   Firms do not "choose collusion". Apart from the fact that that expression has a negative connotation (why would a value-free science call an outcome using a negatively loaded term?), is it not at least thinkable that the outcome called "collusion" is in fact the natural outcome (instead of positive "choice") of perfect competition, and that the one that economists claim (P=MC) is rather a result of their innate bias i.e. wishful thinking?
2. Since the firms are not optimizing, just adjusting their quantities in some ad-hoc way...
   Firms are optimizing (or rather maximizing). I wrote a simple simulator myself, and at the core of the simulation is the following equation evaluated by each firm:
   
   profit = quantity*(unitprice - unitcost(quantity))
   
   As the price is determined by the market, the only value that can be adjusted to maximize profit is the quantity. To increase profit, the quantity must be increased (price is > 0). But of course all other firms do the same thing (increase quantities to maximize profits), so the price may fall as a result, and hence profit. The firms do not know which quantity produces maximum profit (how would they?), and in any case that wouldn't help, because all other firms interfere with any prediction by their own production. So each firm continuously and individually boosts or throttles production depending on whether increasing/reducing production last time round helped to increase/decrease profit. This process is called profit maximization.
3. ...it’s hard to tell what is driving the results.
   No, it's not hard to tell what is driving the results: profit maximization is.
4. [Instead] of going through standard Nash equilibrium computation [...], Keen presents some convoluted model
   Of course, if you go through the Nash equilibrium formula you will guarantee the inherent result, because it is constructed that way. Keen's (software) model is not convoluted at all: even a high school kid with some basic programming skills can write a simulator that will yield the same result, because ... I don't know ... perhaps, this is simply the natural outcome of perfect competition, whereas the one that economists claim simply does not materialize, irrespective of how much they want it to be true. After all, a minimum wage does not lead to unemployment, either, despite every economist saying so. Perhaps economists are simply ... well ... wrong about stuff?
5. ...and derives that optimal level of strategic interaction is zero.
   If by "strategic interaction" the commenter means "collusion", why is it bad that there is none of it?
6. Only problem is that he again assumes...
   The software model assumes only (a) a falling demand curve, (b) market participants being price takers, and (c) absence of information sharing, a.k.a. "collusion" (i.e. no firm [taking] the quantity set by its competitors as a given [and evaluating] its residual demand [Wikipedia]).
7. ...that optimum = maximizing joint profits.
   Firms do not maximize joint profits. How could they? There is no notion of "joint profit" in my simulator (and neither, I presume, in Keen's), and believe me, unless you actively program that notion into your simulator, it does not appear out of nowhere. Instead, they maximize individual profits (see point 2 above). The only information flowing out of the single firm is its production quantity, and the only thing flowing into it is the price that the market determined, based on quantity and falling demand curve. Where would the joint thing come from? Stray electrons in the microprocessor? Perhaps the outcome of the simulator is the natural outcome of perfect competition, and the theory is simply wrong.

 Software does not lie. People with agendas do.

Update: As to the maximizing of joint profits (point 6 above): Even if it were true that firms in Keen's software did indeed end up maximizing "joint profits", why would that discredit his findings? Doesn't the so-called "invisible hand" accomplish the same thing without bothering economists at all? After all, they do claim that the pursuit of individual utility maximization will ultimately lead (through the divine magic of the invisible hand) to the maximization of "joint" utility...

Again, it appears that one of the inherent qualities of the "science" of economics is the twisting and turning of any argument as economists see fit. They don't want to know. They want to win.

Why I might read a first year economics book after all.

It appears that soon after I wrote a post on why I won't read an economics text book, ever, I got a comment by The Man Himself. Wow! Blogito ergo sum!! I'm alive!!!

Unless, of course, it was just an answer-bot.

Anyway, would this book suggested by Unlearning Economics (here) count as a first year economics book? Guess not, but I'll read it anyway. Would Mankiw do? He's an asshole [PDF], but I might — might! — read his Principles if I'll be able to steal it somewhere (download, not take from a bookstore without paying. I don't hurt people, only idiots).

Why I won't read a first year textbook on economics.

While researching material for my previous blog post "series" on the notion of collusion in competitive markets I came across an article by Nick Rowe asking people who comment on his blog to, please, read an economics textbook. In his post he gives a pretty accurate description of myself, perhaps except the "smart" thing:

You are probably very smart. You are probably very well-educated -- either formally, or self-educated, and probably both. You spend a lot of time on the internet reading economics blogs and commenting on those blogs. You maybe even have a blog of your own, where you write about economics topics. You are probably politically engaged. You are probably a lefty, but may be a righty, or someone who is not easily categorised on that political spectrum. You probably think of yourself as a critic of economics, or a critic of what you see as orthodox economics. You are probably sympathetic to what you see as heterodox economics.

But you have never once read a first year economics textbook.

Well, I have read The Cartoon Introduction to Economics (volumes one and two), but I guess they don't count. I have also read many books on economic topics by various people, among them many economists, mostly on specific aspects of the modern globalized economy:

• George Monbiot: Captive State
• Joseph E. Stiglitz: Globalization and its Discontents
• James K. Galbraith: The Predator State
• Naomi Klein: The Shock Doctrine
• Ha-Joon Chang: 23 Things They Don't Tell You About Capitalism
• Steve Keen: Debunking Economics
• Moshe Adler: Economics for the Rest of Us

...and on the financial crisis in particular:

• Matt Taibbi: Griftopia
• John Lanchester: Whoops!
• Yves Smith: ECONned

From these and other books that I cannot remember from the top of my head (and I'm too lazy to walk to the bookshelf to look up), but in particular from Steve Keen's Debunking Economics, I developed a sense that economics is not really a science but a theology (cult?) of the market. So while I am very sympathetic to Nick Rowe's wish, there is a reason why I won't read an economics textbook and actually would discourage anyone from doing so. The reason is simple:

Economics textbooks lie to you. Insidiously.

In his book Debunking Economics, Steve Keen describes many instances where economists' claims have been disproven by other economists, sometimes even those of the same school of thought, yet are still taught in textbooks as if they were still valid. Sometimes they ignore the refutation (no mention in the textbook), sometimes they muddy the waters (as in "the conditions for the claim to be valid are beyond the scope of this discussion"), but sometimes they simply lie (as in "is this claim valid? It certainly is!"). Sometimes they massage the assumptions in a way that makes "true" after all, what had been logically disproven (as in "if we don't find a direct road from A-town to B-ville, let's rename C-city to B-ville, because now there is"). Other claims cannot be justified when contrasted with the real economy ("minimum wage leads to unemployment"), or cannot be replicated when simulated in software ("in a perfect competition, price equals marginal cost"). Sometimes a valid theory has been (silently) replaced by another theory because one of the implications contradicted the dogma, even if — as Moshe Adler writes — "each economics professor is left to invent his own parable" because there is no evidence for their claims.

I am quite certain that I would be able to read a book on, say, Dyanetix — a term that I just made up and bears no relationship to any existing concept or method whatsoever — without becoming a follower of that concept, because the notions in this book would likely be so patently absurd that no sane people would accept them. I am quite immune to bullshit.

But if I read a book on, say, a historic event where the author would take some liberty with facts, assumptions and causes, I'd have no way of telling if and how I was being misled. My desire to learn would be insidiously exploited to implant false facts and ultimately false thoughts into my mind. Facts would blend with fiction to create a pseudo-history that starts shaping my experience of the world, perhaps even to my detriment.

This is exactly the case with economics textbooks. I have no way of telling whether a certain claim is reasonable (because it might contradict the evidence — irrespective of whether it appears logical) or whether a certain assumption is permitted (as it might predispose a certain outcome). Strangely enough, in mathematics or physics textbooks even the most innocuous claim is routinely subjected to a rigorous mathematical proof, whereas in economics textbooks, where they would be most needed to expose sometimes rather blatant distortions, they are (deliberately?) omitted even for grand claims and theories that affect whole national economies and the livelihoods of whole peoples.

Here's a proposition: What if a couple of economics professors of different economic factions — some orthodox, some heterodox — came together and wrote an economics textbook describing the economic mainstream that is taught in economics classes around the world, but in a manner that allows the reader to see which parts are disputed. For example, theories that have been logically disproven or that contradict the empirical evidence would be printed in red, hypotheses that have no supporting evidence or whose validity are disputed would be printed in blue, and so on. Of course, the logical flaws and the grounds of the dispute would have to be listed. Uncontested parts could remain in black ink. If there are alternative theories to the mainstream ones, they'd be contrasted side by side. This way the reader would get all the alleged benefits of being exposed to the mainstream economic thought without being misled or brainwashed with claims that are contradicted by logic, evidence or other economics. Now, that is a textbook I'd be more than happy to read!

Update: It appears that such a textbook does indeed exist! I just bought the The Economics Anti-Textbook by Rod Hill and Tony Myatt, and in it, they argue that the claim of economics to be a value-free science is a myth. The book is a guide to decoding the textbooks, it reveals the hidden value judgements, ignored evidence and unmentioned alternative theories. Exactly what I was looking for. It just moved to the top of the stack of books to be read.