# Economics Rules ## Metadata * Author: [Dani Rodrik](https://www.amazon.comundefined) * ASIN: B00TIZFO90 * Reference: https://www.amazon.com/dp/B00TIZFO90 * [Kindle link](kindle://book?action=open&asin=B00TIZFO90) ## Highlights What makes a model useful is that it captures an aspect of reality. What makes it indispensable, when used well, is that it captures the most relevant aspect of reality in a given context. — location: [180](kindle://book?action=open&asin=B00TIZFO90&location=180) ^ref-7111 --- When models are selected judiciously, they are a source of illumination. When used dogmatically, they lead to hubris and errors in policy. — location: [184](kindle://book?action=open&asin=B00TIZFO90&location=184) ^ref-24084 --- A modeler builds an artificial world that reveals certain types of connections among the parts of the whole—connections that might be hard to discern if you were looking at the real world in its welter of complexity. — location: [193](kindle://book?action=open&asin=B00TIZFO90&location=193) ^ref-38119 --- The correct answer to almost any question in economics is: It depends. Different models, each equally respectable, provide different answers. — location: [243](kindle://book?action=open&asin=B00TIZFO90&location=243) ^ref-41137 --- Models do more than warn us that results could go either way. They are useful because they tell us precisely what the likely outcomes depend on. — location: [244](kindle://book?action=open&asin=B00TIZFO90&location=244) ^ref-25668 --- “The word ‘model’ sounds more scientific than ‘fable’ or ‘fairy tale’ [yet] I do not see much difference between them.” — location: [275](kindle://book?action=open&asin=B00TIZFO90&location=275) ^ref-56715 --- An economic] model always tells a story.” — location: [277](kindle://book?action=open&asin=B00TIZFO90&location=277) ^ref-51422 --- Nancy Cartwright, the philosopher of science, uses the term “fable” in relation to economic and physics models alike, though she thinks economic models are more like parables.7 Unlike fables, in which the moral is clear, Cartwright says that economic models require lots of care and interpretation in drawing out the policy implication. This complexity is related to the fact that each model captures only a contextual truth, a conclusion that applies to a specific setting. — location: [278](kindle://book?action=open&asin=B00TIZFO90&location=278) ^ref-2995 --- As the Finnish philosopher Uskali Mäki explains, the economics modeler in fact practices a similar method of insulation, isolation, and identification. The main difference is that the lab experiment purposely manipulates the physical environment to achieve the isolation needed to observe the causal effect, whereas a model does this by manipulating the assumptions that go into it.§ Models build mental environments to test hypotheses. — location: [298](kindle://book?action=open&asin=B00TIZFO90&location=298) ^ref-21384 --- As with real experiments, the value of models resides in being able to isolate and identify specific causal mechanisms, one at a time. That these mechanisms operate in the real world alongside many others that may obfuscate their workings is a complication faced by all who attempt scientific explanations. Economic models may even have an advantage here. — location: [323](kindle://book?action=open&asin=B00TIZFO90&location=323) ^ref-44848 --- Milton Friedman, one of the twentieth century’s greatest economists, provided an answer in 1953 that deeply influenced the profession.10 Friedman went beyond arguing that unrealistic assumptions were a necessary part of theorizing. He claimed that the realism of assumptions was simply irrelevant. Whether a theory made the correct predictions was all that mattered. — location: [332](kindle://book?action=open&asin=B00TIZFO90&location=332) ^ref-55621 --- What exactly is a critical assumption? We can say an assumption is critical if its modification in an arguably more realistic direction would produce a substantive difference in the conclusion produced by the model. — location: [351](kindle://book?action=open&asin=B00TIZFO90&location=351) ^ref-20585 --- Math essentially plays two roles in economics, neither of which is cause for glory: clarity and consistency. — location: [396](kindle://book?action=open&asin=B00TIZFO90&location=396) ^ref-871 --- Remember: it is a model, not the model. — location: [524](kindle://book?action=open&asin=B00TIZFO90&location=524) ^ref-51358 --- As Borges’s story illustrates, the argument that models need to be made more complex to make them more useful gets it backward. Economic models are relevant and teach us about the world because they are simple. Relevance does not require complexity, and complexity may impede relevance. Simple models—in the plural—are indispensable. Models are never true; but there is truth in models.23 We can understand the world only by simplifying it. — location: [531](kindle://book?action=open&asin=B00TIZFO90&location=531) ^ref-58757 --- “Models Are Experiments, Experiments Are Models,” Journal of Economic Methodology — location: [545](kindle://book?action=open&asin=B00TIZFO90&location=545) ^ref-30527 --- For a relatively informal introduction to the theory, see Paul Milgrom, “Auctions and Bidding: A Primer,” Journal of Economic Perspectives 3, no. 3 (Summer 1989), 3–22. A more thorough treatment can be found in Paul Klemperer, Auctions: Theory and Practice (Princeton, NJ: Princeton University Press, 2004). — location: [563](kindle://book?action=open&asin=B00TIZFO90&location=563) ^ref-55861 --- Second, models enable the accumulation of knowledge, by expanding the set of plausible explanations for, and our understanding of, a variety of social phenomena. — location: [582](kindle://book?action=open&asin=B00TIZFO90&location=582) ^ref-25240 --- The First Fundamental Theorem of Welfare Economics is colloquially known among economists as the Invisible Hand Theorem. — location: [602](kindle://book?action=open&asin=B00TIZFO90&location=602) ^ref-45220 --- Unexpected results also accrue from the economics of “second best.” The General Theory of Second Best is among the most useful in the tool kit of applied economists, and perhaps the least intuitive to the untrained mind. — location: [710](kindle://book?action=open&asin=B00TIZFO90&location=710) ^ref-48066 --- Knowledge accumulates in economics not vertically, with better models replacing worse ones, but horizontally, with newer models explaining aspects of social outcomes that were unaddressed earlier. — location: [800](kindle://book?action=open&asin=B00TIZFO90&location=800) ^ref-54160 --- We have moved beyond competitive models to imperfect competition, asymmetric information, and behavioral economics. Idealized, flawless markets have given way to markets that can fail in all sorts of ways. Rational behavior is being overlaid with findings from psychology. — location: [829](kindle://book?action=open&asin=B00TIZFO90&location=829) ^ref-36351 --- Both the generality and the testability of economic propositions are limited. Economic science is merely disciplined intuition—intuition rendered transparent by logic and hardened by plausible evidence. — location: [938](kindle://book?action=open&asin=B00TIZFO90&location=938) ^ref-33935 --- “The whole of science,” Einstein once said, “is nothing but a refinement of everyday thinking.”21 At their best, economists’ models provide some of that refinement—and not much more. — location: [939](kindle://book?action=open&asin=B00TIZFO90&location=939) ^ref-36223 --- economics as a science advances “horizontally” (by multiplying models) rather than “vertically” (by newer ones replacing older ones). ** — location: [960](kindle://book?action=open&asin=B00TIZFO90&location=960) ^ref-45207 --- “None of the laws of physics known today (with the possible exception of the general principles of quantum mechanics) are exactly and universally valid. Nevertheless, many of them have settled down to a final form, valid in certain known circumstances. The equations of electricity and magnetism that are today known as Maxwell’s equations are not the equations originally written down by Maxwell; they are equations that physicists settled on after decades of subsequent work by other physicists. . . . They are understood today to be an approximation that is valid in a limited context . . . but in this form and in this limited context they have survived for a century and may be expected to survive indefinitely. This is the sort of law of physics that I think corresponds to something as real as anything else we know.” Weinberg, — location: [962](kindle://book?action=open&asin=B00TIZFO90&location=962) ^ref-2698 --- What makes economics a science is models. It becomes a useful science when those models are deployed to enhance our understanding of how the world works and how it can be improved. — location: [1000](kindle://book?action=open&asin=B00TIZFO90&location=1000) ^ref-27151 --- The truly critical assumption here is that firms have market power in one case and not in the other. In the monopolistic model they think they can raise the market price by restricting supply, whereas in the competitive model they hold no such hope. — location: [1147](kindle://book?action=open&asin=B00TIZFO90&location=1147) ^ref-8970 --- But all models of market economies presume the existence of various social, legal, and political institutions. Property rights and contracts must be enforced, fair competition must be ensured, theft and extortion must be prevented, and justice must be administered. Where those institutional underpinnings are nonexistent or weak, as in much of the developing world, freeing up markets not only fails to deliver the expected results, but also can backfire. — location: [1160](kindle://book?action=open&asin=B00TIZFO90&location=1160) ^ref-35629 --- Simplicity is, in fact, a requirement of science. Every explanation, hypothesis, causal account is necessarily an idealization; it leaves many things out so that it can focus on the essence. The term “analysis” itself has its roots in Greek, where it signifies the breaking of complex things into simpler elements. It is the antonym of “synthesis,” which refers to combining things. Neither analysis nor synthesis is possible without these simpler components. Simple need not mean simplistic, of course. As Einstein is supposed to have said, “Everything should be made as simple as possible, but no simpler.” — location: [2050](kindle://book?action=open&asin=B00TIZFO90&location=2050) ^ref-22253 --- Then there is the criticism that economists’ theories cannot be properly tested. Empirical analysis is never conclusive, and invalid theories are rarely rejected. The discipline hobbles from one set of preferred models to another, driven less by evidence than by fads and ideology. Insofar as economists present themselves as the physicists of the social world, this criticism is deserved. As I explained earlier, however, comparisons to natural sciences are misleading. Economics is a social science, which means that the search for universal theories and results is futile. A model (or theory) is at best contextually valid. Expecting general empirical validation or rejection makes little sense. — location: [2093](kindle://book?action=open&asin=B00TIZFO90&location=2093) ^ref-51477 --- Economics advances also by better methods of model selection—improving the match between model and real-world setting. As I explained in Chapter 3, this is more a craft than a science, and one that does not get the attention it deserves in economics. But the advantage of working with models is that the elements required for model selection—the critical assumptions, the causal channels, the direct and indirect implications—are all transparent and laid bare. These elements enable economists to check the correspondence between the model and the setting, informally and suggestively, even if not formally and conclusively. — location: [2100](kindle://book?action=open&asin=B00TIZFO90&location=2100) ^ref-8504 --- Because self-interest features prominently in economic models, economists exhibit a bias toward incentive-based solutions to public problems. Consider climate change and the question of how to address carbon emissions. Public opinion varies greatly, but economists are virtually unanimous: they recommend either taxing carbon or implementing a close equivalent, a quota on carbon emissions with trading of emission allowances among producers.‡ In both cases the aim is to make it more expensive and hence less profitable for firms to use carbon. To economists, the policy is the correct one because it acts on the relevant margin. Firms fail to take into account the environmental effects of their decisions, so the right response is to force them to “internalize” the external costs by paying for carbon. — location: [2150](kindle://book?action=open&asin=B00TIZFO90&location=2150) ^ref-788 --- Putting a price on the good things in life can corrupt them. That’s because markets don’t only allocate goods; they express and promote certain attitudes toward the goods being exchanged. Paying kids to read books might get them to read more, but might also teach them to regard reading as a chore rather than a source of intrinsic satisfaction. Hiring foreign mercenaries to fight our wars might spare the lives of our citizens, but might also corrupt the meaning of citizenship.5 — location: [2161](kindle://book?action=open&asin=B00TIZFO90&location=2161) ^ref-63370 --- I mentioned in passing in Chapter 2 an unexpected real-life experiment that caused quite a stir among economists. To reduce tardiness, an Israeli day care had instituted a penalty for parents who showed up late to pick up their children. This policy was in line with what economists would have recommended: if you want to reduce a behavior, make it more costly for the individuals who exhibit the behavior. To virtually everyone’s surprise, tardiness actually increased after the penalty was put in place. Apparently, now that there was a fee, parents felt it was OK to show up late. — location: [2172](kindle://book?action=open&asin=B00TIZFO90&location=2172) ^ref-14894 --- For example, economists often argue that the removal of fuel subsidies in developing countries would enhance distributional equity alongside efficiency. The reason is that subsidies not only cause overconsumption of fuel (which is the source of their inefficiency), but also benefit mostly the well-to-do (who are the main users of the subsidized fuel). But such arguments have to be demonstrated empirically, on a case-by-case basis. Is efficiency a good thing? Yes it is, taken on its own. We can say without hesitation that efficiency is a consideration—a value—worth taking into account when we compare alternative social states. But it is certainly not the only one. Equity would be another contending value, as would be the intrinsic moral value of other-regarding and socially responsible behaviors. Sometimes these considerations push us in the same direction as efficiency, and therefore reinforce the case for markets. At other times there may be tensions and trade-offs to consider. — location: [2200](kindle://book?action=open&asin=B00TIZFO90&location=2200) ^ref-5902 --- Questions of justice, ethics, fairness, and distribution are tangled up in all of them. Is it necessarily fair to push for free trade if the beneficiaries are predominantly wealthy individuals and the losers are some of the poorest workers in our society? Is it fair to reap the benefits of outsourcing from poor countries where workers lack fundamental rights and toil under hazardous workplace conditions? The 90-plus percent of economists who agreed with these statements must either have been unaware of these questions or consistently subsumed them under efficiency considerations. Either way, there is a problem. Even assuming that the efficiency consequences can be readily and universally predicted—and the concerns I raised in the previous chapter can be downplayed—economists are, without doubt, overreaching in these particular areas. — location: [2219](kindle://book?action=open&asin=B00TIZFO90&location=2219) ^ref-38244 --- Just as today’s advocates of markets overlook the limits of efficiency, perhaps the critics neglect some of the ways in which markets contribute to a spirit of cooperation. — location: [2239](kindle://book?action=open&asin=B00TIZFO90&location=2239) ^ref-49892 --- How do we understand these complaints in light of the patent multiplicity of models within economics? The trouble from the students’ perspective is that much of what goes on in an introductory course in economics is a paean to markets. It gives little sense of the diversity of conclusions in economics, to which the student is unlikely to be exposed unless she goes on to take many more economics courses. Economics professors are charged with being narrow and ideological because they are their own worst enemy when it comes to communicating their discipline to outsiders. Instead of presenting a taste of the full panoply of perspectives that their discipline offers, they focus on benchmark models that stress one set of conclusions. This is particularly so in introductory courses, where the professor is keen to demonstrate how markets work. As the Oxford economist Simon Wren-Lewis points out, “One of the sad things about the way economics is often taught is that students do not see much of the interesting stuff that is going on [in the discipline].”10 Can one fault students for demanding an alternative perspective? I — location: [2254](kindle://book?action=open&asin=B00TIZFO90&location=2254) ^ref-49496 ---