The central attribute of modern economics
Vinod Anand | 20 Mar 2012

If content does not define modern economics, what does? It is method. The same modern economics that is enormously broad in its acceptance of various assumptions and content is extremely narrow when it comes to method.

AS SOLOW (1997) spells out, and as Niehans (1990) emphasizes, the modeling approach to problems is the central element of modern economics. Solow writes: "Today, if you ask a mainstream economist a question about almost any aspect of economic life, the response will be: suppose we model that situation and see what happens. . . . There are thousands of examples; the point is that modem mainstream economics consists of little else but examples of this process".

Modeling is not seen as an end in itself; there is a continual discussion of the need to empirically test, and the formal modeling is undertaken in large part to make the models empirically testable, and applicable to policy, with formal statistical techniques.Given the changes in economics, the 'study of the allocation of scarce resources' definition of economics no longer describes what economists do. A better definition would be 'The study of the economy and economic policies through empirically testable models.' An alternative definition comes from Keynes: 'Economics is the science of thinking in terms of models joined to the art of choosing models which are relevant to the contemporary world.'

The point of these new definitions is that they do not consider content; they consider the approach used. Modern economics is economics of the model.

A model for every pupose" To say that modern economics follows a modeling approach is not to say that other periods did not use models. Economists have always used models. But there is a distinction in how the models are used, to see the distinction between modern economists' use of models and earlier economists'; it is useful to distinguish between pure theory models and applied policy models. Formal modeling has always been the essence of pure-theory of economics' the metaphysics, or science, depending on one's view.

For example, Quesnay, Ricardo, Cournot, and Walras all simplified their views to develop a theoretical model. Modern pure theory has evolved from the general equilibrium theory of Walras to the general equilibrium of Arrow/Debreu, but the modeling approach has not changed. These pure theory models are highly formal and mathematically deep. But such formal models are not the type of models that the large proportion of economists deal with.It is in applied policy where modern economics differs from earlier economics. In previous time periods, economists such as Smith or Marshall kept the theory in the back of their minds, and thought about the policy problem as an art. Their models were kept in the background, and reasonableness 'critical thought' was emphasized in applying the models.

Applied policy belonged in what J.N. Keynes (1897) called the art of economics. In the art of economics the pure theory model served as a backdrop, but one approached problems in an informal way. Formal empirical testing of such loose models was impossible, but one could easily include non-quantifiable variables and sensibilities in one's policy consideration.In modern economics that has changed. There is no art of economics in which policy problems are addressed in an informal manner. Modern applied policy models must be specified in a way that can be directly empirically tested, at least in principle. While such models are informal by mathematical standards, they are formal by artistic standards, which is why some observers call modern economics formalist.Ironically, the modern modeling approach grew out of the Keynesian macroeconomics of the 1930s and Marshall's practical policy approach to problems. It is a blend of the Keynesian and Marshallian visions of economics with the twist that the models are specified in such a way that they are subject to econometric testing.

But, in specifying the models so that they are subject to econometric testing, the current approach fundamentally alters the Marshallian approach to policy. The simplified models are moved up to center stage, and the judgment, embodying the blending of the assumptions kept in the back of one?s mind which lead to the model?s results, is moved to a side stage.Another aspect of modern applied policy modeling is that, with the exception of work in computable general equilibrium, these models pay almost no heed to consistency with general equilibrium theory. New work in micro emphasizes the development of a variety of practical models, such as the asymmetric pricing model, that are relevant for specific problems, but make no claim that, and give little thought to whether, they are general-equilibrium consistent.

Modern applied microeconomics consists of a collection of models with a model for every purpose.Practical models were not always divorced from pure theory models. In the 1950s and 1960s, it was hoped that practical models would be guided by general equilibrium theory. Thus, when Arrow/Debreu proved the existence of a general equilibrium in 1957, there was hope that the pure science of economics would progress in tandem with the practical application of that science. By the 1970s economists recognized that the Arrow/Debreu general equilibrium work was not going to get to the Promised Land. That recognition freed economists to deal with practical policy models that were inconsistent with general equilibrium theory.In my view that recognition accounts for the developments of new growth theory, new trade theory, and other partial equilibrium models that are inconsistent with formal general equilibrium models.