[This is from a larger draft-paper on the history of economics and reflexivity. I blogged about the paper before.]
Another way in which economics is reflexive is in turn divided in three kinds. Economics offers self-fulfilling prophecies, self-refuting prophecies, and what I call philosophic prophecies.These three are structurally akin, but describe slightly different aspects. All three are meant to capture the kind of priestly role of contemporary policy economics. Public pronouncements by economists – preferably brandishing mathematical formulas that are almost impossible to understand for lay-people – play a kind of oracular function in contemporary social life.
[None of this is to deny the possibility of successful predictions (that don’t meaningfully change the path of the underlying system). We can understand the important paper by E. Grunberg & F. Modigliani (1954) “The Predictability of Social Events,”, and J.F. Muth’s (1961) “Rational Expectations and the Theory of Price Movements,”, as characterizing precise (and rather infrequent) circumstances in which this can take place. As Wade Hands points out, Herbert A. Simon (1954) “Bandwagon and Underdog Effects and the Possibility of Election Predictions” does something similar. See W. Hands (1990) “Grunberg and Modigliani, Public Predictions and the New Classical Macroeconomics” Research in the History of Economic Thought and Methodology, 7: 207-223.]
I. “The self-fulfilling prophecy is,” according to sociologist of science, Robert K. Merton, “in the beginning, a false definition of the situation evoking a new behaviour which makes the original false conception come 'true'. This specious validity of the self-fulfilling prophecy perpetuates a reign of error. For the prophet will cite the actual course of events as proof that he was right from the very beginning.” Economic phenomena prominently influenced the development of Merton’s ideas (he was interested in bank runs, among others). One can think of it as a kind of placebo effect on large-scale social phenomena. Among philosophers, Popper, especially, was fascinated by this aspect of theory. In recent years, the sociologist of knowledge, Donald MacKenzie, has investigated and made popular what he calls (in a nod to J.L. Austin) “the performative” aspects of finance theory (in particular the rational option’s pricing theory co-developed by Merton’s son, the so-called Black- Scholes-Merton formula). In accord with the principles of the Edinburgh school in sociology, MacKenzie does not like appealing to truth and falsity, but prefers the language of construction.
II. Self-refuting prophecies build on and then reverse Merton’s self-fulfilling prophecy: a true description of the situation evokes behavior which makes the originally true conception eventually come out false. An admirer of Popper, George Soros, has made this insight a core feature of understanding financial crises very popular in recent times. (He has also made the term, ‘reflexivity’ very prominent.) “Reflexivity asserts that prices…influence the fundamentals and that these newly-influenced set of fundamentals then proceed to change expectations, thus influencing prices; the process continues in a self-reinforcing pattern. Because the pattern is self-reinforcing, markets tend towards disequilibrium. Sooner or later they reach a point where the sentiment is reversed and negative expectations become self-reinforcing in the downward direction, thereby explaining the familiar pattern of boom and bust cycles.” (See here for a nice summary by Soros.)
III. Philosophic prophecies are structurally related to a self-fulfilling prophecy except that the outcome is a contingent fact, i.e., their existence is necessary, but not sufficient for the outcome. I distinguish eight features in it: A) It is ‘secular’ prophecy'. In particular, B) it is not about offering predictions (although these can enter into it), but about intending to help create a possible future. C) It is, thus, a necessary (but not sufficient condition) for the prophesied future (and, thus, resolutely teleological). D) It appeals to the imagination; often by way of narrative, history, or mythic history. E) It often consist of claims that are beyond knowable at the time of articulation, but that avoid obvious falsehoods. F) It is, thus, (ultimately) accepted on faith; G) it relies on the obvious idea that texts and ideas can have an impact ; H) our present, once unforeseen actions can be the intended outcome of past design. I) One sign that one is dealing with an author that engages this genre, is if s/he articulates a dialectic between "true vs false" philosophers (or experts).
The existence of these three kinds of prophetic roles for economics in public policy produces a distinct argument for the role of history of economics that is very similar to a point (inspired by Boulding) I have made before. If economics wants to be a science that can track the major determinants that shape economic behavior it must find a way to evaluate its own impact on the societies and economic phenomena it studies. In order to accomplish this it must understand its own history and its complex relationship with the objects it studies.
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