I had an interesting discussion with Peter Dorman (whose work on assessing the value of a life we discussed in this space a few years ago).

The conversation started when Peter wrote me about his recent success using hierarchical modeling for risk analysis. He wrote, “Where have they [hierarchical models] been all my life? In decades of reading and periodically doing econometrics, I’ve never come across this method.”

I replied that it’s my impression that economists are trained to focus on estimating a single quantity of interest, whereas multilevel modeling is appropriate for estimating many parameters. Economists should care about variation, of course; indeed, variation could well be said to be at the core of economics, as without variation of some sort there would be no economic exchanges. There are good reasons for focusing on point estimation of single parameters—in particular, if it’s hard to estimate a main effect, it is typically even more difficult to estimate interactions—but if variations are important, I think it’s important to model and estimate them.

Awhile later, Peter sent me this note:

I’ve been mulling the question about economists’ obsession with average effects and posted this on EconoSpeak. I could have said much more but decided to save it for another day. In particular, while the issue of representative agents has come up in the context of macroeconomic models, I wonder how many noneconomists — and even how many economists — are aware that the same approach is used more or less universally in applied micro. The “model” portion of a typical micro paper has an optimization model for a single agent or perhaps a very small number of interacting agents, and the properties of the model are used to justify the empirical specification. This predisposes economists to look for a single effect that variations in one factor have on variations in another. But the deeper question is why these models are so appealing to economists but less attractive (yes?) to researchers in other disciplines.

I responded:

There is the so-called folk theorem which I think is typically used as a justification for modeling variation using a common model. But more generally economists seem to like their models and then give after-the-fact justification. My favorite example is modeling uncertainty aversion using a nonlinear utility function for money, in fact in many places risk aversion is _defined_ as a nonlinear utility function for money. This makes no sense on any reasonable scale (see, for example, section 5 of this little paper from 1998, but the general principle has been well-known forever, I’m sure), indeed the very concept of a utility function for money becomes, like a rainbow, impossible to see if you try to get too close to it—but economists continue to use it as their default model. This bothers me. I don’t think it’s like physicists starting by teaching mechanics with a no-friction model and then adding friction. I think it’s more like, ummm, I dunno, doing astronomy with Ptolemy’s model and epicycles. The fundamentals of the model are not approximations to something real, they’re just fictions.

Peter answered:

So my deep theory goes like this: the vision behind all of neoclassical economics post 1870 is a unified normative-positive theory. The theory of choice (positive) is at the same time a theory of social optimality. This is extremely convenient, of course. The problem, which has only grown over time, is that the assumptions needed for this convergence, the central role assigned to utility (which is where positive and normative meet) and its maximization, either devolve into tautology or are vulnerable to disconfirmation. I suspect that this is unavoidable in a theory that attempts to be logically deductive, but isn’t blessed, as physics is, by the highly ordered nature of the object of study. (Physics really does seem to obey the laws of physics, mostly.) I’ve come to feel that utility is the original sin, so to speak. I really had to do some soul-searching when I wrote my econ textbooks, since if I said hostile things about utility no one would use them. I decided to self-censor: it’s simply not a battle that can be won on the textbook front. Rather, I’ve come to think that the way to go at it is to demonstrate that it is still possible to do normatively meaningful work without utility — to show there’s an alternative. I’m convinced that economists will not be willing to give this up as long as they think that doing so means they can’t use economics to argue for what other people should or shouldn’t do. (This also has connections to the way economists see their work in relation to other approaches to policy, but that’s still another topic.) And I’ve been thinking more about your risk/uncertainty example. Your approach is to look for regularity in the data (observed choices) which best explains and predicts. I’m with you. But economists want a model of choice behavior based on subjective judgments of whether one is “better off”, since without this they lose the normative dimension. This is a costly constraint. There is an interesting study to be written — maybe someone has already written it — on the response by economists to the flood of evidence for hyperbolic discounting. This has not affected the use of observed interest rates for present value calculation in applied work, and choice-theoretic (positive) arguments are still enlisted to justify the practice. Yet, to a reasonable observer, the normative model has diverged dramatically from its positive twin. This looks like an interesting case of anomaly management.

Lots to think about here (also related to this earlier discussion).