Of Models and PSST
By Arnold Kling
Some comments on an earlier post raised a number of issues.
1. Shouldn’t the economy just have stayed on its production possibility curve in 1929, rather than go through the Depression? Well, the problem is if it stays on the 1929 PPF, it never gets to the 1950 PPF. In any case, there really is no way to freeze a pattern of specialization and trade in place, given that demography is changing, capital is aging, and so on.
2. Can we model uncertainty using a stochastic simulation or somesuch? I don’t think that solves the problem that concerns me, which is the “unknown unknown.” In 1931, as tractors continue to replace farm laborers, the problem is to find something for those farm laborers to do. There is a lot of random exploration involved, but I don’t think that specification of a probability distribution is sufficient to characterize the problem.
3. What about agent-based modeling?
In some sense, one ought to be able, by playing around with assumptions, to come up with an agent-based model that can produce just about any outcome you want. If I am correct about that conjecture, then this represents both a strength and a weakness. It is a strength in that properties that get ruled out of other models to make them tractable do not have to be ruled out in agent-based models. It is a weakness in that it can be difficult for an outsider (or even the model-builder) to evaluate the reasonableness of assumptions as well as the validity of the interpretation of the result.
I still think that the best model of equilibrium is the 2x2x2 model of international trade. But the PSST story is about an economy groping from one equilibrium to the next (or, if you want to make things really difficult to formalize, an economy never in equilibrium). Even more important, not all production technologies are known. So it is not simply a matter of searching for a price vector. The groping process includes trial-and-error of new methods within firms and creation of new businesses.
Maybe you could set up a simulation with a more complex pattern of international trade (nxnxn), where there are two equilibria. An initial equilibrium, with full employment but that does not make the best use of recently-discovered technologies; and a final equilibrium, which does make the best use, but which involves production arrangements that are not yet known and that differ considerably from those employed in the initial equilibrium. Every experiment with new production technologies takes time. Many experiments fail. etc.