Contributions to Economics Julia Köhn Uncertainty in Economics A New Approach Contributions to Economics More information about this series at http://www.springer.com/series/1262 Julia K€ohn Uncertainty in Economics A New Approach Julia K€ohn Berlin, Germany ISSN 1431-1933 ISSN 2197-7178 (electronic) Contributions to Economics ISBN 978-3-319-55350-4 ISBN 978-3-319-55351-1 (eBook) DOI 10.1007/978-3-319-55351-1 Library of Congress Control Number: 2017942769 © Springer International Publishing AG 2017 This work is subject to copyright All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed The use of general descriptive names, registered names, trademarks, service marks, etc in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations Printed on acid-free paper This Springer imprint is published by Springer Nature The registered company is Springer International Publishing AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland Preface In mainstream economic theory, uncertainty is closely linked to the theory of economic choice Particularly, since the 1950s the epistemic aspect of uncertainty dominates the intellectual debates and uncertainty became modelled as a subjective probability belief of a rational economic agent Several attempts have been made to extend this approach and make it more realistic.1 Yet, the ontological aspects of uncertainty are still not reflected in economic theory The overarching goal of this book is to seek a comprehensive understanding of the economic theory of uncertainty and to appraise it critically Based on this, I aim to develop a theory of economic uncertainty that integrates epistemological and ontological aspects of uncertainty This book is based on my dissertation, which was supervised by Professor Birger Priddat (Department of Economics) at Witten/Herdecke University Therefore, I firstly should establish that ontological aspects of uncertainty are similarly important as epistemic ones In Part I of this book, I therefore analyse the concept of uncertainty in economic thought and show that originally uncertainty was conceptualised as both epistemic and ontological Only due to the economic professions’ attempt to become acknowledged as a science, the more problematic aspect of ontological uncertainty became neglected and the subjective probability approach to uncertainty became dominant in economic theory Secondly, I will explore the ontological facets of uncertainty in Part II Here, I critically appraise theories of uncertainty that emphasise the ontological character of uncertainty It will become obvious that, even though, these theories are not part of the mainstream in economics, they contain significant critiques on the mainstream approach, which explain the blindness of modern economics to economic phenomena such as instability, slumps or excessive booms Furthermore, these approaches suggest that the positivistic and instrumentalist philosophy of the science of economics inhibits a New Economic Uncertainty Paradigm, which For example, Simon (1955), Kahneman and Tversky (1979) or Gigerenzer (2002) v vi Preface could reflect both the epistemic and ontological aspects of uncertainty and its implications for economic behaviour Based on these findings, I develop a new approach to the methodology of economics in Part III, which legitimises a New Uncertainty Paradigm in economics The analysis suggests that taking uncertainty seriously in economics calls for a fundamental change in the methodology of economics, in which reasonable fiction replaces rational probabilities Berlin, Germany Julia K€ohn References Gigerenzer G (2002) Bounded rationality: the adaptive toolbox MIT Press, Cambridge Kahneman D, Tversky A (1979) Prospect theory: an analysis of decision under risk Econometrica 47(2):263–291 Simon HA (1955) A behavioural model of rational choice Contents Introduction 1.1 Many Faces of Uncertainty 1.2 Framing the Issue 1.3 A Readers Guide: Outline and Structure of the Argument References Part I 1 11 Uncertainty in Economic Thought Uncertainty in the History of Economic Thought 2.1 The Uncertain Fundament of Economics 2.2 The Marginal Revolution and Probabilistic Utility Maximization 2.3 From Reason to Rational Choice Theory 2.4 Separating Uncertainty 2.5 Subjective Probability Theory and Uncertainty 2.6 The Janus-Face of Uncertainty in Economics References 17 18 22 24 27 31 34 35 Truth, Probability and Uncertainty 3.1 The Changing Meanings of Probability 3.2 Probabelism, Credibility and the Formalization of Science 3.3 The Problem of Induction 3.4 Conclusion References 39 39 41 44 46 47 The Principles of Economics 4.1 Becoming the Science of Economics 4.2 Rationality and Prediction 4.3 Econometrics 4.4 The Principles of Modern Economics 4.5 Conclusion References 49 50 54 56 58 60 60 vii viii Contents Probability and Neoclassical Uncertainty 5.1 Between Objective and Subjective 5.1.1 Classical Theory of Probability 5.1.2 Frequency Theory of Probability 5.1.3 Logical Theory of Probability 5.1.4 Subjective Theory of Probability 5.2 The Neoclassical Uncertainty Paradigm 5.2.1 Expected Utility and Subjectivity 5.2.2 Rational Expectations and Efficient Markets 5.2.3 Rational Expectations Models in Modern Economics 5.3 Conclusion References Part II 63 63 65 67 67 74 79 82 84 87 90 91 Philosophies of Uncertainty The Origin of Profit 6.1 Uncertainty and Profit 6.2 Uncertainty, Knowledge and Probability 6.3 Uncertainty, Change and Instability 6.4 Conclusion References 97 99 101 105 106 107 Uncertainty and Economic Instability 7.1 Knowledge and Ignorance 7.2 Uncertainty and Reason 7.2.1 Conventional Knowledge 7.2.2 Animal Spirits 7.2.3 A Keynesian Model of Choice Under Conditions of Uncertainty 7.3 Uncertainty, Instability and Science 7.4 Conclusion References 109 110 113 114 115 117 119 121 122 The Division of Knowledge and Unknowledge 8.1 The Nature of the Economic Problem 8.2 Epistemology 8.3 Uncertainty and the Price Mechanism 8.4 Economics, Unknowledge and Surprise 8.5 Surprise and the Non-Numerical Theory of Uncertainty 8.6 Conclusion References 125 126 128 130 131 134 136 137 The Nature of Economics 9.1 Realism and Ontology 9.2 Open and Closed Systems 139 140 141 Contents ix 9.2.1 Critical Realism, Systems and Explanation 9.2.2 Structure and Dialectic 9.2.3 Degrees of Uncertainty 9.3 Non-randomness, Performativity and Uncertainty 9.4 Conclusion References Part III 10 143 144 145 146 152 152 157 159 160 163 164 165 166 167 168 171 175 175 Methodology of Uncertainty Extending the Boundaries of Economics 10.1 Ontological Foundations of a New Philosophy of Economics 10.2 A Reflexive System and Fallibility 10.3 Levels of Reflexivity 10.3.1 First Order Reflexivity 10.3.2 Second Order Reflexivity and the Structure of Events 10.3.3 Third Order Reflexivity 10.3.4 Complexity 10.4 The Uncertainty Corridor 10.5 Epistemological Implications for the Science of Economics 10.6 Conclusion References 11 Uncertainty and Fiction 11.1 The Co-emergence of Fiction and Probability 11.2 Uncertainty and Fiction in Economics 11.2.1 Fictions and Knowledge 11.2.2 Fictions and Understanding 11.2.3 Fictions, Future and Action 11.3 Fictional Choice 11.3.1 Knowledge 11.3.2 Fictions 11.3.3 Intentions and Biases 11.3.4 Weight of the Argument 11.3.5 Dynamics 11.3.6 The Process of Choice 11.4 Conclusion References 177 177 181 181 182 183 184 185 186 187 187 188 188 190 190 12 Human After All 12.1 Pluralism 12.2 Humanism 12.3 Normativity References 193 195 196 197 199 ... the understandings of uncertainty, which take uncertainty to be fundamental to economics Secondly, I introduce the Neoclassical Uncertainty Paradigm Finally, I will delineate a Janusfaced conception... Fundamental Uncertainty If one includes Fundamental Uncertainty in the economic analyses one necessarily leaves the mainstream of the discipline The first part ends with a critical appraisal of Probability... behavioural strategies they apply in situations of uncertainty The central thesis is that people not behave rationally in the face of uncertainty Instead people show biases6 or apply fast and