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SFEL8000 Høst 2011 Roberto Iacono

Individual task [2]

A) For this part of the individual task I decided to analyze and comment

upon a doctoral dissertation written by Luis Rey Los Santos and

defended at European University Institute in Florence during the fall

2010, under the title “Macroeconomic Aspects in Resource-Rich

countries” (available online at http://cadmus.eui.eu)

Summary of the work: the dissertation is composed of three articles and

concerns the macroeconomic effects and consequences of resource

abundance for small open economies. The theoretical background is

constituted by the wide literature on the possibility of a “resource curse”

for resource-rich economies. The striking historical evidence is that not all

countries have been benefiting from the wealth stemming from non-

renewable natural resources, and in addition there is clear and substantial

quantitative empirical evidence that the economic performance of resource-

rich countries has been poorer than the average. The purpose of the

dissertation is thus to discover the hidden mechanisms behind this

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unexpected lower growth and to describe how they could be avoided. More

precisely, the dissertation aims at enriching the literature on the Dutch

Disease by describing the dynamic consequences of positive oil income

shocks in a small open economy under different possible assumptions and

parameterizations.

The three articles of this dissertation are mainly an exercise of descriptive

theoretical analysis, and the method implemented throughout the work is

the classic modeling approach based on utility maximization of the fully

rational representative agent, as it is used all over the science of economics.

As regards the main result and final knowledge claims, the author confirms

that one of the consequences of the increased resource income is an

appreciation of the real exchange rate (as it can be actually seen for the

case of Norway which since the 80’s has had an overvalued currency as

compared with the pre-oil discovery era) and a decline in the employment

level of the manufacturing sector. Since productivity growth of the

economy is affected by the level of the employment in the manufacturing

traded sector (i.e. the so-called “learning-by-doing” argument which

assumes that higher numbers of workers employed creates more

“experience” and improves labor productivity), this decline in the numbers

of workers might trigger lower productivity growth and finally lower

growth rates for the economy in the long-term.

Programmatic/Implicit position: at first, I want to mention that in

contemporary economics research it is not at all common practice to make

explicit epistemological and methodological considerations. Discussion on

methodology and research methods has been dangerously banned from the

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work of contemporary economists. However, shutting down the discussion

did not practically imply the triumph of methodological anarchism (as it

was strongly advocated by Feyerabend in [2]), it rather implied a silent

methodological homogeneity which worked and continues to work as an

invisible barrier to different approaches and perspectives in economics. To

quote some of Feyerabend’s statements ([2] page 154): “For is it not

possible that science as we know it today, or a "search for the truth" in the

style of traditional philosophy, will create a monster? Is it not possible that

an objective approach that frowns upon personal connections between the

entities examined will harm people by turning them into miserable people,

self-righteous mechanisms without charm? I believe that a reform of the

sciences that makes them more anarchic and more subjective is urgently

needed”.

The homogeneity of method has on one side the advantage of making

research articles easier to be compared between each other, in order to

stress with more precision their cumulative scientific contribution.

However on the other side this homogeneity has also created a vacuum as

regards research methods’ evaluation and selection. In addition, as argued

by Rosenberg in [5], the reason behind this methodological ‘conservatism’

in the economics science might not be that of simple complacency, but

instead it might constitute a clear strategy to insulate the field from possible

anomalies and the process of falsification. It is then without surprise that I

point out that the articles of this dissertation do not explicitly state anything

whatsoever as regards to their paradigmatic and epistemological positions.

However, the common features of the positivistic tradition (as exemplified

in [1]) are implicitly present in the dissertation. Ontologically speaking, the

reality of the macroeconomic consequences for an economy that suddenly

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gets natural resource income is a “law-governed” reality in the sense that

some “laws” and tendencies for the dynamics of the exchange rate and the

labor employment in the manufacturing and non-traded sectors are present

and hopefully deterministically traced out by the model. Epistemologically

speaking, the quantitative deductive approach of this work aims at high

degrees of objectivity, though without providing a clear strategy for the

verification and falsification process (no real-world economy presents the

very same features assumed for the stylized economies on which the author

is focusing throughout the analysis). Importantly, some words are spent by

the author on the specific choice of the quantitative macroeconomic

theoretical framework, which happens to be the so-called DSGE model

(Dynamic Stochastic General Equilibrium model) and which of course lies

within the classic utilitarian tradition. As usual for macroeconomic studies

within this tradition, aggregation of preferences is carried out

straightforwardly by summing up individual utility or disutility functions

(i.e. the principle of methodological individualism, which I will analyze

thoroughly in part B of the individual task).

In conclusion, some considerations can be made as regards the cumulative

position of this article, since it is quite clear the manner in which this article

aims at providing the field with new knowledge. The previous numerous

theoretical studies of the Dutch Disease have been using partial equilibrium

(as opposed to general equilibrium models in which the full description of

the behavior of all important agents of an economy is enclosed) and static

frameworks. This dissertation tries then to provide the literature with a new

dynamic and general equilibrium framework in which there are less

restrictive assumptions as regards the dynamics of the capital stock and of

the exchange rate.

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Conceptual system: the most important conceptual phenomenon on

which the dissertation work is focused is the so-called Dutch Disease.

Historically, the term was coined in 1977 by The Economist to describe the

decline of the manufacturing sector in Holland after the discovery of a

large natural gas field. Such a decline has been named a “disease” by the

literature because of the possible negative consequences on labor

productivity dynamics as a result of less workers employed in the traded

manufacturing sector. As opposed to this vision, another strand of literature

has stressed that, being the lower employment level in the traded sector a

“market response” to the increased income from natural resource, the

supposed “disease” cannot be considered as such but simply as an optimal

market-driven reallocation of factors of production. In this respect, the

author of the dissertation argues that the consequence of lower growth is

indeed a “disease”; however he also states that some countries have

managed to avoid it and tries to describe the patterns followed and adopted

by these countries.

Description/Explanation: As stated above, the nature of the text is

exclusively descriptive. No normative position has been taken by the author;

this is clearly understood since a normative standpoint would have called

for a different theoretical approach constituted by the “social planner”

maximization rather than the classic representative agent utility

maximization. More interestingly, and notwithstanding the theoretical

assumption that a micro-founded macroeconomic model is actually based

on the welfare and intentions of the representative agent living in the

economy, structural aspects and “aggregate” macroeconomic laws as

regards the exchange rate and the productivity dynamics play a prominent

role in this dissertation.

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Falsification/Alternative interpretations: I feel the urge to state that this

dissertation work is largely subject to theoretical/methodological

weaknesses and controversies, not only due to the structural assumption of

full individual agent rationality, but more importantly due to the very little

emphasis on the falsification process. Neither alternative theories nor

thorough alternative explanations of the analyzed phenomena (such as the

Dutch Disease) are included, and in addition no potential problems or

possible drawbacks with the author’s conclusions are presented. In a few

words, a genuine falsification process of the present dissertation is simply

not a possibility in the sense that the only way of disregarding its validity

would be that of denying the applicability of the set of assumptions and/or

its entire methodological position, without the possibility of critically

debating and analyzing the core mechanisms of economic analysis

embedded in it.

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B) Describe an aspect of the research process related to topics of

philosophy of science: Methodological Individualism

“It is necessary that we know the things that are to be

compounded before we can know the whole compound”

Thomas Hobbes, London, 1839.

Let us start by giving a definition of what Methodological Individualism

(MI) is in the social science. According to the principle of MI as defined by

the philosopher Watkins in [7], “the ultimate constituents of any society are

the individuals and their acts, which form the base of each and every

complex social interaction…we shall not arrive at rock-bottom

explanations of such large-scale social phenomena until we have deduced

an account of them from statements about the dispositions, beliefs,

resources and inter-relation of individuals”. An important point about this

definition has to be raised: I believe that in this definition Watkins is

slightly mixing things up by making both an ontological statement (i.e. the

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ultimate constituents of any society) at the same time as he is making a

methodological statement (i.e. rock-bottom explanations).

As a consequence of this definition by Watkins, we should never be

satisfied by an explanation of any social phenomena in terms of a so-called

“collective” action. This implies in other words that the only force guiding

social transitions is the action undertaken by human beings; no aggregate

sociological factors are allowed to be at work in social history. The

principle of MI opposes to holist views in the philosophy of social science,

according to which social systems constitute “wholes” in the sense that no

regularities resulting from individual behaviors can be of help to describe

the system’s long-term incontrollable macro-dynamics. Opposing the

holistic views can be seen as denying any social supra-human tendency or

at least as predicting that any of these tendencies could be altered and

promptly modified or guided by active individuals (i.e. the controversial

Alteration Principle as stated in Miller in [4]). This Alteration Principle of

MI assumes that individuals possess the necessary and appropriate

information. This requirement appears to me as both a strong and

restrictive assumption.

In order to conclude on defining it, it has to be stated though that MI is not

usually intended in its stricter and reactionary version (strongly advocated

by free-market fundamentalist Fredrik Hayek in his “The Counter-

Revolution of Science”), which would imply that in the social world only

individuals are real and that social phenomena do not exist at all in history,

or even that social wholes are simply characterized as mental models.

Another important point has to be made to grasp the full meaning of MI.

Watkins in [7] presents also an interesting classic misunderstanding /

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controversy of the principle (Watkins and Karl Popper were among the

most influential proponents of MI). He exemplifies that in the literature on

MI, it has often been implicitly (wrongly according to him, although this

assumption is predominant) assumed that even the psychological

dispositions and beliefs of individuals are “given” from above or at least

that cannot be explained in terms of social inheritance and social

environments in which the individual is living or situated. This appears of

course as highly controversial, I would say slightly metaphysical. In other

words, MI presumes that the formation of personal psychological

disposition and beliefs happens in turn as an individualistic process, as an

independent response of the individual to the different external stimulus

from society.

In order to proceed with the analysis of the assumptions/building blocks of

MI, let us look at Miller who highlights in [5] in a comprehensive way the

set of propositions underlying the principle. An important proposition

which I would like to shed light on is Proposition IV, called the Necessity

Constraint: “If, given condition obtaining at the time, a social event X

would have happened anyway, even in the absence of the sequence of

individual actions, beliefs or dispositions which actually did cause X, then

an explanation of X must explain why X would have happened under the

circumstances, even in the absence of that particular sequence”. Thus the

necessity constraint requires in a few words that no social events are

missing their causal explanation, this explanation being based either on the

presence of a certain sequence of actions and beliefs of individuals or

instead based on its absence.

Since MI and the positivist tradition are two important elements of the

contemporary social science methodology (more importantly in Economics

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but also in other fields), I would like to draw a line between this Necessity

Constraint of MI and the social engineering processes which bases their

validity on the positivist tradition. It might be pointed out that the Necessity

Constraint has to apply not only for the MI to be valid but also for social

engineering experiments and institutions to be useful. How would the very

same existence of those institutions be defended in case no causal

explanations (either based on actual beliefs or on their absence) of social

phenomena can be found? No social engineering processes and applications

of positivistic knowledge claims would be any longer justified and

legitimated in case the social phenomena were proven to be the results of

endogenous social processes that would have taken place regardless of

“intervention” and social engineering experiments.

An important critique of MI is explained by Hodgson in his survey article

[3] on the issue. He points out that all successful and satisfactory

explanations of social phenomena (in economics but also more broadly in

the social science) must involve interactive relations (also in the form of

institutions) between individuals. In other words, if individuals do matter

for explaining reality as MI is assuming, then their interactive relations will

constitute a substantial part of the explanation. Kenneth Arrow and other

neoclassical economists have been trying to face this critique by pointing

out that market price mechanisms do actually qualify social interactions

and structures. In other words, this was the argumentation used by them to

“absorb” the critique, defend neoclassical theory from the accusation of

reductionism and show that the theory allows individual behavior to be

mediated by some sort of social relations. I personally agree with Hodgson

and his criticisms since, although general equilibrium models in economics

do indeed require some degree communication and interaction between

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individuals, however this interaction happens solely through market

institutions (with imperfect communication over price and quantities),

which is equal to say that interaction happens through individuals in

“isolation”.

After criticizing, Hodgson actively proposes that in creating social

explanations the use of MI should be accompanied by statements on the

origin of institutions, and by references to the norms and rules of social

structures. The interrelation between individuals and institutions appears

then as a powerful and never-ending linkage; if institutional influences on

individuals gain importance, then individuals themselves have to be

observed. In turn, the purpose an individual might be fruitfully explained

by the institutional context he lives in, and so on and so forth. In addition,

once interactive relations are assumed to be present, we can think of

individuals as agents filling up social positions. Each social position would

constitute a social specified social relationship with other individuals filling

up other social positions. Crucially (and quite dangerously for the scanty

survival chances of MI), Hodgson adds that “when an individual occupies a

certain social position, he also acquires additional qualities associated with

that position, by virtue of relations with others” ([5], page 220). Therefore

novel properties and skills emerge in agents due to their interaction, rather

than due to their isolation. But then one might ask, why is that MI is

remaining so popular among economists and several other social scientists?

In order to answer this question, perhaps I should consider the linkage

between MI and political individualism, and the role of power associated

with the latter.

Let us thus focus on the implications that MI has had not only for the

progress of social science but also outside the rigorous scientific world. MI

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might have had an important role in the defense of political individualism

as opposed to socialism and other systems based on social regulation. In

other words, MI might have been important to the scientific development

of the body of social sciences which aims at reinforcing the strength of the

individualistic liberalism thought (with political individualism on the

background). Controversially but straight to the point, we could state that If

MI is denied, the fear is that the importance of the individual is under

attack.

At the same time, Schumpeter in [6] (interesting to note that his pioneering

article was the first academic article in English which explicitly introduced

the term Methodological Individualism) is also issuing a warning that the

connection between individualistic science and political individualism need

not be as tight as stated above; individualistic national economies might be

correctly criticized by their opponents on the basis of unfortunate real-

world episodes, however individualistic science does not have necessarily

to be blamed for those episodes. In other words, the degree of efficacy of

MI might be regarded as a purely methodological question, and no conflict

between opposing political schools of thought should be generated from its

widespread use.

Schumpeter concludes his essay [6] by judging MI as a concept that leads

to a quick and fairly acceptable approximation of the intentions of a group

of individuals, and that any other social-oriented concept would not provide

the economists with any greater advantage. He is also warning that things

would be different outside of “pure theory” (for example in organization

theory or sociology) where the atomistic feature of MI would qualify as a

possible disadvantage. In other words, Schumpeter is admitting that

individual preferences might be subject to changes, but he believes that

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investigating the causes of these changes lies outside the scope and purpose

of “pure theory”.

My personal opinion is that, even though political and methodological

individualism are and remain two different principles, the connection holds

quite tightly. By considering the preferences of the individuals (and by

stressing that their desires, actions or intentions have to be formed in a

completely independent way without exogenous intervention) as the central

building block for the theoretical measurement of a society’s welfare, MI

implicitly assigns to individual freedom a prominent role. Getting

eventually rid of MI and consequently taking society as a whole as the

basis for the set-up of welfare improving policies might not guarantee that

each and every individual’s desires or freedom rights are taken rigorously

into account (i.e. a necessary requisite for political individualism). To

summarize this, I could state that absence of MI hinders the strength and

efficacy of political individualism; however absence of political

individualism in a particular group of individuals or society does not

necessarily imply that MI is the wrong guiding principle for the

measurement of that group’s welfare and aggregate satisfaction.

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References:

[1] Benton, T. & Craib, I. (2001), Philosophy of Social Science. The

Philosophical Foundations of Social Thought. Basingstoke: Palgrave,

London, UK.

[2] Feyerabend P. (1975), Against Method: Outline of an Anarchistic

Theory of Knowledge, First edition published in M. Radner & S. Winokur,

eds., Analyses of Theories and Methods of Physics and Psychology,

Minneapolis: University of Minnesota Press, 1970.

[3] Hodgson G.M. (2007), Meanings of Methodological Individualism,

Journal of Economic Methodology 14:2, 211-226.

[4] Miller R., Methodological Individualism and Social Explanation, in eds.

Martin and McIntyre (1994), “Readings in the Philosophy of Social

Science”, MIT Press, Cambridge, MA.

[5] Rosenberg A., If Economics isn’t science, what is it? in eds. Martin and

McIntyre (1994), “Readings in the Philosophy of Social Science”, MIT

Press, Cambridge, MA.

[6] Schumpeter J. (1908), Methodological Individualism, first chapter in

Das Wesen und Hauptinhalt der theoretischen Nationalokonomie (The

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Nature and Essence of Theoretical Economics), München und Leipzig:

Duncker und Humblot.

[7] Watkins J.W.N. (1957), Historical Explanation in the Social Sciences,

British Journal for the Philosophy of Science, 9, 104-117.