Chapter 8: Applied Policy, Welfare Economics, and Mill’s Half-Truths
David Colander 8.1 INTRODUCTION The argument in this chapter is a simple one. It is that sometime around the 1930s the economics profession’s use of models in thinking about economic policy changed. The result has been a tendency to draw unwarranted policy implications from models and theory, such as occurred in the recent financial crisis. The chapter argues that to prevent such misuse of models from occurring, the economics profession needs to return to the earlier methodological approach, which recognized the complexity of the economy and the relative simplicity of our formal models. Up until the 1930s what might be called the Classical method predominated in applying models to policy.1 This method assumed that the economy was too complicated for formal modeling, and that any formal model would have to be seen as providing at best what John Stuart Mill called half-truths (Mill, 1838 ). These half-truths from models would have to be integrated into a much broader implicit theory before they could be applied to real-world policy. Because this broader implicit theory was so complicated, it was accepted that economists would focus only on the economic portion of that broader theory, leaving it to other social scientists, or to economists who were operating outside the science of economics, to add the other elements necessary to draw policy results from economic models. This meant that for Classical economists, welfare economics was not, and could not be, a stand-alone field. Only when these other elements were added could one arrive at...
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