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October 13, 2005
Why the debate over game theory is important
Well, it looks like game theory is a great uniter, with economists on both the right and the left leaping in to defend it from my questions, The first shot came from Tyler Cowen, a libertarian. Now, Mark Kleiman, who identifies himself as a "reality-based" type (think Brad DeLong) writes that
Michael Mandel admires Schelling but seems dismayed that game theory isn't a perfectly predictive Theory of Everything. (Tyler Cowen tries to straighten him out, unfortunately unsuccessfully. If you doubt the utility of game theory, just ask an evolutionary biologist.)
Just ask an evolutionary biologist? Oh. I was commenting on the inability of game theory to make testable economic predictions, and I'm being pointed to the theory of evolution. Hmm...
I've looked through most of the responses to my posts, and I'm not sure I've seen anyone cite a falsifiable prediction of game theory.
This is incredibly important. Game theory is the part of economics which is supposed to take care of things like institutions, bargaining, power, coercion, exploitation, etc. Little things like that.
Summarizing: To the degree that economics has political content, it's dealt with by game theory.
I'd argue that both libertarians and "reality-based" economists like Kleiman (who has a PhD in public policy, so I'll make him an honorary economist) are making a mistake by defending game theory, which is anything but reality-based. Robert Waldmann notes
I'd say my objection to game theory is not that it isn't "a perfectly predictive Theory of Everything" but rather that predictions based on game theory about behavior in the simplest settings for which game theory was developed are consistently refuted by experimental evidence.
Waldmann also points out that "Richard Lewontin..attempted to apply game theory to population biology and found it useless (at the time he was one of the worlds two leading population biologists)."
Brad Plumer examines U.S. strategy in Iraq, and observes that
Mandel's seems right when he says that "real-world decision-makers frequently appear not to evaluate uncertain events according to the laws of probability."
Some economists on the right, like Russell Roberts of Cafe Hayek, also seem to be agreeing that game theory is not all that it's cracked up to be. He argues that
the kind of phenomena that game theory helps with are more limited than most of the profession seems to think. Competition reduces the role and importance of strategic behavior and makes game theory less useful.
...game theory can organize your thinking the wrong way because it tends to cause its users to underestimate the power of competition....
Like I said before, I think both Schelling and Aumann are good choices for the Nobel Prize. I am, however, amused by the profession's reflexive defense of game theory.
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If economics isn't testible, you don't have a science. Having a certain richness is nice, but there are simply too many game theory models that end up making similar predictions. When you can't even differentiate monopoly behavior from perfect competition in predation what good is it? Indeed the goal frequently seems to be how many different models can be generated. I also agree that Game theory creates a bias towards thinking about everything in terms of monopoly. What is interesting in Game Theory disappears when you assume that firms are behaving competitively. For whatever it is worth, I wrote a book on all this entitled: "Are Predatory Commitments Credible?" Take a simple example in Predation to show how sensitive the results are. All the models basically look at the information held by the predatory firm. But what if the victim firm can sell short the stock of the predator? Given that the costs to the predator from actually engaging in predation are so large, indeed much greater than the losses imposed on the victim, victim firms that sell short the stock of the predatory might not only hope that the predator enters the industry but the victim firm might now want to stay in the industry just so that they can benefit from the predator's losses. Of course, the very possibility of short selling can make it unnecessary. The whole thing is a mess.
Posted by: John Lott at October 17, 2005 08:49 AM