Methodological Mistakes at the Heart of Modern Economics & Econometrics

The Quran 3:196 states that:

لَا يَغُرَّنَّكَ تَقَلُّبُ الَّذِينَ كَفَرُوا فِي الْبِلَادِ

Do not be deceived by the prosperity of the non-Muslims throughout the land. It also tells us that what we (the Muslims) have been given (that is, the Quran), is much better than anything that they (the non-Muslims) can gather. It also tells us that Allah is the friend of those who believe and leads them to the Noor of guidance, while those who reject God are befriended by the devils who lead them astray, from light into darkness.

This post continues the theme initiated in the previous post on the Modern Mu’tazila, by debunking the illusions created by the extremely complex and sophisticated mathematical bases upon which modern economics and econometrics is founded.  This complex and elaborate cover has deceived Muslims into believing that modern econometrics provides us with a sound methodology to obtain information about the real world from data. Similarly, complex mathematical models used in economic theory provide us with insight into the economic processes operating in the real world. Nothing could be further from the truth. There are major and fundamental flaws in the conventional methodology. These have been pointed out be several authors, but the sharp criticisms have been ignored, because no reasonable alternatives are currently available. Several major mistakes in the development of European thought have led to the current methodology for economics and econometrics, based on deep and fundamental flaws. These can be itemized as follows:

  1. The Deification of Science: In a long and complex historical process, Europeans came to believe that their religion (Christianity) was just ignorance and superstition, while the newly emerging sciences were the sole guide and the only source of knowledge. They generalized this belief, without examination, to all religions. This eventually led to the exclusion of morality and ethics from the realm of knowledge. Excluding concepts of justice, fairness, exploitation etc. from economics has led to a highly impoverished subject, incapable of guiding us about the source of deep and increasing income inequalities, and the co-existence of vast amounts of misery, together with vast amounts of wealth, more than enough to eradicate poverty.
  2. The Battle of Methodologies (Methodenstreit): In the late nineteenth century, there was an intellectual battle in economic methodology between the traditional historical and qualitative approach of the German Historical School headed by Gustav Von Schmoller, and newly emerging analytical, quantitative and scientific approach advocated by the Austrian School, headed by Carl Menger. As detailed in Geoffrey Hodgson’s book “How Economics Forgot History“,  this led to the adoption of scientific methodology in economics, without taking care of extremely serious problems created by this approach. Are there universally invariant laws of economics, which operate without regard to historical, geographical and human cultural context, like the scientific law of gravity? Modern economics assumes so, even empirical evidence is strongly against this ideas. In econometrics, we assume that patterns observed in the past will continue in the future, dis-regarding free will of human beings, which allows them to create new and unexpected changes.
  3. Logical Positivism: A philosophy of science which was spectacularly successful in the early twentieth century, and played a central role in creating the foundations of modern economic and econometrics. The main idea of this philosophy was that science is trustworthy and reliable because it is based on observables facts and logic, while religion is superstition because it is based on unobservables entities and speculations. The attempt was made to remove all unobservable terms — like gravity, electrons, electro-magnetic forces, etc. — from science, by replacing them with their equivalents in the form of observables. This attempt eventually failed, leading to the collapse of logical positivism as a philosophy. Nonetheless, despite this failure, the foundations of economics and econometrics were not revised, and economists continue to believe in the principle ideas of logical positivism, even though they have been refuted. As a result, current foundations of economics and econometrics are fundamentally unsound, resting on concepts which have logical contradictions, and have been proven wrong.

The fact that modern economic theory is based on drastically wrong foundational ideas leads to the necessity of creating a new set of foundations for economics, especially if we want to build a new discipline of Islamic Economics. This requires providing an alternative methodology which does not suffer from the defects described above. A major flaw in existing economics is that it completely fails to consider ethical and moral issues, which are actually central to economics. The necessity of taking into account moral considerations has been highlighted by  Hausman and MacPherson: Economic Analysis, Moral Philosophy, and  Public Policy.  However, economists have been unable to take these ideas on board in mainstream economics because of ideological blinders, and also because logical positivism says the ethics and morality are not part of science. Here, Islam offers us an excellent platform on which to build a new economic theory grounded on ideas of economic justice, fair play, and equity. Below, I provide links to lectures on a proposed new methodology for Islamic Economics which would avoid the defects of conventional modern economic theory highlighted above:

Lecture  on Islamic Economics: A New Methodology delivered in 17th IRTI Distance Learning Course on Islamic Economics , 28th May 2013 — Part I is 38 minutes:

Part II of the lecture is 52 minutes.

For Related Readings — short posts — see links below:

Fundamental Flaws of Conventional Economics: WEA  Pedagogy Blog Post. Provides more explanation and details about how twentieth century economics departed radically from previous schools of thought and constructed foundations based on logical positivism. Explains how these foundations have fundamental flaws, which are reflected in the blindness of economics to important issues related to human welfare.

Three Goals for Pedagogical Change: WEA Pedagogy Blog Post.

Deification of Science: WEA Pedagogy Blog Post — this paper provides an introduction to my complex and difficult paper on this topic. It explains why the methodology of social sciences currently in use in the West is fundamentally flawed, and how this problem can be fixed.

The Rise and Fall of Logical Positivism: WEA Pedagogy Blog Post. Provides a short history of the philsophy of logical positivism and the history of its spectacular rise, and equally spectacular fall in the twentieth century. This is a short post of less than 1000 words. For readers who would like more details, please see Logical Positivism and Islamic Economics.




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About Asad Zaman

BS Math MIT (1974), Ph.D. Econ Stanford (1978)] has taught at leading universities like Columbia, U. Penn., Johns Hopkins and Cal. Tech. Currently he is Vice Chancellor of Pakistan Institute of Development Economics. His textbook Statistical Foundations of Econometric Techniques (Academic Press, NY, 1996) is widely used in advanced graduate courses. His research on Islamic economics is widely cited, and has been highly influential in shaping the field. His publications in top ranked journals like Annals of Statistics, Journal of Econometrics, Econometric Theory, Journal of Labor Economics, etc. have more than a thousand citations as per Google Scholar.

7 thoughts on “Methodological Mistakes at the Heart of Modern Economics & Econometrics

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