Umair Khan Assignment No: 2 (Q N0: 1) MPhil Econometrics

Book review
(Economics Rules by Dani Rodrick)
Dani Rodrik is a Turkish economist and Ford Foundation Professor of International Political
Economy at the John F. Kennedy School of Government at Harvard University.whose research
covers globalization, economic growth and development, and political economy.

In the book “Economic Rules” Dani Rodrik seeks to explain how economists develop and use
models to explain economic outcomes, and then use the models to make real world decisions.
“I wrote this book to try to explain why economics sometimes gets it right and sometimes
doesn’t “(p.10).

The term “economics” has use in two different ways. One focuses on the substantive domain
of study while the other focuses on methods and in this book author focus on the second way.

In this book the author discussed the big questions of economics like, when do markets work
and when it fails, what makes economies grow, how can full employment and price stability
be achived, and so on and how economic Models be use to handled and solved these questions.

In Economics Rules, Rodrik tries to show that critics have been criticizing economics for the
wrong reasons. Economists, on the other hand, were right in defending economics, but they
have been doing it all wrong. In order to make his case, Rodrik presents an alternative
account of economic models. He argues that this alternative account will provide economists.

Unlike natural sciences in Economics one model will never suit all areas of the economy. So,
an economist must pick a model that suits a particular problem.

This book has 6 Chapters, the review of Each Chapter is given below.
Chapter 1
(What Model Do)

In this chapter the author focuses on the economic models and their importance, in this chapter
comparison between the physical Models and Economic Models are discussed. Like an
architect might build one model to present the landscape around a house, and another one to
display the layout of the interior of the home. Economists’ models are similar, except that they

1
Umair Khan Assignment No: 2 (Q N0: 1) MPhil Econometrics

are not physical constructs but operate symbolically, using words and mathematics, like the
supply-demand model familiar to everyone.

Models are useful because they tell us precisely what the likely outcomes depend on. According
to Rodrik abstract theoretical models are useful, but they are also restricted by the assumptions
they make. from Economic models we can not derive Economic laws, because Their results
depend on the conditions described by their assumptions. so thus we can not genelize there
results. according to Rodrik a common mistake in economics, is to mistake a model,
with the model.

Models as Fables
According to Rodrik, Economic models are like fables in the sense that different models give
us different and sometimes contradictory results. According to Rodrik, fables are similar to
economic models because, fables are simple, fictional (not real), have clear story lines and
morals.Theoretical models in economics utilize unrealistic assumptions Like Perfect
rationality, perfect competition, etc fairy tales, or just so stories that have nothing to do with
the real world. But does this mean that economics is useless?. So then how can we trust on
Economic Models? Economic rule is use to settle the answers to these questions. it presents an
account of economic models that accept the mentioned properties of economic models and
argues that it is because of these properties. in this chapter the author uses another analogy

Models are Experiments

“ The lab experiment purposely manipulates the physical environment to achieve the isolation
needed to observe the causal effect, whereas a model does this by manipulating the assumptions
that go into it. Models build mental environments to test hypotheses”(p.19).

Economic models isolate specific mechanisms and how these mechanisms work under certain
conditions. These conditions are specified by the assumptions of the model.By applying a
different set of assumptions each model helps economists to study the possibilities in the real
world.

Un realistic Assumptions
According to Rodrik Economic models are typically assembled out of many unrealistic
assumptions. Friedman supported the idea “that unrealistic assumptions were a necessary part
of theorizing. He claimed that the realism of assumptions was simply irrelevant”.

2
Umair Khan Assignment No: 2 (Q N0: 1) MPhil Econometrics

But some economists did not agree with this that the realism of assumptions is entirely
irrelevant. “As Stanford economist Paul Pfleiderer explains, we always need to apply a “realism
filter” to critical assumptions before a model can be treated as useful” (p.21).

According to Dani Rodrik realism of a particular assumption matters.The applicability of a

model depends on critical assumptions that how closely to approximate the real world. And
what makes an assumption critical depends in part on what the model is used for.But at the
same time we can not avoid the unrealism nature of assumptions but we can not use this an
excuse for the models whose assumptions greatly violate the realism.

On Math and Models

According to Dani Rodrik math in Economics is use for two reasons, clarity and consistency.
clarity ensures that the elements of a model are stated clearly and transparent while the
consistency ensures the internal consistency of a model.

Math provides a useful check. Alfred Marshall, a famous economist had a good rule use math
as a shorthand language. Math play a vital instrumental rule in the economic models. But
according to Rodrik some economists are use such a heavy math that forget its instrumental
nature.

According to Rodrik that math does not get you far in the economics profession. But it useful
to make an intractable problem soluble, or devise a new empirical approach to a substantive
question. But according to author we should focus on the important public problems, such as
poverty, public finance, economic growth, and financial crises and not its mathematical
wizards.

Simplicity versus Complexity

According to Rodrick as the availability of big data and advance computation techniques why
we not prefer the complex models over simple models which can cover all aspects that we want
in a model? He gave two reasons that why we do not prefer complex models over simple.

First, the assumptions and behavioral relations that are built into the large models must come
from somewhere, and for this two different researchers make two different models if they think
different about the nature of the data and models so These prior understandings do not derive
from complexity itself, they must come from some first-level theorizing.

second suppose build a large-scale model relatively the theory-free, using big-data techniques
based on observed empirical regularities, such models can deliver predictions, but never

3
Umair Khan Assignment No: 2 (Q N0: 1) MPhil Econometrics

knowledge on their own. So according to Rodrik we should prefer simplicity over complexity
when building a model.

Chapter 2
(The Science of Economic Modeling)
In the second chapter Dani Rodrik deals Economics as social science, unlike physics, which
has, more or less, a central theory of how the universe works, Economics will always be a
pluralistic pursuit. Economics differs from these natural sciences like physics and chemistry.
Dani Rodrick argues that economics does not have fundamental laws, and economists should
not behave as if they have discovered the fundamental laws of economics and society. Rodrik
admits that this is more art than science, and involves a great deal of intuition.

In this chapter Rodrik discussed, Models clarify hypotheses,” The First Fundamental Theorem
is a big deal because it actually proves the Invisible Hand hypothesis. That is, it shows that
under certain assumptions, the efficiency of a market economy is not just conjecture or
possibility; it follows logically from the premises. The payoff from all the mathematics is that
we actually have a precise statement. The model shows us exactly how the result is produced.
It reveals, in particular, the specific assumptions that we have to make to be sure efficiency is
achieved” (p.33).

Clarifying Hypotheses
According to Rodrik from the Hypothesis we can seeks what they say exactly, why they work,
and the conditions under which we can expect them to apply. In this chapter the Rodrik also
discussed the amplification of an empirical method, and help economists generate knowledge
based on shared professional standards, and discussed that how unexpected results accrue from
economists of the “second best” and discussed the importance of “second best” thinking.

Rodrik discussed many examples of “second best” importance one of them is “Dutch disease
syndrome”. “The competitiveness of Dutch manufacturing suffered in the 1960s, as the Dutch
guilder strengthened in response to the gas bonanza and Dutch factories lost market share”
(P.38). And then discussed that how can we use the “second best” for the clarification of the
circumstances.

Scientific Progress
4
Umair Khan Assignment No: 2 (Q N0: 1) MPhil Econometrics

In this chapter Dani Rodrik also discussed that what economics make a science? and gave the
answer of this question is that when we use scientific methods like building hypothesis and
tests them, we can accept it or replace it, by a scientific method due to which economics became
science, but however in the real world phenomenon we have some restriction to use such ideal
procedures. Moreover, even when a truly deductive, hypothesis-testing approach is followed,
much of what economist’s produce is not really testable in any strict sense of the word. Then
such a situation the researcher develops a new model with different assumptions and different
hypothesis that he or she claims better accounts for the “deviant” observations.

Models and Empirical Methods

According to Dani Rodrik the empirical verification of a model is necessary because it clarify
the source of disagreement and due it, it clears to everyone that what is going on the real world.
“Indeed, typically it doesn’t, given the different ways that each side is likely to read reality.
But at least we can expect that the two sides will eventually agree on what they disagree about”
(p.44).

According to Rodrik the economic models are models contain information about the
circumstances in which they’re relevant and applicable. Evaluating and examining theses
models and the real-world situations we can derive it that when we can use them and when not.
According to author that it is not necessary that empirical verification will work always but
even when the empirical data are inconclusive, models enable rational and constructive debate
and These kinds of debates take place endlessly in economics.

And in this chapter Rodrik discussed Reinhart and Rogoff debate.

Chapter 3
(Navigating among Models)
This chapter is basically on how navigating among different models, according to Rodrik the
economics become a useful science when its models carry the knowledge that how the worlds
work and how can we improve it. In this chapter the writer guide the reader that how navigate
among the models by using by his own growth diagnostics, in which he said that how countries
differ from each other but in each there is same central question that we have faced when we
developing policies for them .

5
Umair Khan Assignment No: 2 (Q N0: 1) MPhil Econometrics

According to him although that there will be different problems of different countries but
“Once it became clear that our differences on policy were the result of favoring
different models, the discussion became a lot clearer. Now we could understand where
each one of us was coming from. More important, we could begin to narrow our
differences by confronting the separate models informally with the evidence at hand” (p.53).

According to Rodrik that the virtue of true analysis is that from it does not presume that a single
model is applies to all countries, nor a specific model remain same over time for a specific
country, because as time and circumstances change a different model may became more
relevant.

In this chapter the Rodrik discussed the general principles of model selection which are the
verification of critical assumptions, mechanism, direct implications and incidental implications
of a model.

Critical Assumptions
According to Rodrik the realism of a model is determined by its critical assumptions, these
assumptions would produce a substantively different result if they were altered to be more
realistic. Abstractions away from reality allow economists to predict the outcomes and
consequences of policies, such as setting a ceiling on the price of oil, an increase of the federal
minimum wage regulation, or reducing global migration restrictions. Without simplifying
assumptions, economists would have little contribution to public policy or business
administration.

“Models often make assumptions that are critical but unstated. Failing to scrutinize those
assumptions can lead to severe problems in practice. Economists and policy makers learned
this the hard way during the 1980s–90s frenzy over market liberalization” (p.57). Economists
make mistakes when they become overconfident in one popular paradigm or when they
disregard important characteristics of the specific context in which a model is being applied.
The financial crisis represents a huge mistake on the record of many economists.

Verifying Mechanisms

According to Rodrik not only the assumption but pairing the assumptions with mechanism
produces conclusion, where he gave the example of the relationship of between firms’ supply
and the market price which show a critical mechanism. “If no real-world evidence supports the

6
Umair Khan Assignment No: 2 (Q N0: 1) MPhil Econometrics

model’s operative mechanism, the model probably isn’t a good guide to what is really going
on. We may need to turn to an alternative model” (p.58).

Verifying Direct Implications

According to Dani Rodrik verification of direct implications of the economic model also a
basic and general principle, Economists sometimes test whether their models’ implications are
borne out in so called natural experiments. These experiments rely on randomness that is
generated not by the researcher, but serendipitously by circumstances that have nothing to do
with the research per se. Economists adopt different strategies to check wither the
amplifications of different models is confirmed by the real world or not. He gave an example
of “in Kenya, a model for the effect of small price disincentives in discouraging bed net use;
and in Pakistan, a model for the role that parents empowered by better information can play in
improving school performance. They have shown the powerful impact of imaginative solutions
when an important constraint is identified correctly” (p.61,62).

Verifying Incidental Implications

Dani Rodrik argued that the economic models should be advantageous enough that these
models not only verify the essential observations and basic problems but also provide a wide
range of implications in the real world, and due to this the economist became able to select best
model for a given situation. The Rodrik argued that how this enables him and his team to
looked for the tangential implications of a hypothesis. and in this chapter the Rodrik discussed
the External Validity, Redux and argued that the external validity of a model depends on the
setting where it is applied.

Chapter 4

(Models and Theories)

This chapter discusses the relationship between theories and models. “To see the difference
between models and theories, as well as where they can overlap, we should first distinguish
among three kinds of questions” (P.66).

7
Umair Khan Assignment No: 2 (Q N0: 1) MPhil Econometrics

1st What questions “what is the effect of A on X?”, and in the examples he gave different
examples like the what is the effect of minimum wage on employment? what is the effect of
govt expenditures on inflation? etc.

2nd why questions “why did some particular event take place?” like Why did the industrial
revolution take place? Why did inequality rise in the United States after the 1970s? Why did
we have the global financial crisis of 2008?

3rd Timeless questions “what determines the distribution of income?” What determines the
distribution of income in a society? Is capitalism a stable or unstable economic system? What
are the sources of social cooperation and trust, and why do they vary across societies?

According to Rodrik in economic models we are just answer what questions. For Answering
why questions requires some particular models or set of models. Big questions require
universal theories, and according to Rodrik it is impossible to formulate universal theories in
social sciences. One important argument in this chapter is that general economic theories are
frameworks for organizing our thoughts. In order to show this, Rodrik sweeps through history
of economics; exemplifying his argument with discussions of theory of value and distribution,
and theory of business cycles and unemployment. Later in the chapter he discusses how
theories are used in order to explain specific events; using the example of the rise of inequality
in US. These types of explanations in economics, Rodrik argues, are not like universal theories,
rather they are specific to particular cases. Finally, Rodrik argues that economics is a modest
science that mostly tries to answer what questions, investigating one cause at a time. And in
the end of this chapter Rodrik discussed that Theories Are Really Just Models and clarified the
misunderstanding that term “theory” is used in economics like game theory, contract theory,
search theory, growth theory, monetary theory, and so on are the collection of set of models in
reality.

Chapter 5

(When Economists Go Wrong)

In this chapter Rodrik discussed that how economists mistaking their model, and discussed
that“When economists confuse a model for the model, two kinds of mischief may follow.
First there are the errors of omission, in which a blind spot shows up in the inability to
see troubles looming ahead. Most economists, for instance, failed to grasp the

8
Umair Khan Assignment No: 2 (Q N0: 1) MPhil Econometrics

dangerous confluence of circumstances that produced the global financial crisis of

2007–8. Then there are the errors of commission, in which fixation on a particular
view of the world makes economists complicit in policies whose failure might have
been predicted ahead of time. Economists’ advocacy of the so-called Washington
Consensus and of financial globalization are in this category” (p.85).

In this chapter Rodrik discussed the financial crises and its results, and the case of Washington
Consensus. He tackles the housing market crash and recession of 2008. As he warns of “errors
of omission” by economists.

In the case of Washington Consensus, the preferred models were the models that assume that
the main drivers of growth were saving and access to investable funds. “The economists behind
the Washington Consensus forgot they were operating in an
inherently second-best world. As discussed in Chapter 2, in environments where
markets are subject to multiple imperfections, the usual intuition on the effects of
policies can be quite misleading. Privatization, deregulation, and trade liberalization
can all backfire. Market restrictions of a certain sort can be desirable. Policy reforms
in these environments require models that explicitly take such second-best
complications into account” (p.90).Rodrik argues that, in both cases, economists essentially
misunderstood their own field. They mistook one type of model for the universally valid model.
In both cases, the favoured type of model featured markets that work efficiently.

According to Rodrik the economists became overconfident concerning some models, and
ignored others, and Rodrik argued that this is not the problem of economics but this is the
problem of economists.

Chapter 6

(Economics and Its Critics)

In this chapter Dani Rodrik argue that “ Economics without its critics would be like Hamlet
without the prince”(p.98). in this chapter the Rodrik argues that economics is just the collection
of models and those models have the different policy implications. If economists fail to reflect
or properly exploit this diversity, this is not a fundamental flaw in the discipline. It is only a
flaw of the people that practice it.

Rodrik reminds us that there is a harder, superordinate question: How do economists learn
when they have a variety of models at their disposal, each of which seems to some extent

9
Umair Khan Assignment No: 2 (Q N0: 1) MPhil Econometrics

relevant, but they each point to different conclusions? Rodrik not only raises this question, but
also presents interesting examples of where economists have dealt poorly or well with the
plurality of models.

Rodrik responds to critics. He argues that idealization, abstraction, utilization of unrealistic

assumptions, methodological individualism are not problems as long as one appreciates the
diversity of economic models and accepts the fact that each economic model is an attempt to
understand some real world relationships in isolation. Rodrik stresses that, although the social
world is .

Dani Rodrik argue that It is true that economic models cannot be tested like the models in
physics, but this is because economics is a social science. “Economics deals with this, there is
the criticism that economists’ theories cannot be properly tested.
Empirical analysis is never conclusive, and invalid theories are rarely rejected. The
discipline hobbles from one set of preferred models to another, driven less by
evidence than by fads and ideology. Insofar as economists present themselves as the
physicists of the social world, this criticism is deserved” (p.100).And as economics is a social
science its models should not be precise as the models of natural sciences but its models only
help in conditional predictions as he write “Economics is a social
science, which means that the search for universal theories and results is futile. A
model (or theory) is at best contextually valid. Expecting general empirical validation
or rejection makes little sense” (p.100).

In this book Rodrik tried to gave good examples from history and debates from current
situations. Rodrik took critics of economics seriously and responded to them sincerely. In this
book Rodrik followed the tradition of many great economists in engaging in a critical reflection
on economics. In this the Rodrik opened a channel of communication between economists,
their critics, philosophers of economics and historians of economics. In the of this book the
Dani Rodrik gave twenty commandments in which twenty for Economists and Twenty for non-
Economists.

10
Umair Khan Assignment No: 2 (Q N0: 1) MPhil Econometrics

11