Shift happens indeed



The Chronichle of Higher Education has a very good piece on the 50 year anniversary of Thomas Kuhn's classic The Structure of Scientific Revolutions (SSR). It is worth remembering that the official methodology in economics remains Popperian.

The conventional history of ideas in economics, as represented by Schumpeter’s monumental History of Economic Analysis or by Mark Blaug’s work is one that emphasis the continuity and growth of knowledge. Hence, the frontier contains the set of accepted truths and the past is a history of how true knowledge was achieved. Knowledge progresses in a twofold process, first conjectures are made. Conjectures are not the ultimate truth, but are accepted while not proven incorrect. Then, tests are designed to falsify the conjectures. Hence, in Popperian terms theories can never be proven true or verified, but they can be accepted while they are not refuted. In other words, there is rational progress in science, including economics. Falsification is, then, the instrument to measure progress, since it provides the demarcation criteria to define what is and what is not scientific knowledge, and also to determine whether a theory is superior to the other.

Thomas Kuhn provided and alternative to the conventional approach. The evolution of scientific knowledge is tied to history and to the sociology of the scientific community. A paradigm can be described as the set of rules and methods accepted by a scientific community. Scientific knowledge is for the most part the result of normal science, that is, the work of scientists within the confines of their paradigm. However, normal scientists are sometimes confronted with critical anomalies that put in doubt the validity of the whole paradigm (Kuhn’s model of paradigmatic change is the Copernican revolution). An accumulation of anomalies leads eventually to a paradigmatic crisis, and to the emergence of new paradigms.

New paradigms explain the anomalies unexplained by the old one. More importantly, new paradigms often provide a new vision of the object of study. Hence, new paradigms imply that hypotheses are incommensurable in terms of the old paradigm. The methods of testing hypotheses are no longer accepted. Progress is then only possible within the paradigm. Comparisons between paradigms involve the values of the scientific community and the persuasive ability of scientists.

The Kuhnian model was developed to discuss scientific progress in the hard sciences, so a reasonable question is whether it applies to soft sciences too, admitting that economics is a soft science. In economics several paradigms co-exist for long periods, something that should happen only in periods of crisis. Also, the Marginalist Revolution took place even though there was no evident anomaly unexplained by the dominant paradigm (classical political economy; in all fairness Ricardian economics had been abandoned in the 1830s, and vulgar economics dominated the profession). Ideological reasons seem more important in that case. Further, the Keynesian Revolution, that occurred as a result of the high levels of unemployment (an anomaly if there is one for the normal marginalist science) that could not be explained by the dominant paradigm, was to a great extent aborted, and the idea of a natural rate of unemployment was reinstated.

A. W. Coats (1969; subscription required) notes that anomalies and critical experiments are not common, but still the concept of scientific revolutions may serve in economics as an ideal type to clarify the sociological elements in the development of economic ideas. SSR remains vital for economic methodology, in particular after the last crisis has shown, once again, the limitations of the self-adjusting marginalist paradigm.

The IMF with a thorn on its side

By Martin Khor

A serious impasse emerged in the preparatory committee of UNCTAD XIII, which is tasked with preparing the draft outcome document that Ministers are scheduled to adopt at the end of UNCTAD XIII in Doha on 21-26 April.

While the previous two or three conferences were rather tame affairs, it looks like UNCTAD XIII (whose general theme is development-centred globalization) will be more difficult, with the organisation’s future scope of work and influence at stake.

UNCTAD was set up in 1964 to support developing countries to strengthen their weak position in international economic structures, and to design national development strategies.

It became a kind of secretariat on behalf of developing countries, providing a small pro-development balance to the huge organisations dominated by the developed countries, such as the OECD, the IMF and World Bank.

Read the rest here.

Also read this piece by Martin Khor too.

Palley on the crisis and more

Philip Pilkington interviews Tom Palley on his new book at Naked Capitalism.

Saving UNCTAD

Last week, guest blogger Robert Wade sounded the alarm about efforts on the part of some developed country governments to severely restrict the mandate of the UN Conference on Trade and Development (UNCTAD) at the organization’s April 21-26 ministerial conference in Doha, Qatar. We follow up on that post with a sign-on letter from former UNCTAD senior staff members urging that the institution’s broad mandate be maintained, as a critical source of heterodox economic thinking and policy analysis. We reprint their letter and signatories below.

Read the letter here.

Sraffian economics vs. Post Keynesian methodology

A very nice debate on the nature of heterodox economics took place yesterday in a heterodox conference in Buenos Aires. Sergio Cesaratto and Marc Lavoie (depicted above during the interval) presented alternative views which, in spite of some important differences, agreed that Sraffian economics is part of the broadly defined heterodox Keynesian camp (or Post Keynesian if one prefers the term). The question of the relation of Sraffians, and more broadly all of those that believe in the importance of the old classical political economy school (from Petty to Marx, including Quesnay, Smith and Ricardo), with non neoclassical Keynesians, that is, those that believe that unemployment does not result from some rigidity or imperfection (be that of the price, wage or interest rate), has been difficult to say the least.

Marc presented first. A version of the paper is here. Taking aside obvious confusions, and sloppy scholarship of the type that suggests that Sraffians accept Say’s Law, because in the determination of normal prices quantities are taken as given (the fact that those quantities are determined by demand in accumulation theory is, apparently, not understood by these critics), the main line of critique of Sraffians comes from what Marc refers to as Post Keynesian methodologists. For him, “the influence of methodologists ... felt through the study group around Tony Lawson at Cambridge ... that [argues that] proper economics should be based on critical or transcendental realism and ‘open’ systems” and that has led to an “‘open systems’ criterion to judge whether a model can be given a post-Keynesian stamp of approval” (Lavoie, pp. 6-7).

Marc correctly dismisses this supposition that from a methodological point of view the Sraffian approach is limited to closed models. As he clearly notes the Sraffian price equations require that one distributive variable (real wages or rate of profits) are determined exogenously outside of the system by historical and institutional circumstances, which by definition makes it an open system, that is, one in which there is an exchange with its environment. Marc, in fact, suggests that the strong case for a Sraffian-Keynesian interaction is based on the fact that the determination of the rate of profit by the exogenous short term rate of interest set by the central bank provides an obvious link to Post Keynesian endogenous money literature (Pivetti and Panico’s work in that area, among others, shows that Sraffians do have a lot to say about money too, by the way).

Marc notes that the main reason, however, why Post Keynesians reject the Sraffian approach is there is “little enthusiasm for any notion of long-period ‘prices of production’ as centers of gravity towards which short-period or market prices are supposed to tend” (p. 14). However, as Marc suggests there is little difference between prices of production and full cost pricing. Full cost pricing, in my view, should be connected to the Oxford Economists Research Group (particularly P.W.S. Andrews, a tradition that through Andrews’s disciple Wynne Godley influenced Cambridge Keynesians). In other words, I see full cost pricing as compatible with the normal prices in Sraffa, both being determined by a mark up, which represents the social conflicts that allow one class to subtract surplus from another, over costs, which are determined by the technical conditions of production.

My main disagreement with Marc’s exposition, then, is related to his argument that “if one wishes to connect Sraffian economics with the other strands of post-Keynesian economics, one needs to examine production prices in a different light, not as long-run or long-period centers of gravity to which market prices tend” (p. 15). This is also complicated by the incorrect notion that gravitation requires the use of marginalist principles in order to obtain that market prices converge to normal long term prices, which is not the case [I’ll leave the details of that for another post though]. It seems to me that Marc believes somehow that full cost prices are somehow not fully adjusted prices, and that firms do not use their normal costs rather than their short run costs when computing prices.

Sergio counter presentation (not available, but you can check some of his extensive publications here), was narrower in scope, and dealt with the difference between certain Post Keynesian growth models (in particular the so-called Neo Kaleckian school) and Sraffians (he also distinguished among certain Sraffian groups). I should note that Cesaratto agreed with Marc in his rejection of the critique of the so-called Post Keynesian methodologists, and suggested that their lack of understanding of the capital debates and its consequences, reduces the significance of their views. He correctly points out that the capital debates produced the only occasion that forced neoclassical economics to openly recognize its flaws, and, I would add, led to a significant change in the way they do economics, forcing the change in the notion of equilibrium and the development of disaggregated intertemporal short term models (i.e. without a uniform rate of profit, something first noted by Piero Garegnani).

Sergio notes that when dealing with models of accumulation there are three features that most heterodox groups would want to incorporate in their models, namely: (A) the Classical (or in general exogenously given) income distribution, (B) the Keynesian Hypothesis of an investment rate independent from an exogenously given rate of savings, and (C) normal accumulation paths, with the traditional corollary of a long run normal degree of capacity utilisation. Between these three features one obtains what Sergio refers to as the Magical Accumulation triangle.

Neo Kaleckian (NK) models (some of Marc’s models, particularly in his Foundations of Post Keynesian Economic Analysis are of this type, but not the ones in his book with Wynne Godley) tend to assume A and B, but not C. The absence of the notion of normal (or fully adjusted) positions, as we saw above with regards to prices, is the main difference between the NKs and what Sergio calls the supermultiplier Sraffians (which have A, B and C). The supermultiplier models (which are in a sense Kaldorian, on Kaldor and Sraffa see this paper) implies that long term capacity output (not optimal in the sense of full employment) is determined by the exogenous components of demand, and investment is derived demand (as noted by Sergio the key contribution here is Franklin Serrano’s PhD thesis).

Here it is important to note why long term normal positions are important. It has little to do with a belief that economic systems are stable and tend to optimal levels, since the normal positions are tendencies, and are, generally, below full capacity, and crisis are the norm. Normal positions are important because they show that the regular functioning of capitalist economies does not produce efficient allocation of resources. Without suggesting that those that deny the relevance of long term positions are imperfectionists in the same sense that neoclassical authors that believe that an accumulation path below full employment is due to price, wage or interest rate rigidities, the argument still relies on an inability of capacity to adjust fully to the exogenous growth of the autonomous components of demand. The question then is why would a business not invest enough to keep its capacity growing in line with the growth of its demand? Here, I believe, lies the fundamental difference between classical-Keynesians (or supermultiplier Sraffians) and Neo Kaleckians.

By the way, as I noted before in the blog, the use of the term Kaleckians for the NKs is a bit of a misnomer, since the models derive really from Joan Robinson (and as noted by Sergio, Harrod and Steindl too). In part, I think, for her role in the rejection of normal positions and her views on history versus equilibrium, Sergio suggested that Robinson played a negative role in these debates.

There are several other things to discuss about this topic (the role of Joan Robinson among the important ones), brought about by the interesting, controversial, but very friendly debate between Marc Lavoie and Sergio Cesaratto which I’ll leave for other posts.

MMT and its discontents

The Washington Post had a substantial profile on what is now termed Modern Monetary Theory (starts with Jamie Galbraith, and then goes on to the Kansas version of post Keynesian economics). A few reactions in the blogosphere. Two worth noticing are by Dean Baker and Jared Bernstein that provide qualified support.

Dean suggests that beyond fiscal deficits stimulus should also come from monetary policy (lower interest rate), and a more depreciated dollar. My guess is that, at least the Kansas MMTers would be fine with both, but suggest that lower rates of interest are not much in play now. But from what I understand a depreciated dollar has been seen as part of a solution by most progressive economists. Randy Wray, for example, is certainly less concerned with the size of a trade deficit than Dean, since the US is the issuer of the key currency [I have less confidence on flexible exchange rates as a way of solving balance of payments constraints in developing countries, but I'll leave that for another post].

My concern with Dean's notion of a more devalued dollar, which is generally fine and will not lead to the demise of the dollar in the near future, is that for the workers with low wages that depend on cheap imports at Walmart it implies higher prices and lower real wages. A boost to increase real wages would be necessary [see Jamie on that here]. So better income distribution should be the most important channel to boost consumption on a sustainable way.

Jared Bernstein fundamentally adds that taxes on the wealthy should be increased. Which he argues from a political standpoint, and I think it is quite reasonable, since that is one way (besides hiking minimum wages, and repealing right to work and other anti-labor legislation) to improve income distribution.

On a more personal level, my problem with the WaPo piece, and the general discussion of MMT, is that for the most part it sees MMT as just a policy program (the Kansas one is, for example, an Employer of Last Resort of some type, which is fine with me, by the way), and does not separate the theoretical discussions from the policy stuff.
Endogenous money, chartalism, and functional finance, are relevant because they fit the theoretical framework of a coherent heterodox alternative to the mainstream based on Keynes' Principle of Effective Demand [for a full alternative you need also long term pricing; in Kansas your man for that would be Fred Lee]. For my views on that go here. I think, hence, that a coherent alternative to the mainstream, beyond Keynesian economics, requires a good dose of the old and forgotten methods of classical political economy.

PS: My point about theoretical versus policy matters is driven by the fact that on certain policy issues, like the need for further fiscal stimulus, New Keynesians like Krugman and DeLong would be fundamentally in agreement with MMTers.

Reviewing the reviewers of the crisis

From Triplecrisis:

Gary Gorton and Andrew Metrick have just produced a survey on the vast literature on what happened during the last financial crisis (and to a lesser extent why it did) titled “Getting Up To Speed on the Financial Crisis,” to be published by the Journal of Economic Literature. They used only 16 documents, between papers from ‘top journals,’ reports and speeches and congressional testimonies. It must be noted that the objective of the review is to provide “a one-weekend-reader’s guide” to the crisis.

The biggest problem with their paper is not the limited number of documents reviewed, which seem to be fairly representative of conventional views on the financial crisis, but the limitations of what the mainstream of the profession knows about the crisis, and worse, what the profession clearly does not know it does not know, the unknown unknowns, so to speak. And that is why ignoring heterodox and progressive contributions has been very harmful for the profession.

Read the rest here.

Failing grade for econ courses

From Remapping Debate:

"Until the 1980s, undergraduate students in economics were generally required to take a course in economic history or the history of economic thought, or both. Over the last twenty years, however, those requirements have been dropped from the curriculum in nearly all undergraduate programs, and even many graduate programs do not require them.

This ahistorical view of economics, according to David Ruccio of Notre Dame, deprives students of fundamental knowledge about the field they are studying and how it has developed. “The implication for students is that what exists now has always existed and will always exist,” he said. “It allows for the impression that there is only one perspective on economics and ignores the multiplicity of perspectives that have existed and exist today.”

Julie Nelson, chair of the economics department at the University of Massachusetts Boston, agreed. “Not having those courses removes the context from the theories and makes them seem like they’re divinely ordained,” she said. “There’s no sense that economics is created by people.”

According to Frederic Lee of the University of Missouri–Kansas City, “if you were actually teaching them about the economy, you might have to talk about the rise of capitalism and the industrial revolution,” he said. “You’d need to talk about American history and the plantation economy and the attack on workers in the 1880s and the Great Depression and the military–industrial complex and the Cold War. These are just some examples to illustrate that without the history we have no place to understand what we mean by capitalism, which is essentially what they’re studying.”

Of course there are a few oases in the profession.

Minsky's Papers



Minsky's papers are available here. Several interesting nuggets for those willing to dig. Enjoy!

A Note on the Concept of Vulgar Economics

The concept of vulgar economics, developed by Karl Marx, is often cited, but seldom properly used or understood. In the preface to the second German edition to Capital Marx said that:

"[The] period, from 1820 to 1830, was notable in England for scientific activity in the domain of Political Economy. It was the time as well of the vulgarising and extending of Ricardo’s theory, as of the contest of that theory with the old school."

It is important to note that Marx clearly knew that "the theory of Ricardo already serves, in exceptional cases, as a weapon of attack upon bourgeois economy," in particular, because Ricardo was the first to show conclusively the necessary oposition between wages and profits, and the conflictive nature of the capitalist system. The problem with post-Ricardian economics was that it could not claim to be scientific and at the same time argue that the capitalist system was harmonious. For him:

"Men who still claimed some scientific standing and aspired to be something more than mere sophists and sycophants of the ruling classes tried to harmonise the Political Economy of capital with the claims, no longer to be ignored, of the proletariat. Hence a shallow syncretism of which John Stuart Mill is the best representative. It is a declaration of bankruptcy by bourgeois economy."

So vulgar economics was the dominant, or common, view of Political Economy after Ricardo, which was fundamentally apologetic and dismissed the Ricardian conflictive view of capitalist economies.

Also, it is important to note that, although critical of bourgeois economics (Quesnay, Smith, Ricardo), Marx knew his theory built on their analysis. He says:

"As early as 1871, N. Sieber, Professor of Political Economy in the University of Kiev, in his work 'David Ricardo’s Theory of Value and of Capital,' referred to my theory of value, of money and of capital, as in its fundamentals a necessary sequel to the teaching of Smith and Ricardo. That which astonishes the Western European in the reading of this excellent work, is the author’s consistent and firm grasp of the purely theoretical position."

So the excellent work of Professor Sieber correctly grasps Marx's theoretical position, according to Marx, and says that it is "a necessary sequel to the teaching of Smith and Ricardo." I'll leave for another post the discussion of the current state of economics, and in what sense one can talk of a return of vulgar economics.

Blog related working papers

All these papers were published this year in the U's working paper series. A holiday treat; enjoy!

Working Paper 2011_07
Title: The Veblenian Roots of Institutional Political Economy
Author: Kirsten Ford Download PDF (221 KB)

Working Paper 2011_08
Title: An Aristotelian View of Marx’s Method
Author: Nathaniel Cline, William McColloch and Kirsten Ford Download PDF (184 KB)

Working Paper 2011_09
Title: Marx’s Appreciation of James Steuart: A Theory of History and Value
Author: William McColloch Download PDF (166 KB)

Working Paper 2011_11
Title:Thorstein Veblen: A Marxist Starting Point
Author: Kirsten Ford and William McColloch Download PDF (139 KB)

Working Paper 2011_12
Title: Easy Balancing Act: Reducing the Balance of Payments Constraint; Improving Export Competitiveness and Productivity; and Absorbing Surplus Labor – The Indian Experience
Author: Suranjana Nabar-Bhaduri Download PDF (374 KB)

Working Paper 2011_13
Title: Portrait of the Economist as a Young Man: Raúl Prebisch’s evolving views on the business cycle and money, 1919-1949
Author: Esteban Pérez Caldentey and Matias Vernengo Download PDF (452 KB)

Working Paper 2011_14
Title: The return of vulgar economics: A Rejoinder to Colander, Holt and Rosser
Author: Matias Vernengo Download PDF (100 KB)

Stephen Marglin on Heterodox Economics

I have lots problems with Marglin's views, not just on heterodox economics, but on the mainstream too. Marginalism (neoclassical economics), the supply and demand story that emerged in the 1870s, is not simply about efficiency. It is about a certain type of efficiency (factors of production are fully utilized). There are different views of efficiency, and certainly that was the case for the authors of the surplus approach (Smith/Ricardo/Marx), for whom efficiency was essentially about capital accumulation, i.e. the wealth of nations. Also, the problem is not that the mainstream ignores income distribution, but that it provides an untenable position on income distribution (to each according to its productive). In contrast, for the surplus approach authors income distribution depends on class conflict.

From my point of view, Marglin is very close to presenting a post-modernist view of critiques of the mainstream, that is, several alternatives to the mainstream are acceptable, as the much as the mainstream is. This is Deidre McCloskey's view that economics is about the rules of conversation, rhetoric. I'm more of a realist, I think there is an external reality independent of my views about it, and that there are, besides logical aspects, facts that allow us to discern between theories that are not correct (the mainstream) and theories that have not been proved wrong (classical-Keynesian). For my view on heterodoxy read this.

PS: Marglin's syllabus here. Thanks to Pedro Américo for the tip.

Garegnani and the revival of the surplus approach

(1930-2011)

Last weekend Pierangelo Garegnani passed away in Rome. He was the main disciple of Piero Sraffa, and one of the most important heterodox critics of the mainstream marginalist (neoclassical) approach. A full account of his contributions to economics is well beyond what I can offer in this space, but here are a few highlights.

As early as 1961, while spending an academic year at MIT, he suggested during a presentation by Paul Samuelson that his results depended on the assumption that all sectors use the same capital-labor ratio. The final results of his critique were presented in Garegnani's paper "Heterogeneous Capital, the Production Function and the Theory of Distribution." His paper shows conclusively that the marginalist theory of value and distribution based on an aggregate production function is untenable. This of course builds on Sraffa's work in the Production of Commodities (PC). By 1966, in the famous Quarterly Journal of Economics (QJE) Symposium, Samuelson had admitted that the neoclassical parable was not defensible.

In his 1976 paper "On a Change in the Notion of Equilibrium in Recent Work on Value and Distribution" Garegnani argued that to avoid the problems associated with the aggregative marginalist model, the mainstream had switched to Arrow-Debreu (AD) General Equilibrium models, which did not use aggregative capital, but also did not assume a tendency to a uniform rate of profit, which implies that it can only be seen as a short run equilibrium. Further, Garegnani later argued that, beyond the problem of being stuck with a short run theory, the AD model was still open to the capital critique, since a notion of aggregate capital was still needed for the equilibration of savings and investment (see his 2003 paper "Savings, Investment and Capital in a System of General Intertemporal Equilibrium").

Garegnani was also the central author arguing that the recovery of the classical theory of value and distribution (and hence Marx) was not incompatible with the Principle of Effective Demand (PED), as developed by Keynes and Kalecki. His two papers in the Cambridge Journal of Economics show that a rejection of the marginalist notion that labor and capital markets tend to full employment depends on the rejection of the mainstream theory of value and distribution, and that Keynes' PED is fully consistent with the old and forgotten classical or surplus approach. He also actively contributed to the extension of the PED to the long run until the end of his life (e.g. his paper with Trezzini).

There are several other contributions, in particular his work on the interpretation of Ricardo and his debates with orthodox Marxists, which again follow in the steps of his teacher. His work is essential for those interested in the understanding of the functioning of capitalist economies, and the incapacity of the mainstream to provide a useful tool to analyze reality.

If you’re surprised, that means that you were part of the problem

Back in July, in the midst of the debt-ceiling debate, Paul Krugman argued that those that were surprised by the GOP tactic of blackmailing the administration, threatening a default in exchange for cuts on social spending and the maintenance of the tax cuts for the rich were part of the problem. Normal was already not part of the GOP. I agree.

Now Krugman tells us that in this crisis a "lot of the blame goes to the economists, by the way, who abandoned what they used to know." But the thing is that the mainstream of the profession has been dominated by the academic equivalent of the Tea Party for a very long time. My point is that if you didn't know that economists forgot certain things about recessions, and never learned a few other things, you have not been paying attention and/or you must be part of the problem too.

Krugman knows this well, since he argued that:

“By the early 1980s it was already common knowledge among people I hung out with that the only way to get non-crazy macroeconomics published was to wrap sensible assumptions about output and employment in something else, something that involved rational expectations and intertemporal stuff and made the paper respectable. And yes, that was conscious knowledge, which shaped the kinds of papers we wrote. So you could do exchange rate models that actually had realistic assumptions about prices and employment, but put the focus on rational expectations in the currency market, so that people really didn’t notice. Or you could model optimal investment choices, with the underlying framework fairly Keynesian, but hidden in the background. And so on.”

That is, in order to publish (in 'respectable' journals) you had to wrap your reasonable assumptions in crazy models. So it should have been clear back then that rational expectations, real business cycles, supply siders, and their political counterparts in the Reagan administration were more dangerous that Old Keynesians and New Old Keynesians (or Old New Keynesians for that matter) were willing to admit.

The problem is not just that New Keynesians of all sorts and political affiliations (Ben Bernanke, Brad DeLong, Paul Krugman, Greg Mankiw, Christina Romer or Larry Summers) can be seen as equivalents to the old Neoclassical Synthesis, the modern equivalents of John Hicks and Alvin Hansen, trying to incorporate the Keynesian insights that lack of effective demand was behind the Great Depression (now our Great Recession), and that fiscal stimulus is necessary, while maintaining the contradictory argument that the price and quantity of all "factors of production", including labor, can be determined by the equilibrium in the labor market. [If this is true lower real wages should equilibrate the labor market and involuntary unemployment should vanish].

From a policy point of view this is certainly important, but it misses the more essential question that Keynes theory was not (at least was not intended to be) about imperfections, and arguably the inability of the Neoclassical Synthesis of overcoming that original contradiction is part of the reason of the rise of New Classical economics, and the acceptance by New Keynesians of the Friedmanian notion of a natural rate.  Can you blame the profession that believes in the self-adjusting nature of the system towards the natural rate (included in all New Keynesian models) that fiscal stimulus is only needed in the short run and that the economy is on its path to recovery?

Hansen (1938, p. 34), in the book depicted above, said that the profession was: "living in a time when economics stands in danger of a sterile orthodoxy." [The time, by the way, was the 1937-38 recession]. We are in that position again, and people like DeLong and Krugman, as I said before, the best within the mainstream, would miss the opportunity of providing a more solid foundation for economic theory if they do not recognize the importance of the heterodox contributions of the more radical disciples of Keynes and Kalecki. We do not need another Neoclassical Synthesis, and we should try not to miss this new opportunity to complete the Keynesian Revolution.

Further, although we have our Hansens, so to speak, we do not have our Lauchlin Currie or our Marriner Eccles.  That is, the real heterodox Keynesians within the administration. Currie, by the way, wrote an unpublished review of the General Theory, for the eyes of the Board only, that is far better than most responses in academia, which did not rely in either interest rate (liquidity trap) or real wage rigidity. In fact, Currie argues correctly that (following chapter 19 of the General Theory) falling wages would make things worse. If respectable economists in the mainstream, like Krugman and DeLong, miss this opportunity this period will be remembered as 'the years of low theory.'

PS: For a discussion of Eccles and Currie see here. The classic book on Currie is by Roger Sandilands here.

On General Equilibrium (GE)

Nice post (and rare, since this kind of topic is often not dealt with) on GE by Alejandro Nadal at TripleCrisis.  In my view, the problem is less that equilibrium per se does not exist, as Nadal seems to suggest, but the particular notion of equilibrium that has come dominate economics after Arrow-Debreu and the Capital Debates.  I highly recommend the paper by Fabio Petri (here) for those interested on the subject.

Macro vs. Micro

A debate on the relation between micro and macroeconomics has been raging in the mailing list of the Societies for the History of Economics (SHOE; yep that's the acronym they went for!).  The main question being discussed is whether micro-foundations are necessary for coherent macroeconomic theory. I have argued in a previous post that, in fact, this is the other way round, macro-foundations for microeconomics are essential.

From a history of thought point of view, it is important to note that the distinction is a relatively modern one, starting in the 1930s.  The term macroeconomics was first used, most likely, by Ragnar Frisch in his lectures notes in 1933-34, and first used in print by Jan Tinbergen and Eric Lindahl in 1936 and 1939, respectively (for a full discussion see Vela Velupillai, 2009; subscription required).  Keynes did not use the term in his General Theory, even though the book is considered the foundational book of macroeconomics. To a great extent the work of John Hicks -- both his ISLM paper and his Value and Capital -- is central to understand the direction in which the profession developed.

Yet, Keynes book was central in the eventual split of macroeconomics and microeconomics.  In particular, because Keynes defied the conventional wisdom, associated with marginalism, that the rational maximizing behavior of firms and individuals would lead to the optimal (meaning full) utilization of resources, including obviously labor resources.  Full employment was not the normal equilibrium position of the economy.  In that sense, Gary Mongiovi provided the most enlightened note to the SHOE debate.  He tells us:

"the macro/micro distinction actually arose after Keynes's theory took root, and students had to be taught two distinct and apparently incompatible stories about how market economies work: (1) a neoclassical distribution theory in which the real wage adjusts to bring the S & D for labor into line with one another; and (2) a Keynesian story about how the economy could settle into an equilibrium in which the labor market doesn't clear."

That incompatibility and incoherence is still with us.  Students are taught that markets are efficient in their micro text, and some imperfectionist story is told in order to provide a foundation for the Keynesian macro story (at least in salt-water departments).  Of course an alternative would be to discard the marginalist approach altogether, since it does have insurmountable problems as admitted by Paul Samuelson during the capital debates in the 1960s.  But that's another story for a different post.

Heinz Kurz on the state of the dismal science

Here is a very important paper, by Kurz, published in Investigación Económica (see previous post).  He shares a similar view of what it means to be a heterodox economist with this blogger, and argues that:

"Economics may be a dismal science or discipline, but its present dismal state applies not to the discipline as a whole or to all traditions of economic thought available. It applies to the neoclassical mainstream and especially to NCE [New Classical Economics]."

It is the notion of an economic system that automatically tends to full employment that makes ours a dismal science, but that is NOT a general, even if it is dominant, view in the profession.

Sensible theory and economic predictions



Economists are well known for having predicted nine of the last five recessions.  Or so goes the joke.  The fact that economists cannot predict and that forecasters are always wrong is not new, and I would suggest less important than often understood.  The problem is not so much that economists cannot predict particular events, but that the dominant theory is an ineffective tool for understanding real economies. And that is true for both the New Classical/Real business Cycle types that believe that markets are efficient immediately, or the imperfectionist New Keynesian, that think that they are too, but only in the long run (this view should lead you to believe that the main solution is to reduce imperfections). As a result, the mainstream always provides unreasonable predictions.



But let me give an example of what I mean. Rudiger Dornbusch was a well respected mainstream economist.  He said back in 1999 that the euro would:

"reinforce financial deregulation (national and cross border) in Europe to create a broad and deep capital market. Europe comes from a dinky and segmented national, bank-based financial structure. It is on the way to a US-style capital market where households hold funds and companies issue paper and stocks, intermediation margins are small and governance significant. European companies will benefit from the transformation, the most significant supply side influence we will see. … the Euro is a thoroughly modern institution, well-adapted to a highly integrated and trigger-happy international capital market."

Not only deregulation was something good for Europe, but also giving up the currency would allow for lower interest rates and higher growth.  For him:

"Having a national money is expensive … It offers little flexibility and year after year an interest cost is paid for what is the illusion of independence. … Monetary sovereignty nowadays means only the right to bad money.  How can the periphery get out of the self-inflicted historical curse of a central bank and a national money. Do what Argentina did ... Give up the national money and create a hard link to a world class currency."

It goes without saying that this does not sound like good advice these days.  And before you say that hindsight is always 20-20, I want to remind you that yes some people that were in favor of the European project actually saw the limitations of the euro.  The economists that did not believe in the efficiency of markets (at least not for allocating resources, including labor) argued that giving up a tool (like the exchange rate) would imply the need for other tools.  Here is Wynne Godley in 1992, about the project of a common currency for Europe:

"It needs to be emphasised at the start that the establishment of a single currency in the EC would indeed bring to an end the sovereignty of its component nations and their power to take independent action on major issues. … the power to issue its own money, to make drafts on its own central bank, is the main thing which defines national independence. If a country gives up or loses this power, it acquires the status of a local authority or colony. Local authorities and regions obviously cannot devalue. But they also lose the power to finance deficits through money creation while other methods of raising finance are subject to central regulation. Nor can they change interest rates. As local authorities possess none of the instruments of macro-economic policy, their political choice is confined to relatively minor matters of emphasis – a bit more education here, a bit less infrastructure there."

And colonies are exactly what the countries of the European periphery have become.  And the options have been a lot less education, retirement, employment and infrastructure.  Further, Godley was concerned that the European project, that he supported, was incorrectly based on the notion:

"that economies are self-righting organisms which never under any circumstances need management at all ... It is a crude and extreme version of the view which for some time now has constituted Europe’s conventional wisdom … that governments are unable, and therefore should not try, to achieve any of the traditional goals of economic policy, such as growth and full employment."

Hence, sensible theory did allow, not to get the timing of the euro crisis (or wouldn't allow now to know exactly when Greece is going to default), but to get reasonable understanding of how economies work, and to provide fitting advice.  Of course almost nobody got the message.

Eclecticism, Complexity and Hypocrisy in Economics



In some of my posts there is an open critique of what I referred to the best in the mainstream, people like Krugman and Brad DeLong (and even Larry Summers), that have been in favor of fiscal stimulus, QE, and against tax cuts for the rich.  The critique is not about the soundness of their policy advice or even about their political views, which are liberal in the American sense of the word.  My trouble is the same that Joan Robinson had with the neoclassical synthesis, that is, that their policy propositions do not follow (logically) from their economic models.

Some people may think that this is just splitting hairs, an irrelevant exercise in taxonomy, to determine who is or is not heterodox. And that would certainly be a complete waste of time and energy. But the problem is that this inconsistency between reasonable policy advice and coherent economic theory is at the heart of the problems with the mainstream, and not just the crazy ones that believe in extreme versions of market efficiency (see for example Lucas’ Milliman Lecture; as I suggested these views could be referred to as the Intelligent Design version of economics. Krugman calls it the Dark Ages of macroeconomics).

As I argued somewhere else (subscription required, or preliminary version free here), there is a symbiotic relation between the best in the mainstream (what David Colander refers to as the cutting edge), that sound reasonable and provide rational policy advise particularly in times of crises, and the hardcore fundamentalists that stick to neoclassical/marginalist principles (despite logical problems). The problem is not a trade off between relevance and coherence in general, as Mark Blaug tried to argue with respect to Sraffians (his point being that Sraffians are rigorous and cannot be relevant for that reason; see the reply by Kurz and Salvadori here).  The trade off is a particular problem for the mainstream (that's why Blaug's argument is preposterous).

Rigorous arguments are NOT detrimental for empirical relevance, and they are essential for coherent policy advice. Part of the problem with the current state of the economics profession, what Alessandro Roncaglia has called the cultural roots of the crisis, is that the reasonable so-called New Keynesians, like Larry Summers and Ben Bernanke, were for deregulation and did not see (or didn’t want to see) the crisis coming. There is no intention to revise the foundations of economic analysis.

The whole argument of the best in the mainstream (and even some heterodox economists) is that conventional models are too simplistic and we need more sophisticated models.  In this view, the problem is the complexity of the real world.  Also, the mainstream is not monolithic, and there are several strands, some better some worse, with a high degree of eclecticism. I find the argument disingenuous, at best.  Sure the real world is complex, but the increase in the number of complex models have served since the 1970s as a way of introducing more realistic and often more relevant policy results while maintaining the respectability of the mainstream defense of the sanctity of market efficiency.  Some of these models are not even compatible among them, and, it is true that the mainstream is fragmented or eclectic.  In this sense, I borrowed the use of the term organized hypocrisy to describe, not the behavior of individual economists per se, but of the profession as a whole.

Organized hypocrisy implies that the mainstream can still maintain that markets are efficient, and that General Equilibrium models are a coherent proof of that (which allows the Tea Party version of the profession to go around and preach Real Business Cycles and Supply Side Trickle Down Voodoo Economics), while at the same time say that there are more sophisticated models, with imperfections, and alternative patterns of behavior, that explain reality.  Hence, whether Krugman and other cutting edge authors understand it or not, they have a role within the mainstream which actually serves to perpetuate their hold on the profession.  They are there to make the mainstream sound reasonable without the need to rethink the foundations of the subject.  Eclecticism is not a good feature of the mainstream, it reflects their lack of coherence and the inability to provide a theory that is both realistic and logically sound.

PS: Eclecticism should not be confused with pluralism. One is the result of incoherence, the other of tolerance with different approaches to economics.  For example, institutionalists take a different starting point than Sraffians, but say relevant and coherent things that add to understanding of the real world.  A pluralistic approach that encompasses some of the contributions of both schools is, therefore, quite reasonable.  The same could be said about other heterodox schools.

The meaning of heterodox economics, and why it matters

Heterodox economics is often defined as potpourri of of schools, too many to mention. Further, most of these heterodox schools are defined against marginalism (or neoclassical economics, which is also a fragmented school of economic thought).  In this sense, the heterodox camp is defined in a negative (against orthodox) and fragmented (depending on what aspect of orthodoxy is contested) way.  I think that is a counter productive approach, and that heterodoxy should be seen as a set of principles.  A positive (in its own terms) and unified (in the sense of the minimum set of propositions that are universally accepted) definition of heterodoxy is necessary.

Two things are central from my point of view.  First, heterodox economists are concerned with the amplified reproduction of society, and this implies that the production and distribution of the social surplus is central for their theories.  This is part of a tradition that harks back to classical political economy.  The determinantion of the surplus implies that distribution is determined exogenously by social and institutional conditions (be that the real wage as affected by the bargaining position of the labor class, or the rate of profit as determined by the monetary rate of interest influenced by the central bank).  Further, the determination of surplus, for an externally determined distribution, and a given technology, provides an explanation of relative prices (value).

It is important to note that there are several particular theoretical ways of approaching each of these questions associated to the reproduction of the economy.  For example, some Marxists emphasize that relative prices are proportional to the amounts of labor directly and indirectly needed to produce the commodities.  Sraffa provides a different approach, that is compatible with Marx's views of the working of the economy.  Post Keynesian groups that emphasize the determination of prices according to full cost pricing are also compatible with this general preocupation about the determination of the social surplus.  In other words, several schools of thought are heterodox in the acceptance of the necessity of understanding how the surplus is generated and distributed, even if they have different theories (that are not always compatible among them).

The second essential proposition that defines heterodoxy is related to the theory of output and employment determination.  Heterodox economists believe that output is demand determined.  That is, autonomous spending determines the level of activity.  There are a few implications to this simple proposition.  First, the level of autonomous spending will only generate full employment of productive resources by chance, and unemployment is a permanent feature of the economic system.  Second, as the level of income equilibrates savings to investment, the rate of interest must be a monetary (not real phenomenon). Additionally, heterodox economists argue that effective demand is valid in the long run.

In sum, if one believes that prices reflect, for a given technology, the way classes struggle for higher income shares within the process of reproducing the material conditions for survival (including processes in which there is accumulation), and one believes that output and the process of accumulation are driven by the exogenous forces of demand, one may be called heterodox.

Some other issues are often seen as central for defining heterodox economics.  Endogenous money is a typical example.  And it is true that most, if not all, heterodox economists follow some version of endogenous money theory.  However, it is clear that even if money is not endogenous, the rate of interest is still a monetary variable in heterodox economics (e.g. in Keynes' General Theory).  Also, several mainstream economists have endogenous money, from Wicksell to those using the Taylor rule now. The same could be said about true or non-probabilistic uncertainty.  It is important, but neither the determination of prices of production or effective demand are directly affected by uncertainty.  And several Austrians (hardly heterodox according to the criteria above) are very fond of the idea of uncertainty.  The last additional issue that sometimes is used to define heterodoxy is complexity (or non-ergodicity), but is the least relevant.  The main difference between heterodox and orthodox are related to causality issues, and they can be reproduced in simple or complex theoretical frameworks.

The obvious question that anyone may pose is why does it matter to define heterodox economics precisely.  For example, Colander, Holt and Rosser (CHR) suggest that heterodox economists should not consider themselves heterodox but just economists, and try to influence the mainstream working with the best among the orthodox.  The problem is that logic and evidence can support either prices of production or supply and demand, and, by the same token, either Say's Law or Effective Demand must be wrong.  In economic policy compromise might be possible, but in theory principles cannot be compromised.  I replied to their paper here.

PS: My paper is published in the Journal of Post Keynesian Economics, with CHR's reply (subscription required).