Mainstream Economics/Sold Out?

I recently taught a short workshop (online) on Post Keynesian Economics (PKE) for Summer Academy for Pluralist Economics. I basically discussed the definitions of heterodox and Post Keynesian economics, and some critical issues in the theory of output, employment, money and inflation, and income distribution and growth. Students were from several countries, backgrounds, disciplinary fields and stages in their academic careers (from undergraduates to PhD candidates). I will post some brief reactions from a few students on their views on PKE and how they got interested in it, which I think might be of interest, since many have told me over the years that this blog was the only source they had on heterodox economics.

The Unreal Basis of Neoclassical Economics

By Al Campbell, Ann Davis, David Fields, Paddy Quick, Jared Ragusett and Geoffrey Schneider

originally posted here

Introduction
Ten years after the financial crisis, we still find mainstream economists engaging in overly simplistic analysis that does not accurately capture the dynamics of the real world. People studying economics need to know that the principles of mainstream economics are hopelessly unrealistic. In this short article, we demonstrate that the ten principles of economics in Gregory Mankiw’s best-selling textbook are divorced from reality and reflect an extreme and unwarranted bias towards unregulated markets.[ii] Mankiw’s “Ten Principles of Economics” should more accurately be titled “Ten Principles of Unrealistic Neoclassical Theory.”

Mankiw’s Principle #1:  People Face Tradeoffs/There is no such thing as a free lunch.
Mankiw ignores the historical determination of the distribution of resources and the crucial distinction between those whose income comes almost entirely from the performance of labor and those whose income comes from their ownership of capital. As a result he is unable to recognize the political power that results from the concentration of wealth in the capitalist class, and to analyze the distributional impact of decisions in which those who gain are often significantly different from those who lose. In addition, history is full of accounts of forcible appropriation of resources that appeared to be “free” to those who acquired them.

Mankiw’s Principle #2:  The Cost of Something Is What You Give Up to Get It/Opportunity Cost
Insofar as individuals are able to make decisions, their choices can be described as “giving up” one opportunity in order to take up another. This tells us nothing about the determination of the choices that are available to them. The “choice” of a worker as to whether to take on a dangerous job or face eviction from a home requires a very different analysis than one suitable for a discussion of the choice between apples and oranges. On a different level, an analysis of the “trade-off” between income now and increased income in the future requires an understanding of ecological limits to the growth of material production.

Mankiw’s Principle #3:  Rational People Think at the Margin.
Neither consumers nor producers, nor humans in many other social roles, generally act on the margin. The assertion of marginal analysis that decisions must be such as to equate marginal benefit with marginal cost is simply a restatement of the first derivative condition resulting from maximization subject to a constraint, rather than a reflection of real human choice. Mainstream theory then defines behavior according to this mathematical construction even though it does not govern actual choice in the real world. But more important is the presumption that all decision-making is guided by the well-being of isolated individuals, and thus that “rationality” consists of behavior that maximizes the benefit of the individual decision–maker. This dismisses the fact that people are social animals whose decision-making recognizes the interaction between individuals, and it ignores how in the real world people make decisions considering their whole situation under possible alternatives, material restraints, imperfect information, their cognitive abilities, the existing power structures, and culture.

Mankiw’s Principle #4:  People Respond to Incentives.
This is tautological. Furthermore, models based on monetary incentives by selfish, isolated individuals and firms in perfectly competitive markets are unrealistic and ignore crucial real world issues. Monetary incentives are not all that matters. In the real world people make many decisions on the basis of their evaluation of the resulting well-being of many people beyond themselves, or on social and cultural norms.

Mankiw’s Principle #5:  Trade Can Make Everyone Better Off.
Trade can increase total production, but trade has distributional impacts, with winners and losers. Trade in modern capitalism tends to foster inequality while undermining wages and working conditions for many laborers. This principle promotes unregulated trade, but unregulated trade has not proven to be the best route to economic development, nor is it good for all people. In the real world, infant industries, immiserating growth, terms of trade shocks, and increasing inequality render this principle useless as a policy guide.

Mankiw’s Principle #6:  Markets Are Usually a Good Way to Organize Economic Activity.
As there are no measurable units by which one can classify all specific economic activities in the real world as “good” or not, principle #6 is nothing more than a neoclassical ideological declaration of faith. Markets are human creations that operate differently in various economic systems, and the various existing and potential economic systems themselves are human creations. The first real question then is if under an existing system private capitalist markets driven by the profit motive do better than possible alternative human creations for providing the good or service, potentially driven directly by the desire to meet specific human needs. Important examples providing evidence of the inferior performance (efficiency and effectivity) of private capitalist market-driven systems are well run social security systems and single-payer health care systems. Avoiding the error of accepting the system as given, a deeper question would be if under some different economic system, which was not built to favor capitalist accumulation, alternatives could outperform profit-driven markets operating in capitalist systems.

Mankiw’s Principle #7:  Governments Can Sometimes Improve Market Outcomes.
Behind this assertion is the idea that markets are natural and could run without any government intervention, and that such natural markets tend to be efficient but sometimes are not quite optimal. In those cases the efficiency of markets could be improved by government tweaks. To the contrary, in the real world all markets are created by governments, which both establish the rules of the game and enforce them, and thereby determine market outcomes. If the government passes laws requiring that food be safe, that changes the market for food, and yields different market outcomes than if those laws did not exist. With this understanding, principle #7 is reduced to the not very profound statement that because governments create markets, they have the ability to create them with better or worse outcomes. Further, the issue always ignored by neoclassical economics of social divisions is particularly important for considering “better market outcomes”: better for whom? Market rules are shaped by power structures to benefit some classes and other social groups more favorably than others (for example capitalists at the expense of workers, First World countries at the expense of Third World countries, etc.).

Mankiw’s Principle #8:  A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services.
Higher GDP per capita does not necessarily result in a higher material standard of living for all people within, as well as between, countries. Furthermore, neoclassical economics operates with a definition of “standard of living” as the amount of goods and services consumed, so this principle reduces to the not quite tautological, but not very insightful, claim that the amount of goods and services consumed in a country depends on its ability to produce them. In the real world what people are concerned with is their quality of life, which includes social respect, power to act on one’s desires, conditions of work (and not just pay), social relations, and much more. Neoclassical economics does not address the extension of principle #8 to what people in the real world are actually concerned with, their quality of life, for which the goods and services produced are just one among many determinants.

Mankiw’s Principle #9:  Prices Rise When the Government Prints Too Much Money.
Since the neoclassical definition of “too much money” is the amount that makes prices rise, this is a tautology. In the real world the relationship between prices and the money supply is complex: expanding money might cause a jump in prices or it might cause no price increases at all, depending on many other things in the economy.  The applied policy transformation of this into the incorrect claim that “prices rise when the government prints more money” is an ideological artifice, used today to justify austerity policies and keeping wages low.

Mankiw’s Principle #10:  Society Faces a Short-Run Tradeoff between Inflation & Unemployment.
The relationship between inflation and unemployment is complex and does not follow a systematic pattern. By the 1970s data from the real world had caused textbooks to go from Phillips Curves to Shifting Phillips Curves to abandoning them entirely. In view of that experience, principle #10 of a short-term trade-off between inflation and unemployment has become a neoclassical ideological justification for challenging those who advocate policies that would reduce the rate of unemployment, by fostering fears of inflation that may never materialize.
In conclusion, Mankiw’s so-called “Ten Principles of Economics” ignore crucial realities of the economic world. In particular, Mankiw excludes power imbalances, inequality, social forces, development experiences, the realities of market behaviors, laws and outcomes, realistic measures of quality of life, and recent macroeconomic data from his principles. It is hard to imagine a less useful set of ideas to guide modern societies in designing a good economic system. Unfortunately, almost all other mainstream principles of economics textbooks parrot these same principles. Students of economics will have to look elsewhere for useful analysis of the economy and how to build a democratic economy and society that works for all.

References
Mankiw, Gregory. Principles of Economics, 7^th Edition. Stamford, Connecticut: Cengage. 2015.

End-notes
[i] In a subsequent article, we will offer a set of principles of radical political economy to provide a more realistic, alternative approach.
[ii] The authors are members of the steering committee of the Union for Radical Political Economics (URPE). The ideas presented in this article are those of the authors and not of URPE. The purpose of this article is to make readers aware that there are alternatives to the principles of economics put forth by mainstream economists. We synthesize the critiques of mainstream economics by radical political economists in order to give students and teachers ammunition to confront the unrealistic paradigm of neoclassical economics that currently dominates the profession.

Heterodox, Trespasser, Malthusian and other economist labels

I discussed long ago what it means to be heterodox in economics. Bob Kuttner, who I once saw giving a talk at the New School (in the 1990s), a very sharp journalist that knows quite a bit about economics, sings the praises of Dani Rodrik as an heterodox economist. I discussed Rodrik before, in particular his notion that there is only one economics (neoclassical, of course as in the title of his book One Economics, Many Recipes). And he is not subtle about it either. As I noted back then, in his Has Globalization Gone Too Far, that in spite of Kuttner's review is not particularly critical and is indeed mildly for globalization, Rodrik says that: “when I mention ‘economists’ here, I am, of course, referring to mainstream economics, as represented by neoclassical economists (of which I count myself as one).”

Rodrik is, or was a few years ago at least, in what Colander, Holt and Rosser refer to as the cutting edge of the profession (my views on that here), which is to say he is heterodox in the same way that Joe Stiglitz or Paul Krugman are heterodox. They are willing to suggest that some imperfections make the laissez-faire dream of the most fundamentalist neoclassical authors somewhat overstated. But as much as Krugman and Stiglitz accept the conventional macro model, with the natural rate hypothesis, the same is true for Rodrik, which essentially accepts the basic Heckscher-Ohlin-Samuelson trade model (for a critique go here). He is a moderate neoclassical economist; a potty trained one if you will, but certainly not heterodox.

Don't get me wrong, in many policy issues Rodrik, like Krugman and Stiglitz, is on the right side, even if he gets there in ways that I would suggest are contradictory, and can be seen as an ally of heterodox economists on these policy issues. But I think it is a bit much to call him a critic of globalization, in particular because it underplays the role of true critics, that often paid a steep professional price, in terms of prestige and money, to defend their views. For example, his critique of the Washington Consensus was that the policies (essentially austerity cum deregulation, trade liberalization and privatization, or what you would call neoliberal policies) were incomplete and more institutional reforms were needed to make them work. So Rodrik was basically playing the Douglas North New Institutional imperfection card (now used very effectively by Acemoglu, Robinson and co-authors). Summarizing his work I said back then:

"Rodrik (1999b) suggested that five types of institutions, defined as behavioral rules that govern the interaction between economic agents, are relevant to explain successful development experiences: property rights, regulatory institutions, institutions for macroeconomic stabilization, institutions for social insurance, and institutions for conflict management."

The problem, as I noticed back then, was that the institutions he was pushing for (note that property rights are in the original Williamson consensus decalogue) were more harmful than good. They reduced the ability to promote state intervention in the economy and the scope for industrial policy, they were geared for macro stability narrowly focused on price stability (he probably wouldn't disagree with the idea of the natural rate in macro), and even when he was for social insurance policies, didn't seem to notice that his macro policies would make more social spending almost by definition impossible.

I should say that I find it very apropos that Kuttner compares him with Albert Hirschman, and calls the latter one of Rodrik's heroes, even if I think Rodrik is a different kind of trespasser, not interested in interdisciplinarity per se, but in using economics concepts for insights into other social sciences. More like a social science imperialist (for my take on Hirschman's interdisciplinarity go here). Hirschman was a development economists that was against planning, and that thought that there was something relevant about Hayek's Road to Serfdom (a book that says that any intervention by the state ends up in a slippery slope towards fascism*; the same argument Reagan made about Medicare in the 1960s). Hirschman had a serious debate with Currie on the issue of planning, regarding the latter's World Bank mission to Colombia, and was generally seen as friendly critic of the mainstream (see Roger Sandilands views, which are, correctly I would add, very critical of Hirschman). Like Rodrik, Hirschman got hired by Harvard, which is hardly known for hiring controversial lefties that go against the grain, which he only left to the Institute of Advanced Studies because he was a terrible teacher. Also, like with Hirschman's contributions, many heterodox and progressive intellectuals tend to overplay the critical aspects of Rodrik's work.

In my view, the problem with the friendly critic, that accepts all of the main tenets of mainstream marginalism, without taking seriously the heterodox critiques of the internal logic of neoclassical economics, is that they end up validating some of this illogical ideas, and the foundation for the neoliberal policies people like Rodrik supposedly abhor.

On a slightly different note, and I guess once we are in the topic of who should be considered heterodox and who is a follower of Hirschman, here is another question of labels. Dietrich Vollrath comes out of the closet as a Malthusian. That's a bit funny. I know neoclassical economists, in particular, after Clark's A Farewell to Alms, have come to embrace the epithet, but in all fairness, for a reasonably educated person Malthusian is sort of an insult (btw, on my views on some of the mistakes with the ideas of demographic transitions and Malthusian traps see this).

* On this, Jeremy Adelman tells us in his biography of Hirschman that: "when he found a copy of Friedrich von Hayek’s recently published (in London, in March 1944) The Road to Serfdom in a Rome bookstore, a nerve was struck. 'Reading this book is very useful for someone like me who grew up in a ‘collectivist’ climate—it makes you rethink many things and has shown me in how many important points I have moved away from the beliefs I had when I was 18 years old.'" Those would be his more progressive, Marxist, convictions. Hirschman had lived in Germany, not the Soviet Union, by the way.

A Taxonomy of Piketty's reviews

Brad DeLong wrote a lengthy review of Piketty's Capital, paraphrasing in the title the famous ISLM (ISLL in Hick's original terminology) paper by John Hicks, which deserves a review by itself. In particular the discussion of Piketty's analytical model, which is, as noted before, incredibly problematic. It is worth noticing that Brad argues somehow that there two kind of reviews, namely: those that are useful and worth reading, in which he includes Tyler Cowen's review (which I've only indirectly alluded to here and here), and the ones that are wrong and are 'distracted by irrelevances,' which include Galbraith and Palley's reviews.*

Brad's idea is not bad, I mean of a taxonomy of the reviews of Piketty, but his take is neither useful to understand the differences, nor constructive for dialogue. So here is my very brief taxonomy.

There are only a few that I included, not because these are the more important necessarily, but because they seem to be representative. I made two analytical distinctions. Mainstream and Heterodox, which is based on the theoretical background, and whether the authors accept the Neoclassical paradigm or not (Murphy and Austrians do, in a confused way). Also, reviews are classified as favorable or critical of the policy prescriptions in Piketty's book. Basically, one distinction is theoretical and the other is policy oriented.

Note that the interesting thing that emerges is that there are NO, at least to my knowledge, Critical Heterodox views, that is, heterodox authors that are against higher taxes and wealth taxes.

The basis for the mainstream critiques (Cowen and Murphy) is that taxes create distortions and lead to lower growth making things worse. After all greed is good, or something like that. This comes from the more radical fringe of the pro-markets are efficient wing of the profession. The conventional defense of Piketty is basically based on New Keynesian (or old in the case of Solow) views, and it suggests that market imperfections are sufficiently large that there is space for redistribution, and tax policy is the main way to go to redress the increase in inequality of the last 30 years.

Finally the Heterodox views (Galbraith, Palley and Lance Taylor), and here I included a non-economist, David Harvey that follows a distinctly Marxist view,** which all suggest that Piketty raises and important point, which has been discussed by heterodox economists forever, that the empirical analysis is also an addition to our understanding of inequality, but that there are theoretical flaws, which both mainstream groups (Piketty would be closer to a New Keynesian, and he is a Socialist, or at least supported Holland in the last election) share, and that this limits, but does NOT disqualify the argument for redistribution.

This illustrates also a point made in this blog for a while. On the one hand, heterodox groups are politically closer to some New Keynesian authors, which, however, remain firmly based on the orthodox notion that markets unimpeded by imperfections produce optimal outcomes. Once, the New Keynesians get rid of some of the limitations of their theoretical framework, the essential being the natural rate (of interest or unemployment), their political argument would be more coherent and stronger.

* The ones that are wrong or distract point to the logical flaws in Piketty's theoretical model, by the way.

** I didn't include Cassidy's good review, simply because as a journalist the mainstream/heterodox distinction doesn't quite apply, but his views are fundamentally favorable. By the way, the Financial Times, also would not fit that dichotomy, but it certainly fits more clearly the political one, and has come clearly against Piketty for his empirical mistakes (here). For a response see Branko Milanovic here (h/t Daniele Tavani).

Classics and Marxism

A website with lots of great books and papers to download (h/t Revista Circus), including several marginalist/mainstream contributions as well in spite of the title, right here. Enjoy.

Heterodox and Mainstream Economics: The Great Confusion

Simon Wren-Lewis has a post on heterodox versus mainstream macroeconomics in which he seems surprised by what he calls the Great Divide between the two groups. He claims to be sympathetic to the heterodox project, at least along the lines of Steve Keen, but argues that the "rejectionist strategy is of course unlikely to win friends within the mainstream."

Wren-Lewis also suggests that a Minsky model developed by Keen (which according to Keen was rejected by several mainstream journals) is very similar to his ideas, but he fails to note that the Keen's model, as well as Minsky's theory, does not include a crucial characteristic of mainstream models, New Keynesian (NK), New Classical (NC), Real Business Cycle (RBC) and New Neoclassical Synthesis (NNS) alike, namely: Friedman's natural rate hypothesis.*

If you accept that cycles are just a shock (monetary or real) to an optimal trend and that the only thing that prevents the return of the economy to its optimal level is some sort of rigidity, then the obvious solution, at least in the long run, is to eliminate the rigidities. By the way, that is the reason why the NKs and NNSs authors end up believing in a confidence fairy, very much like NCs and RBCs authors. The NK and NNS fairy being about higher inflation expectations allowing for more investment demand, rather than directly about the less uncertainty allowing for more investment.

Wren-Lewis' confusion is to assume that the proximity of heterodox Keynesian groups and NKs like him on policy issues implies that on a deeper theoretical level there must be agreement too, and that this does not happen because of the sectarian nature of the heterodoxy.

Krugman's views, by the way, are very similar, in the sense that he seems to not quite understand why he is not seen as Keynesian by some heterodox economists. In a recent post, he argues that:

"Some devotees of Keynes claim that people like me aren’t really Keynesians – and while there are some serious grounds for the charge, part of the reason is precisely that we’ve treated Keynes as an inspiration to be modified in the face of evidence rather than as holy writ."

The confusion is incredible. Keynes himself accepted some neoclassical ideas that made his argument limited and heterodox authors actually have discarded a lot of Keynesian concepts (I myself believe that both the marginal efficiency of capital and liquidity preference are highly problematic, but that is material for other posts). The problem with Krugman is that he maintains (yes you guessed) the natural rate (a concept that a least Keynes wanted to drop from his theory), and suggests that unemployment and the recession are caused by the downward rigidity of the interest rate (a liquidity trap), propositions for which there is little evidence. Krugman is the one that treats neoclassical principles (the idea that a natural rate exists) as holy writ!

Both Krugman and Wren-Lewis seem to believe that economics (and science) is about convincing the others on a political level and are puzzled by the fact that heterodox do not fall in line with the NKs. That is why a less rejectionist, to use Wren-Lewis term, strategy is suggested (a similar view by Colander is criticized here). The problem is that evidence and logic (for the logical critique of the natural rate you must get the capital debates) suggest that the natural rate does not exist. Don't get me wrong, on political issues most heterodox authors are with Krugman, Wren-Lewis and company, against austerity, but science implies (as Krugman himself notes) adherence to facts.

So why don't NKs just renounce to the idea of a natural rate once and for all. For one they would make lots of friends within the heterodox community, which is way ahead in understanding the crisis (and foreseeing it too), and also would make their models more realistic.

* I have my own troubles with the kind of model presented in that paper by Keen, which are related to his profit driven investment function, but that is better discussed in another post.