Showing posts with label Joan Robinson. Show all posts
Showing posts with label Joan Robinson. Show all posts

Friday, September 26, 2014

History versus equilibrium: a false dichotomy

The title comes from Joan Robinson's famous essay. However, the motivation is to clarify some comments on a previous post on what Keynes meant by unemployment equilibrium (sent to me, but not published). There is a relatively widespread notion among some post-Keynesians that neoclassical economics assumes always a single unique equilibrium, and that Keynes, or at least his closer followers like Robinson, believed in multiple equilibria. The idea is that post-Keynesians believe in an unstable, uncertain capitalist system in which full employment is only one possibility.

Beyond what one may think about equilibrium, there is no basis in the history of economic ideas for that view. Keynes was a Marshallian, and as such did believe in the notion of a single stable long run equilibrium of the system. The radical element in Keynes analysis is that such equilibrium might be suboptimal, that is, one in which resources are not fully utilized. He is very clear when he says in the General Theory that:
"it is an outstanding characteristic of the economic system in which we live that, whilst it is subject to severe fluctuations in respect of output and employment, it is not violently unstable. Indeed it seems capable of remaining in a chronic condition of sub-normal activity for a considerable period without any marked tendency either towards recovery or towards complete collapse. Moreover, the evidence indicates that full, or even approximately full, employment is of rare and short-lived occurrence. Fluctuations may start briskly but seem to wear themselves out before they have proceeded to great extremes, and an intermediate situation which is neither desperate nor satisfactory is our normal lot."
So what Keynes said is pretty clear, fluctuations around a normal equilibrium. Unemployment is the normal position, the long run equilibrium around which the system fluctuates. Like the old classical political economists (e.g. Smith, Ricardo, and Marx) and the marginalists of his time (e.g. Pigou, and Marshall) Keynes believed in a single stable long run equilibrium position. Note that nothing in Keynes analysis implies that the long run equilibrium is ever attained, or that it cannot be affected by the process by which it is approached, and, hence that it would be path-dependent [the supermultiplier story with a Kaldor-Verdoorn process is path dependent and is still a long run equilibrium position].

The problems associated to the negative impact of uncertainty, and failed expectations, and the institutions and conventions that are relevant in a certain historical context to minimize the effects of instability are all part of the normal operation of the economy for Keynes, and not, like in neoclassical models, superimposed on an essentially stable system. In other words, Keynes equilibrium theory is not a-historical, and hence does not require the addition of more realistic (historical?) elements to provide explanation of say why the system is stuck below full employment equilibrium.

For example, lack of demand (caused by stagnant wages and not enough fiscal stimulus) means that the US economy will the near future fluctuate around levels of unemployment that are above the previous normal levels. In the graph below (source) that is visible in a trend that was lower in the 1950s and 1960s, and goes up in the 1970s and 1980s, only to go down (as a result of a series of bubbles) in the 1990s, and, as I suggested, is likely to go up again. This trend represents the normal position to which Keynes alluded in the passage cited above. Unemployment fluctuates, but is not violently unstable (sometimes it might be; asks the Greeks). In the neoclassical model, in contrast, without imperfections, be that price rigidities or lack of information or any other kind, the system would move to full employment. That's why they often resort to change what the meaning of full employment is (the natural rate goes up; nudge, nudge; wink wink).
However, the interesting thing is that while the old neoclassical authors shared the classical political economists and Keynes notion of a stable long run equilibrium (optimal for the neoclassical, and not so for Keynes and the classical authors), they have departed from that view after the capital debates. In fact, it is in the Walrasian world of Arrow-Debreu's intertemporal equilibrium, that the notion of multiple equilibria becomes relevant (for the reasons why the mainstream changed their views on equilibrium go here; Garegnani classic paper titled "On a Change in the Notion of Equilibrium in Recent Work on Value" is the source of this idea). But in that world, anything could happen, it is wildly unstable and there no forces bringing the economy back to its normal position. Certainly not what Keynes thought, and also not an accurate description of the graph above.

More importantly, the very idea of long run equilibrium is central to our ability to theorize about the functioning of real, historically and institutionally specific economies. It is the fact that there are persistent forces, with regularities, which allows to say something meaningful about the functioning of the economy. If uncertainty rendered economic calculation impossible, then even Keynes' theory about how effective (autonomous) demand determines income, would be irrelevant, and in that case post-Keynesians would have (notice I said would have, since I don't think this is the right way to describe post-Keynesian economics) more in common with the modern neoclassical economists that have embraced multiple equilibria and all sorts of imperfections.

Friday, September 12, 2014

Krugman is actually right on ISLM and Minsky

I tend to disagree a lot with Krugman, at least on theoretical issues. His brand of Keynesianism supposes that the system doesn't work because of imperfections. For him, the current slow recovery is due to the fact that the natural rate of interest is basically negative and you cannot use monetary policy to stimulate the economy (see critique of this here). However, on his recent debate with Lars Syll (and here; Brad De Long also posted here), a post-Keynesian, with whom I probably share a more radical interpretation of Keynes and its relevance for economic theory, Krugman seems to get things right.

The main points in Lars initial post, based on Minsky's book John Maynard Keynes is that traditional representations of Keynes do not emphasize the cyclical component of Keynes' theory and that true or fundamental (non-probabilistic) uncertainty is often ignored. Lars adds a little bit more on his response to Krugman and De Long, but essentially is the same argument. Keynes didn't like the ISLM (which is from a historical point of view difficult to defend, after all the only stuff he wrote on this, to Hicks, was quite positive, even if it is of little relevance), that it is static (not paying attention to cyclical or dynamic phenomena), and perhaps more interestingly that the interaction of real and monetary variables in the model is simplistic.

Krugman points out that the General Theory (GT) is NOT about cyclical fluctuations per se. It is about the determination of the long run level of output and employment, around which the economy fluctuates, and he correctly notes that cycles only appear as an afterthought in chapter 22 of the GT. And that is precisely correct. The GT is revolutionary because it suggests that with price flexibility (not price rigidity as in the old Neoclassical Synthesis or the New Keynesian stories) the system gets stuck in a situation of unemployment equilibrium. Emphasis on equilibrium. Yes, unemployment at less than full employment and output below its potential level are both together in an equilibrium situation.

Patinkin suggested that Keynes meant unemployment disequilibrium, since within the neoclassical framework, unless there is a rigidity of some sort, and the system should go to its long run equilibrium position with full employment. Minsky (1975, p. 268), in the book cited above, says that Keynesian economics should be seen as the: "economics of permanent disequilibrium." That has no basis on the GT. Actually, the GT would be a less radical book if it only said that with instability the system might be always in a disequilibrium position. Keynes was very radical since he argued that the very notion of a natural rate should be abandoned (on this Paul and Brad have a lot to learn). Some Post Keynesians tend to dislike the idea of equilibrium (echoes of Joan Robinson's late critique of the idea), which ends up making them closer in many respects to the modern mainstream authors with their dislike for long term equilibrium positions.

So the GT is not about cycles (Keynes' Treatise on Money, a very conventional and Wicksellian book was about cyclical disequilibrium caused by differences between the natural and banking rates of interest, which, interestingly enough is closer to Krugman's way of thinking than the GT, or than to Lars, who is aware of the limitations of the natural rate concept). But that's not all that Krugman got right this time.

He quotes the famous passage in which Keynes says that the system is not violently unstable (GT, p. 249). And while Post Keynesians are correct to note the relevance of fundamental uncertainty, it is important also to consider the stabilizing role of conventions and institutions, to which Keynes alludes. Expectations play a role, but investment is not completely volatile, and it was a problem for Keynes only when "the capital development of a country becomes the by product of the activities of a casino" (GT, p. 159). In fact, given the relevance of the accelerator in determining investment, the central role of expectations is about the level of demand. For example, in the US investment has been subdued since demand is not growing fast and there are not reasonable expectations that it will any time soon.

Where New Keynesians go wrong, and in this case is actually Brad, not Paul (but he would certainly agree) is on the relevance of the marginal efficiency of capital, criticized by Minsky (even though it's far from clear that Minsky abandoned it). Brad thinks that Minsky critique of it is myopic and basically a PR problem. He says that it is: 
"Short-sighted, in that it is not Hicks who would be Minsky’s long-run intellectual adversary but rather Freidman [sic], Lucas, and Hayek, and so building bridges to the Hicksians ought to be a very high priority."
Probably true, but from a policy point of view. From a theoretical point of view, Hicks use of the marginalist notion of an investment function inversely related to the rate of interest (something Keynes also used) implies that there would be a rate of interest low enough that would produce full employment, that is a natural rate, which would preclude Keynes' claim about unemployment equilibrium (and the absence of a natural rate). In other words, with the marginal productivity of capital you have that unemployment must be a disequilibrium situation caused by some imperfection that inhibits the system from reaching the natural rate.

And yes the capital debates are relevant since they show that the inverse relation is only possible in a one commodity world. No natural rate, and no need to think about imperfections. And that's why the comment by Lars on the connection between real and monetary variables being simplistic within the ISLM is right on the mark. The idea that the central bank controls a monetary rate, that may get out of whack with the natural, and that by manipulating it can affect real variables is limited at best.

PS: For my previous defense of a modified ISLM go here and here

Saturday, April 5, 2014

Lars P. Syll: Piketty and the Cambridge capital controversy

By Lars P. Syll
Piketty wants to provide a theory relevant to growth, which requires physical capital as its input. And yet he deploys an empirical measure that is unrelated to productive physical capital and whose dollar value depends, in part, on the return on capital. Where does the rate of return come from? Piketty never says. He merely asserts that the return on capital has usually averaged a certain value, say 5 percent on land in the nineteenth century, and higher in the twentieth.  The basic neoclassical theory holds that the rate of return on capital depends on its (marginal) productivity. In that case, we must be thinking of physical capital—and this (again) appears to be Piketty’s view. But the effort to build a theory of physical capital with a technological rate-of-return collapsed long ago, under a withering challenge from critics based in Cambridge, England in the 1950s and 1960s, notably Joan Robinson, Piero Sraffa, and Luigi Pasinetti.
Read rest here.

Friday, February 28, 2014

Tuesday, February 4, 2014

Yes, The Cambridge Capital Controversies Do Matter

From Unlearning Economics:
I rarely (never) post based solely on a quick thought or quote, but this just struck me as too good not to highlight. It’s from a book called ‘Capital as Power’ by Jonathan Nitzan and Shimshon Bichler, which challenges both the neoclassical and Marxian conceptions of capital, and is freely available online. The passage in question pertains to the way neoclassical economics has dealt with the problems highlighted during the well documented Cambridge Capital Controversies:
The first and most common solution has been to gloss the problem over – or, better still, to ignore it altogether. And as Robinson (1971) predicted and Hodgson (1997) confirmed, so far this solution seems to be working. Most economics textbooks, including the endless editions of Samuelson, Inc., continue to ‘measure’ capital as if the Cambridge Controversy had never happened, helping keep the majority of economists – teachers and students – blissfully unaware of the whole debacle.
A second, more subtle method has been to argue that the problem of quantifying capital, although serious in principle, has limited practical importance (Ferguson 1969). However, given the excessively unrealistic if not impossible assumptions of neoclassical theory, resting its defence on real-world relevance seems somewhat audacious.
The second point is something I independently noticed: appealing to practicality when it suits the modeller, but insisting it doesn’t matter elsewhere. If there is solid evidence that reswitching isn’t important, that’s fine, but then we should also take on board that agents don’t optimise, markets don’t clear, expectations aren’t rational, etc. etc. If we do that, pretty soon the assumptions all fall away and not much is left.
However, it’s the authors’ third point that really hits home:
The third and probably most sophisticated response has been to embrace disaggregate general equilibrium models. The latter models try to describe – conceptually, that is – every aspect of the economic system, down to the smallest detail. The production function in such models separately specifies each individual input, however tiny, so the need to aggregate capital goods into capital does not arise in the first place.
General equilibrium models have serious theoretical and empirical weaknesses whose details have attracted much attention. Their most important problem, though, comes not from what they try to explain, but from what they ignore, namely capital. Their emphasis on disaggregation, regardless of its epistemological feasibility, is an ontological fallacy. The social process takes place not at the level of atoms or strings, but of social institutions and organizations. And so, although the ‘shell’ called capital may or may not consist of individual physical inputs, its existence and significance as the central social aggregate of capitalism is hardly in doubt. By ignoring this pivotal concept, general equilibrium theory turns itself into a hollow formality.
In essence, neoclassical economics dealt with its inability to model capital by…eschewing any analysis of capital. However, the theoretical importance of capital for understanding capitalism (duh) means that this has turned neoclassical ‘theory’ into a highly inadequate took for doing what theory is supposed to do, which is to further our understanding.
Apparently, if you keep evading logical, methodological and empirical problems, it catches up with you! Who knew?

Thursday, March 14, 2013

Sraffa and the Marshallian system

(Sraffa circa 1976)

G. L. S. Shackle argues in The Years of High Theory that ‘there began in the mid-1920s an immense creative spasm, lasting for fourteen years until the Second World War, and yielding six or seven major innovations of theory, which together have completely altered the orientation and character of economics’ (Shackle, 1967, p. 5). However, by 1967, the two most important developments of this period—Keynes’s principle of effective demand and Sraffa’s criticism of the marginalist theory of value—were rapidly fading from the main corpus of mainstream theory.

The relative ease with which neoclassical economics reasserted its main conclusions is, in fact, explained by Shackle’s account of those years. First, Sraffa’s critique of the Marshallian theory of value is seen only as a step in the development of the theories of imperfect competition by Joan Robinson and Edward Chamberlin. Second, Keynes’s General Theory is seen as stating that unemployment results from the existence of uncertainty and irrational expectations (Shackle, 1967, p. 129). Both developments can be interpreted as asserting that market imperfections render neoclassical theory, although internally coherent, irrelevant for the analysis of the real world.

Also Shackle’s failure in 1967 — well after the publication of Production of Commodities — to acknowledge the importance of the revival of classical political economy to the debates of the 1930s represents a serious inadequacy of his interpretation of ‘the years of high theory’.

Before getting into Sraffa's critique of Marshall, it is worth noticing that Sraffa came to economics via monetary economics, like Ricardo and Keynes. His dissertation for the Law Degree, L’Inflazione Monetaria in Italia Durante e Dopo la Guerra (subscription required), dealt with postwar inflation and the return to the Gold Standard, the same topic of Keynes’s Tract on Monetary Reform. According to Eatwell and Panico (subscription required), in the analysis of the asymmetric effects of inflation and deflation Sraffa reveals the heterodox character of his position, more akin with the works of the classical authors and Marx than the conventional marginalist analysis. The notion that social conflicts and monetary factors determine the normal real wage was part of Sraffa’s analysis, although several elements of his analysis were still conventional, e.g. the acceptance of the Quantity Theory and of the Purchasing Power Parity theory.

Sraffa’s criticism of the Marshallian theory of supply represents an analogous situation, in the sense that some elements of the conventional marginalist views were still present. Marshall’s or Sraffa’s dilemma (which appears in Sraffa's 1926 paper) refers to the incompatibility between increasing returns and perfect competition. It is a long period problem. Sraffa’s critique can be summarized in the following way. First, rising costs derive from diminishing returns to substitution, and, therefore, in the general case where there are no fixed factors, increasing costs do not seem to exist. Secondly, increasing returns are incompatible with perfect competition. In the long period, when the firm cannot experience marginal costs arising from the existence of some fixed input, there can be no diminishing returns. Replication is always possible, except for the case of indivisibilities. In addition, Sraffa showed that increasing returns to scale are inconsistent with the notion of perfect competition.

In the case of increasing returns, the average cost is decreasing, implying that the marginal cost is below average variable cost, and, hence, there is no infinite, non-zero solution for the profit maximization problem. In other words, there is a tendency for the firm to expand to infinite size. Sraffa’s argument proves the failure of perfectly competitive assumptions to determine any equilibrium of the individual firm. Two alternatives are opened by Sraffa’s critique of Marshallian theory. If it is not legitimate to treat average cost as either increasing or decreasing within the framework of perfect competition, we are left with the result that the only satisfactory assumption is that of constant returns. On the other hand, ‘everyday experience shows that a very large number of undertakings work under conditions of individual diminishing costs’ (Sraffa, 1926, p. 543), which suggests that we should instead abandon the notion of perfect competition.

Sraffa considered the imperfect competition approach to be the only logical way to develop the theory of value along Marshallian lines. However, he showed no inclination to pursue this solution, and he appears to have already been working toward the revival of the classical approach. The origins of this project can be traced back to his early draft of the opening propositions of the Production of Commodities, which he asked Keynes to read in 1928 (Sraffa, 1960, p. vi). The reasons for not pursuing imperfect competition were never quite explained by Sraffa, but are fairly reasonable to infer (note that in Cambridge it was two of his students, Richard Kahn and Joan Robinson, that developed the imperfect competition theory).

Note that in order to obtain partial equilibrium, which is what the Marshallian model presumes, one must assume that prices in a particular industry are not affected by and do not affect the prices in other industries. Hence, externalities have to be internal to the industry, since otherwise production in one sector would affect the prices in other industries [perfect competition in partial equilibrium, the U-shaped cost curves and the equilibrium at the minimum with marginal cost equal marginal revenue, require also that externalities are external to the firm, since if they weren't the firm would became a monopolist; of course externalities that are internal to an industry and external to firms are an empty set]. That seems to be a dead end. Sraffa was already interested in the determination of long term prices. By this time, the summer of 1927 when he was preparing his ‘Lectures on Advanced Value Theory’ that he gave from 1928 until 1930, it was already clear to him that he needed to start from classical preocupation of determining relative prices and one of the distributive variables (the rate of profits or wages) strictly in material terms, that is, the quantities of labor and commodities needed to produce commodities.

For further on Sraffa's critique of Marshall see Gary Mongiovi's paper here (subscription required). For a general critique of Shackle's stance in the history of 'the years of high theory' read this one. For the implications of Sraffa's 1960 book for economics go to this old post (yes on the capital debates!).

Wednesday, December 26, 2012

Joan Robinson on neoclassical economics

Given Krugman's involuntary reopening of the discussion on the capital debates and the limits of neoclassical/marginalist economics, it would be good to hear this audio (here and here; not very good quality) of a lecture given by Joan Robinson (with a brief intro by Don Harris). H/t F*#k Yeah Piero Sraffa.

Friday, September 14, 2012

Path Dependency and Hysteresis

I promised to discuss the difference between these two concepts a while ago. The idea of path dependency is related to Joan Robinson’s famous objection according to which equilibrium is not an actual outcome of real economic processes, and it is for that reason an inadequate tool for analyzing accumulation.  Her view would suggest that path dependency should be seen as a property of models that break with conventional methodological stances, and, in particular, with the dominant neoclassical school.

It is important to note that mainstream defenders of the idea that ‘history matters’, like Paul David (of QWERTY fame), tend to disagree with the view that path dependency implies a rupture with neoclassical economics. David (2001, p. 22) says, in this regard: “imagine … my utter surprise to find this approach being attacked as a rival paradigm of economic analysis, whose only relevance consisted in the degree to which it could be held to represent a direct rejection of the normative, laissez-faire message of neoclassical economics!”  For David, path dependency is a property of dynamic and stochastic processes and cannot be used to assert anything about models and propositions derived in static and deterministic setting [which is, apparently, what he thinks neoclassical economics is all about].

Mark Setterfield's research might hold the key to this issue, by differentiating hysteresis [a concept from physics, that shows that mainstream economists do have physics envy!] and path dependency, and suggesting that the former, more typical of mainstream models, is a special case of the latter, more general and the concept often linked to heterodox models. He suggests that hysteresis is a variation of traditional equilibrium analysis, which implies that some displacements from equilibrium would be self-correcting while others would not. Hysteresis results from the non-uniqueness of equilibrium and under certain conditions the economic system would adjust to a new equilibrium. On the other hand, Setterfield argues that the typical path dependent model is based on cumulative causation, a concept that harks back to Gunnar Myrdal and Nicholas Kaldor’s contributions to economics. In this case, transitory shocks always have permanent effects.

A simple example might illustrate the difference between the more restricted notion of hysteresis and cumulative causation. In the conventional mainstream description of labor markets, an increase in unemployment insurance that allows workers to hold out longer for better paid jobs increases the natural rate of unemployment. After a fall in demand (an external shock), if structural changes to the labor market like higher benefits take place, the level of unemployment will increase and eventually fall, as real wages fall, but to the new and higher natural rate [think of Gordon's Time Varying NAIRU]. Hysteresis implies that history matters, but the system is still self-adjusting.

The quintessential example of cumulative causation is associated to the Kaldor-Verdoorn Law, which says that output growth leads to rising labor productivity. Thus, higher demand leads to higher output growth, which implies higher productivity, lower costs, and higher income in a virtuous circle of expansion. There are several possible expansion paths, depending on the strength of the multiplier-accelerator forces and the Kaldor-Verdoorn coefficient, rather than a single equilibrium to which the system adjusts. There is no adjustment to an optimal equilibrium level, no natural rate fixed or varying. The heterodox notion demands the rejection of the natural rate.

Thursday, June 21, 2012

And here's to you, Mrs Robinson

Jesus loves you more than you will know (wo, wo, wo) ...I know, but I was going to talk about the other Mrs Robsinson, Joan Violet (née Maurice), the main disciple of Keynes,* as I had promised in a previous post. Joan Robinson's contributions to economics demand several posts. She has participated, as Maria Cristina Marcuzzo noted, in three Revolutions, namely: the imperfect competition, the Keynesian and the capital debates ones.

And to reduce her to those three one has to fit her contributions to growth theory into a subcategory of either the Keynesian Revolution (the extension of the Principle of Effective Demand to the long run) or the capital debates (the critique of mainstream growth theory), and omit her various other contributions to monetary theory (e.g. endogenous money and the circuit), methodology (e.g. history vs. equilibrium), Marxist economics and so on. She was prolific for sure.

There are several great reviews of her contributions in all of them, which would make my post irrelevant. But what I want to discuss is the point raised in Sergio Cesaratto’s presentation, that in the last one of those revolutions her contributions might have been seen as negative. In his exposition Sergio emphasized quite correctly her rejection, at least in certain contributions, of the notion of long term normal equilibrium positions, and, hence, the traditional method of economics.

This was done, for the most part, to emphasize the notion that history matters and that path dependency was important, since the process of reaching the equilibrium would affect the equilibrium itself. Arguably, the role of uncertainty, following Keynes and some post-Keynesians, played a role in her rejection of normal equilibrium positions.

Path-dependency is indeed an important feature of real economies, and Robinson was quite right in emphasizing its relevance.++ However, the fact that the normal or long run equilibrium positions might depend on the initial conditions and on the trajectory to its final position would render the very notion of equilibrium irrelevant for the analysis of real historical situations might not be granted.

In her view, the notion of equilibrium originated from a misleading mechanical analogy with movements in space, and shouldn’t be applied to movements in time.  However, nothing suggests that the long run position of equilibrium cannot be path dependent and actually represented by an equilibrium position. Let me suggest that the idea of the supermultiplier is, for example, a case in point. Output depends on the autonomous components of demand, and investment, as derived demand, behaves in a way which leads to the adjustment of capacity (supply conditions) to demand.  It is an equilibrating process, but not a unique one, or one that leads to a determinate path of accumulation, since alternative initial conditions (e.g. sizes of the relevant coefficients) lead to different outcomes.  Also, changes in several factors can affect the trajectory by which capacity adjusts to demand.

Further, uncertainty, or true, fundamental and non-probabilistic uncertainty was also a relevant component of Robinson’s critique of equilibrium positions. Uncertainty also suggests that historical processes are complex and could not be reduced to equilibrium analysis. This was also in line with the post-Keynesian developments in the 1970s, by Paul Davidson and others, that suggested that uncertainty was central for Keynes understanding of the functioning of the economy.

That is again true. Uncertainty was important for Keynes, and is central in the functioning of real economies. However, uncertainty does not preclude the use of equilibrium. Uncertainty implies that agents use conventions, rules of thumb in order to make decisions. In an uncertain world agents stick to social norms, and even if there is significant uncertainty on an individual basis, the institutional framework tends to reduce uncertainty. In that sense, for example, the New Deal reforms decreased to a great extent the degree of uncertainty in the functioning of the economy, and guaranteed a high degree of stability to workers.  Another example of how institutional framework would reduce uncertainty is the use of capital controls (and fixed but adjustable exchange rates) to reduce the pressures on interest rates during the Bretton Woods era. With that framework, fiscal expansion with low real rates of interest produced a normal equilibrium with low unemployment level. In other words, nothing implies that uncertainty suggests that the multiplier and accelerator processes are not operational or that normal positions of equilibrium cannot be achieved.

In my view, the two main problems to Joan Robinson’s critique of the equilibrium method in the latter part of her career are that, on the one hand, by emphasizing the independence of the investment function and of uncertainty it led to the development of a set of models (later incorrectly referred to as Kaleckian) that bring back the entrepreneur as the central figure in economic growth (the so-called profit-led regimes). On the other, and even more problematic, it took place at the same time that (as noted by Garegnani) the mainstream rejected the old notion of long term equilibrium, and started to use dominantly the intertemporal models (this ones in fact terrible mechanical analogies to movement in space).

The old classical (and indeed even the old Marshallian) notion of normal positions, which allowed for historical contingency and path dependency was abandoned by the mainstream, but that was seen by several heterodox authors as an improvement because now mainstream models were ‘capable’ of incorporating multiple equilibria and instability. In fact, Keynes point was that normal situations (and hence stable equilibrium positions) in capitalism were sub-optimal. And Joan Robinson, at least in part, is responsible for some of those heterodox (very confused) views of the development of the mainstream.

* Richard Kahn would be the other candidate, but his contributions to the Keynesian Revolution were considerably less visible, if admittedly incredibly important, with the formalization of the multiplier on the top of the list. Kalecki and Kaldor, although quintessential Keynesians, were not disciples of Keynes in a direct way, and Sraffa, although personally close, and contrary to what some think, very favorable to the idea of effective demand, was not a disciple proper either.

++ Note that path-dependency is not exactly the same as hysteresis, a point raised by Mark Setterfield. I’ll expand on this on another post.

PS: A paper in which some of the pros and cons of Robinson's approach to economics, in particular on money and growth, is available here (subscription required).

Wednesday, May 2, 2012

Not entirely debauched by economics

The quote of the week (I should instate it as a policy) comes from a letter from Piero Sraffa to Joan Robinson:
"If one measures labour and land by heads or acres the result has a definite meaning, subject to a margin of error: the margin is wide, but it is a question of degree. On the other hand if you measure capital in tons the result is purely and simply nonsense. How many tons is, e.g., a railway tunnel? If you are not convinced, try it on someone who has not been entirely debauched by economics. Tell your gardener that a farmer has 200 acres or employs 10 men – will he not have a pretty accurate idea of the quantities of land & labour? Now tell him that he employs 500 tons of capital, & he will think you are dotty – (not more so, however, than Sidgwick or Marshall)."
That was in 1936. The reference comes from this paper by Velupillai on Krishna Bharadwaj’s contributions to economics.

Monday, October 10, 2011

A beautiful blind

Sylvia Nasar wrote a new book (the old and famous was the one on Nash's mind and life) on the history of economic ideas. Robert Solow is not too happy, since he thinks the book is superficial, and spends too much time on the economists lives and on what he thinks are second rate minds (e.g. Beatrice Webb, and I suspect for him Joan Robinson too). I did not finish reading the book, and hence will not review it here now, but I can comment on Solow's review, which is quite misguided.

In fact, the preoccupation with policy issues and the general context in which theories are developed is one of the good aspects of this book. In this sense, Nasar's book is in the direct line of descent of those, like Robert Heilbroner, that think that economics is (and should be) about the great questions (accumulation and the wealth of Nations, the quintessential themes of classical political economy) and that the economist's vision is as essential as, if not more so, than the analytical tools utilized.

For example, Solow complains that the book does not spend enough time discussing the theoretical achievements of Alfred Marshall. The fact, that somebody, with Solow's credentials, can write that after Piero Sraffa's devastating critique of Marshallian partial equilibrium (still in all textbooks, by the way), as if his technical achievement was not simply incoherent and irredeemably incorrect is a testimony about the poor state of our discipline.

Solow's complaints about Nasar discussion of Keynes are more puzzling, since he should be as neoclassical synthesis Keynesian be very comfortable with the 'developments' of Keynesian theory within the mainstream, which are after all the dominant model (the New Keynesian model with an IS, a monetary rule and a Phillips curve). He was instrumental in the creation of the current macroeconomic consensus, and his growth model (for which he won the Sveriges Riksbank Prize, also known as the Nobel in economics, although it's not one of the original Nobels) is the dominant view on growth. If the profession has failed, Solow is certainly responsible for it to a great extent.

If anything the problem with the book is that it shares with the mainstream (including Solow) a certain view of economics, and progress in the discipline, that has been established since the rise of marginalism in the latter part of the 19th century. In this view, there is a direct line of descent from Smith and Ricardo to Marshall (via Stuart Mill) to modern economics. According to this approach, the critical authors are, not the true heirs to classical political economy (that is from Smith/Ricardo to Keynes/Kalecki, via Marx), but critics of some aspects of capitalism that seem to have more heart than brains.

In all fairness, however, it's not surprising that a journalist/writer that is not an specialist economist buys the conventional wisdom on the history of ideas. The conventional history of ideas texts are fundamentally, like the parable in Bruegel's painting, written by blind professors to guide their blind students.

PS: The Sveriges Riksbank has been awarded to two professors (Sargent and Sims) that most likely believe that government intervention in the middle of the crisis is worse than some version of laissez faire. This is the reason, not the predictions about the end of times, why this is a dismal science.

Monday, July 4, 2011

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.

Wednesday, May 4, 2011

More on income distribution and growth (wonskish, as Krugman would say)

A few years back Sam Bowles presented a paper (Kudunomics: Property rights for the information-based economy) at the University of Utah. At dinner he reaffirmed his conviction that Arrow-Debreu General Equilibrium (GE) is compatible with different kinds of behavior and can be a force for progressive economics. Conventional marginalist theory suggests that income distribution is the result of relative scarcities, and, as a result, real wages should equal the marginal product of labor, i.e. labor productivity. When asked how he squares the belief in GE with the fact that wages in the US do NOT follow productivity since the 1970s, Bowles seemed puzzled. And the relation of income distribution and growth remains puzzling for the mainstream and its sycophants.

In the heterodox camp, the discussion has been centered, for the most part, between the so-called Kaleckian and Kaldorian models. First, I should note that from a history of ideas point, the Kaleckian name is a misnomer. Kalecki’s models where about the interaction of multiplier and accelerator, with shocks and lags, to produce fluctuations. In the various forms of his accelerator equation Kalecki included a trend, producing fluctuations around a trend. The so-called Kaleckian models derive from Harrod and Joan Robinson’s attempts to extent Keynes’ Principle of Effective Demand (PED) to the long run.

The PED says that an increase in investment is matched by an exact increase in savings, and that the level of income is the main adjusting variable (rather than the interest rate as in the Loanable Theory of Funds). The Kaleckian models basically normalize the IS identity by the capital stock, assume (in the extreme case) that the propensity to save out of wages is zero, and a propensity to save out of profits (s) between zero and one, and in Keynesian fashion have investment determine savings. The difference with the short-run story is that now accumulation (investment-to-capital ratio) determines income distribution (the rate of profits), a result often referred to as the Cambridge equation.

The various incarnations of the Kaleckian models are defined by the way the investment function is specified. For example, in the influential paper by Bhaduri and Marglin (B-M) (subscription required) they argue that investment and savings are functions of the profit share (h) and capacity utilization (z). In other words:

I(h, z) = shz

Solving for z and deriving with respect to h we have:

dz/dh = (Ih – sz)/(sh – Iz)

Where Ih is the response of investment to profitability and Iz to capacity utilization. Assuming stability, that is, that savings respond to profitability more than investment to capacity utilization and the denominator is positive, the sign of the equation depends on the numerator. If investment is strongly responsive to profitability (Ih > sz), then the system is profit-led (exhilarationist in B-M terms). If not we have the wage-led (stagnationist) regime.

As I suggested in my previous post, there are some theoretical problems with the type of model used to argue that the US economy is profit-led, besides the empirical ones alluded before. The independent investment function suggests that capacity utilization affects capital formation, if capacity is low there is more investment, and vice versa when z is high. In other words, firms would try to adjust capacity to demand. If that is the case you would expect that a normal relation between capacity and demand would be established in the long run (in the neoclassical view demand adjusts to capacity; that’s Say’s Law), which could be seen as the relatively stable output-to-capital ratio over the whole period for the US, in my previous post.

If that is the case, investment is determined by the adjustment of capacity to exogenous demand in order to reach the normal capacity utilization, and it is essentially derived demand (the accelerator principle). It is not instrumental in determining the normal level of capacity utilization, which must be determined by the exogenous components of demand. This is the basis of the supermultiplier models, first developed by Hicks, and then by Nicholas Kaldor, and referred to as Kaldorian in the heterodox literature (for more on that see this paper).

That is the essential difference between the Kaleckian and Kaldorian models, whether investment is partially autonomous and determined by profitability or it is derived demand. Of course income distribution in Kaldorian models might have ambiguous effects on growth, but firms would not investment more if profits went up, if there is no increase in demand. In this sense, worsening income distribution might lead to higher growth if demand keeps going for some reason (say more private debt stimulates consumption; or stimulates the consumption of a higher income group). But in general profit-led growth that stimulates investment, as in the M-B framework seems hard to explain from a theoretical point of view. Hence, the confusion it generates empirically (e.g. in the case of the US the notion that a debt-led consumption boom is a profit-led story).

PS: The typical Kaldorian model is based on Thirlwall's work, but the book by Bortis and Serrano's dissertation (or his paper; subscription required) are essential readings.

Monday, May 2, 2011

Is the American economy profit-led?

In a recent post I showed the evolution of real wages and long-term real rates of interest in the United States from 1950 until now. The figure below shows the real rate of output (GDP) growth for the same period. Between 1950 and 1973 the average (red line) rate of growth was 4.2% and in the subsequent period it was 2.7%. In other words, the change in income distribution dynamics, with a significant slower rate of growth of wages, was accompanied by a significant reduction in the pace of economic growth (we also saw in the previous post that it also went hand in hand with higher real rates of interest).

Many authors (e.g. the late David Gordon), in particular when looking at the evidence post-1970s, argued that the American economy is profit-led. In other words, as profits (some emphasized profit shares while others prioritized profit rates; the profit rate time the level of capacity utilization gives the profit share) expanded, it stimulated investment, and this, in turn, led to output growth. Growth was driven by profits.

The idea is that, even though the reduction in wages has a negative effect on consumption and output growth, this is more than compensated by the increase in investment. However, there are some empirical problems (there are some theoretical issues that I’ll deal with in another post) with this kind of model (often referred to as Kaleckian, even though it seems that their origin should be traced to Joan Robinson’s Accumulation of Capital and the influential formalization by Bob Rowthorn in the early 1980s).

For starters, growth actually fell significantly after real wages stagnated. Also, the output-to-capital ratio (shown from 1960 to 2008 using a OECD measure), as can be seen in the graph below, does not indicate a marked shift in the 1970s. The output-to-capital ratio goes up in the Johnson and Clinton booms, and falls otherwise. The Reagan boom was mild at best. This is consistent with the accelerator. As the economy moves closer to full employment, the output-to-capital ratio, a proxy for capacity utilization, moves close to its maximum. The accelerator would suggest that investment adjusts capacity to output. Investment is not the locomotive of the system, is the rear car (the idea behind the accelerator principle).

Since the 1970s the drivers of accumulation in the United States have been consumption booms driven by debt accumulation. In other words, as Barba and Pivetti have argued, increasing debt has allowed American families to continue to consume, in spite of stagnated wages. This has been mistaken in the empirical literature as a profit-led boom. The suggestion here is that the booms have continued to be driven by consumption (as in more traditional wage-led cases), and that the benefits for capital have been financial and associated to higher interest rates. The last three booms have been more Wall Street debt-led booms, rather than profit-led investment booms. Wall Street, not the Silicon Valley, defines the current American economy. After all, we all remember Gordon Gekko’s “greed is good” (uttered in real life by Ivan Boesky) and nobody remembers an iconic phrase by Bill Gates!