Posts Tagged ‘neoclassical’

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Back in 2009, in the midst of the Great Crash (and therefore at the start of the Second Great Depression), a colleague and friend asked me whether I expected the teaching of economics to change. His view was that, since mainstream economics had so miserably failed in both predicting the crash and providing a guide as to what to do once the crash occurred, it was obvious the economics being taught to students had to fundamentally change. My answer was that, while the need for a change was obvious, I didn’t see it happening—and it probably wouldn’t happen (thinking back to the emergence of the Union of Radical Political Economics in the late-1960s) unless and until students of economics demanded a different approach.

Well, in various places (starting almost a decade before the current crises, with the eruption of the Post-Autistic Economics movement in June 2000), students have been demanding a fundamental change in the way economics is being taught. The latest effort to move that project along is a report from the University of Manchester Post-Crash Economics Society. Here are some of their key findings, which refer to how economics is taught at Manchester but clearly have much wider relevance, in and beyond the United Kingdom:

  • Economics education at Manchester has elevated one economic paradigm, often called neoclassical economics, to the sole object of study. Other schools of thought such as institutional, evolutionary, Austrian, post-Keynesian, Marxist, feminist and ecological economics are almost completely absent.
  • The consequence of the above is to preclude the development of meaningful critical thinking and evaluation. In the absence of fundamental disagreement over methodology, assumptions, objectives and definitions, the practice of being critical is reduced to technical and predictive disagreements. A discipline with a broader knowledge of alternative perspectives will be more internally self-critical and aware of the limits of its knowledge. Universities cannot justify this monopoly of one economic paradigm.
  • The ethics of being an economist and the ethical consequences of economic policies are almost completely absent from the syllabus.
  • History of economic thought is an optional third year module which students are put off taking due to it requiring essay writing skills that have not been extensively developed elsewhere in the degree. Very little economic history is taught. Students finish an economics degree without any knowledge of momentous economic events from the Great Depression to the break-up of the Bretton Woods Monetary System.
  • When taken together, these points mean that economics students are taught the economic theory of one perspective as if it represented universally established truth or law.

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Let’s leave aside for a moment whether the participants were the right ones to call on (I would have turned to plenty of better commentators, who have read both Marx and contemporary scholarship on Marxist theory, to offer their opinions) or even whether they get Marx right (very little, as it turns out).

What’s perhaps most interesting is that the New York Times felt the need at this point in time to host a debate on the question “was Marx right?” and, then, that most of the participants admit that Marx did in fact get a great deal right.

The problem is, of course, that at this point in time mainstream economics (in either its neoclassical or Keynesian varieties) is not a particularly good guide for analyzing or proposing solutions to the key economic problems of soaring inequality, massive unemployment, and generalized insecurity of a broad mass of the population in the United States and in other high-income countries. So, I suppose it’s not surprising people continue to turn to Marx for ideas about how to make sense of the economic contradictions that caused the Second Great Depression and the new contradictions that right now are preventing a full recovery of capitalism.

In the end, what is key to Marx is not this or that prediction (of which, as it turns out, there is very little in the texts, although there certainly are lots of tendencies that critics are hard put to ignore or effectively counter) but, instead, the idea of critique. Because what Marx set out to do over the course of the three published volumes of Capital was provide the cornerstones for a far-reaching critique of political economy. And the method of that critique—a two-fold critique, of mainstream economic theory and of capitalism as a system—is what endures, precisely as a challenge to what passes for serious economic analysis today.

Marx, then, was surely right about one thing:

if constructing the future and settling everything for all times are not our affair, it is all the more clear what we have to accomplish at present: I am referring to ruthless criticism of all that exists, ruthless both in the sense of not being afraid of the results it arrives at and in the sense of being just as little afraid of conflict with the powers that be.

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Harvard’s Greg Mankiw fancies himself a political philosopher. The problem is, he’s not very good at it. But, even then, he manages to cobble together a political philosophy that serves the interests of the tiny minority at the top of the current economic system.

You won’t learn much about political philosophy from reading Mankiw’s latest. Basically, he rehashes a couple of the main criticisms of nineteenth-century utilitarianism and then resorts to some combination of the principle of natural rights and “do no harm.” Not much new or interesting there. If he wanted to actually be on top of the current literature concerning economics and political philosophy, including what it means to do no harm as an economist, he might start with The Economist’s Oath by George DeMartino.

Actually, the main problem with Mankiw’s approach is he only considers the effects of tinkering with a free-market system, policies such as Obamacare and raising the minimum wage—not the economic system as a whole. And, even then, he hides behind a distinctly non-Rawlsian veil of ignorance: “when a policy is complex, hard to evaluate and disruptive of private transactions, there is good reason to be skeptical of it.”

The effect, then, of invoking economists’ ignorance—we have a hard time calculating all the costs and benefits of any particular policy—is to leave things as they are. What Mankiw doesn’t want to talk about are the insults and injuries meted out by current economic arrangements, even before they are ameliorated however imperfectly by policy interventions. The injustices that are incumbent upon an economic system in which a tiny minority at the top manages to capture and keep a large share of what the other members of society produce.

In that sense, Mankiw does manage to create a political philosophy for the 1 percent.

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Yesterday in our class on A Tale of Two Depressions, we discussed Robert McElvaine’s notion of “moral economy” (which he introduces in chapter 9 of his book, The Great Depression: America, 1929-1941). The idea is that, during the first Great Depression, Americans were engaged in an intense debate between different moral economies (which McElvaine characterizes as the difference between the “cooperative individualism” of workers and the “acquisitive individualism” of businesspeople).

As I explained to students, all economic theories—for example, neoclassical, Keynesian, and Marxian theories—represent moral economies. And they arrive at very different conclusions concerning the justice or fairness of capitalism. Thus, for example, neoclassical economists argue that everyone gets what they deserve and, through the workings of the invisible hand, the result will be full employment. In contrast, Keynesian economics is based on the proposition that, while everyone may get what they deserve (with the possible exception of coupon-clippers), it’s quite possible that will result in less-then-full-employment equilibrium, which then requires the visible hand of government intervention. Marxian economists propose a third possibility: even if everyone gets what they deserve in markets, in production things are different (because of exploitation)—and the consequence, whether there’s an invisible or visible hand, is inequality and instability. In other words, the three economic theories represent radically different moral economies.

One student then invoked the idea of moral economy and blamed greed for causing the current crisis. I responded by making the distinction between individual greed and economic institutions, which like the different notions of fairness among economic theories leads to quite different solutions: throw the greedy bankers in jail (which of course we haven’t done) or change the economic institutions (which we haven’t done either).

Chris Dillow makes a similar distinction between “greedy bankers” and “overly powerful bankers.” His view is that “the habit of over-emphasizing individuals’ traits and under-emphasizing situational forces” leads us to “to moralize inequality; the rich are rich because they are greedy whilst the poor are poor because they are lazy.”

What this effaces is the fact that inequalities in capitalism are instead the result of inequalities of power – a power which rests in part upon ideology. Moralizing inequality tends to blind us to this fact. It creates the illusion that capitalism would be acceptable if only those at the top were better people, when in fact the faults in capitalism are structural and not due to the flaws of passing individuals.

That’s pretty much the same distinction I was trying to make, although I still want to characterize the two explanations as different moral economies: one is a moral economy of flawed individuals, while the other is a moral economy of flawed institutions.*

 

*Although I’m willing to admit I’m sympathetic to Dillow’s view for another reason: because he invokes my favorite football club and blames Crystal Palace fans (who greeted Wayne Rooney with chants of “you fat greedy bastard”) for committing the error of “blaming Rooney’s salary upon his personal character rather than upon his situation.”

 

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It used to be Harvard-based neoclassical economists could count on their Republican friends and allies to support their free-market policies. Now, apparently, not so much.

That’s the only explanation for why Jeffrey Frankel has to step forward and attempt to remind Republicans that market mechanisms—such as cap-and-trade and Obamacare—were their idea.

In the US, cap-and-trade was originally considered a Republican idea. Market-friendly regulation was pushed by those who thought of themselves as pro-market, rather than by those who thought of themselves as pro-regulation. . .

Republican politicians have now forgotten that this approach was ever their policy. To defeat the last major climate bill in 2009, they worked themselves into a frenzy of anti-regulation rhetoric. . .

One can draw a fascinating parallel between the evolution of American political attitudes toward market mechanisms in the area of environmental regulation and Republican hostility to the Affordable Care Act, also known as Obamacare. Obamacare is a market mechanism in the sense that health insurers and care providers remain private and compete against each other.

Frankel is, in fact, right. Both cap-and-trade and Obamacare came straight out of Republican think tanks, precisely in the way neoclassical economists had designed them. Then, they were the best of friends. Now, apparently, Republicans have to be reminded of that friendship.

Or scared into remembering that close relationship. Because, Frankel warns, the alternative is more government regulation.

It really is a sign of how much political and economic discourse has changed in the United States that it’s Democrats who are implementing market-based, originally Republican-designed policies. And that, even more: from the perspective of someone like Frankel, any government regulation of business (not, mind you, government ownership) can blithely be referred to as “command and control.”

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Economic reality is always stranger than economic theory. Human capital is no exception.

While we can trace ideas akin to human capital back to the classical political economists (such as Smith) and the critics of political economy (including Marx), the notion of human capital really takes hold within neoclassical economics (in the work of Arthur Lewis, Ted Schultz, and especially Gary Becker). It came to refer to the stock of skills, knowledges, and social and personality attributes individual workers had acquired, which in neoclassical models determined their productivity and their appropriate compensation (which, these days, means that CEOs are “worth” 323 times average workers).

But, however offensive and misguided the use of human capital within neoclassical economics has been, it still doesn’t capture the latest development in the economy: human capital contracts [ht: sm].

We’ve heard a lot about corporate personhood – the idea that, as one former Massachusetts governor put it, “Corporations are people.” But there’s a new hot concept in the land of personal finance: personal corporatehood, the notion that people can act like corporations. Increasingly, amid record-high stock markets that have rewarded anything with a ticker symbol, normal people are finding new ways to sell stock, lash themselves to investors, and throw themselves at the market’s mercy.

The latest such deal was the IPO of Arian Foster, the NFL running back who partnered with a sports-marketing agency called Fantex to offer himself up on the public markets. Under the terms of the deal, Foster would earn $10 million by selling 20 percent of his future earnings to investors in the form of a personalized “tracking stock.” (The IPO fell through after Foster sustained a season-ending injury.)

But you don’t have to be a millionaire NFL star to play the stock-selling game. There are now a handful of companies offering what are called “human capital contracts” or “income-share arrangements” to normal people. These contracts don’t involve actual stocks, but they have stocklike characteristics. People who sign up for these programs agree to give a percentage of their income to their financial backers for a period of several years, in exchange for a one-time cash infusion. It’s a sort of Kickstarter for people, a crowd-funding platform that provides backers with monthly royalty checks instead of signed T-shirts.

It used to be the case that workers were encouraged to invest in their human capital portfolio in order to improve their own lot. But economic events have moved us beyond that idea of human capital, making it possible for wealthy investors to acquire portfolios that include a claim on workers’ future earnings.

 

Much of the debate within mainstream macroeconomics about the current crisis takes place within the limits imposed by the AS-AD model (as illustrated in the video above). Either the problem is aggregate demand (as Keynesians tend to argue) or aggregate supply (the side neoclassical economists tend to focus on). Each side presents an analysis of the cause of the crisis—and, with it, the preferred solution: economic stimulus (through fiscal and/or monetary policy for the Keynesians) or tax cuts and other supply-side measures (basically, additional incentives for the so-called “job creators,” as neoclassical economists see them). And then, of course, there’s the ever-shifting middle position (sometimes more Keynesian, other times more neoclassical) and the corresponding policies: a bit of economic stimulus and a bit of supply-side incentives.

That’s all familiar territory for anyone who’s been following the macroeconomic debates (in both political and academic circles). And it’s certainly the way macroeconomics is taught to thousands and thousands of students every year.

But what has gone largely unnoticed in these debates is the presumption that aggregate demand and supply are independent of one another (not unlike in the microeconomic counterpart, the supply and demand conception of individual markets). In other cases, the only way the initial equilibrium is undone is because there’s an exogenous change that affects either one side or the other: either aggregate demand or aggregate supply (or, at the microeconomic level, market demand or market supply). The underlying cause is on one side or the other.

But what if changes on one side affect the other? In my view, that’s why the recent paper by Dave Reifschneider, William L. Wascher, and David Wilcox [pdf] of the Federal Reserve Board is receiving such attention. What their study shows is that potential GDP “is currently about 7 percent below the trajectory it appeared to be on prior to 2007.” In other words, the future growth potential of the economy (the blue line in the chart below) has been undermined by the current downturn in economic activity (the red line in the chart), both of which are below what might have been the case if past trends had continued (the green line). It’s as if economic resources had been destroyed by not utilizing them in recent years.

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In terms of the mainstream model, the collapse of aggregate demand leading to the crash of 2007-08 has also affected the aggregate supply of the economy—thereby shattering the illusion of the independence of the two sides of the macroeconomy. As the authors put it, “a significant portion of the recent damage to the supply side of the economy plausibly was endogenous to the weakness in aggregate demand—contrary to the conventional view that policymakers must simply accommodate themselves to aggregate supply conditions.”

Not only does the destruction of a significant portion of the future growth potential of the U.S. economy challenge the model mainstream economists use to analyze the macroeconomy and to formulate policy; it also forces us to question the rationality of a set of economic arrangements in which trillions of dollars of potential wealth (which might then be used to improve lives for the majority of the population) are sacrificed at the altar of keeping things pretty much as they are.

It represents the indictment both of an academic discipline and of economic system.

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Menzie Chinn does a good job explaining, with the use of the chart above, how in a purely neoclassical world an increase in the minimum wage can lead to an increase in employment. (The key is, the demand for labor is a derived demand, which will increase as the working poor receive higher incomes as a result of an increase in the minimum wage.)

But why not then explain that employment can be increased even further (and unemployment eliminated entirely) through a jobs program in which workers—especially jobless and low-income workers—are hired directly by government agencies to do jobs that actually benefit society?

Or, alternatively, why not let minimum-wage workers participate in deciding how their enterprises will be run? That will surely increase the level of employment, even as the minimum wage continues to rise.

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We’ve known for a long time (as I’ve written about before, e.g., here, here, and here) that neoclassical economists blame workers and their downwardly rigid wages for creating and maintaining high levels of unemployment. If the labor market is flexible, a fall in the price of labor is presumed to eliminate involuntary unemployment. If it’s not, then other means are necessary, such as austerity policies that raise unemployment, thus creating pressure to decrease nominal (and, with them, real) wages with the promise of eventually restoring full employment.

Keynesian economists, for their part, reject many features of the neoclassical model, including the effectiveness of austerity policies. Their argument is that, in general, nominal wages are downwardly rigid—and, even if they weren’t, forcing wages down might lead to deflation, and therefore move us further away from macroeconomic recovery. Their preference, instead, is for a combination of external devaluation (when possible, such as in the United States) and internal inflation (when currency devaluation is not possible, such as in the euro zone), which have the effect of lowering real wages even when nominal wages are constant.

That’s exactly what Paul Krugman has been advocating all along, such as in this recent post:

There are two reasons moderate inflation is actually a good thing for modern economies — one involving demand, one involving supply.

On the demand side, inflation reduces the problem of the zero lower bound: nominal interest rates can’t go negative, but real rates can to the extent that modest inflation is embedded in expectations.

On the supply side, inflation reduces the problem of downward nominal wage rigidity: people are very reluctant to demand or accept actual wage cuts, which becomes a serious constraint if the relative wages of large groups of workers “need” to fall.

Keynesian economists are now soft-peddling inflation for precisely that reason: workers’ wages “need to fall” but employers are reluctant to demand and workers are reluctant to accept nominal wage cuts. But, if inflation rises and workers aren’t able to keep up by demanding higher wages, their real wages will fall.

As it turns out, both wings of mainstream macroeconomics—neoclassical and Keynesian—accept the idea that full employment can only be restored by forcing down real wages. They only differ about how that effect can and will be achieved.

The alternative, of course, is to focus not on wages but on profit margins. But corporate and financial profits, it seems, remain sacrosanct. So, under current economic arrangements, workers are the ones who are forced to pay the costs of recovery. By any means necessary.

 

*The reference is not to Malcolm X but, instead, to Jean-Paul Sartre, in his 1963 play Dirty Hands (act 5, scene 3): “I was not the one to invent lies: they were created in a society divided by class and each of us inherited lies when we were born. It is not by refusing to lie that we will abolish lies: it is by eradicating class by any means necessary.”

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This semester, I’m teaching a course on Marxian economic theory. It’s been a real eye-opener for the the students, who seem a bit surprised to learn that there is such a wholesale critique of the mainstream economics they’ve been learning. Some are even intrigued by this new way of thinking about the economy, which led one of them to pose the following question: did Marxists predict the crisis better or more accurately than mainstream economists?

Well, I explained, that’s setting the bar pretty low, since mainstream economists simply failed to predict the crash of 2007-08. But, I explained, Marxists did no better. And that’s because economic forecasting is like selling snake oil: lots of folks earn lots of money promising the ability to predict economic events but all they’re doing is selling the promise, not the actual ability, to get the forecasts right. (And, of course, they pay nothing for their failures, since they’ve left town long before people discover the magic elixir doesn’t work.)

And that’s what has happened to the students: they’ve been told mainstream economics is superior to all other approaches, that it’s a “real science,” because of its predictive power. And they’re willing to jump ship, as it were, if an alternative theory offers more predictive power.

The problem is, as Sir David Hendry explains, forecasting only works if the future behaves the same as the past, if it follows the same rules and falls under the same normal distribution. If it doesn’t, then all bets are off. What that means for me (and for Chris Dillow) is that Marxists are no better at predicting the future than mainstream economists. In fact, economic forecasting, of whatever sort, is a false promise.

But then I went on in my response to the student’s question: what really distinguishes different groups of economists is whether or not they include the possibility of a crisis in their theories and models—and what they would suggest doing once such a crisis occurred (including measures to prevent future crises). And there the difference between mainstream and Marxian economics couldn’t be starker: mainstream economics simply doesn’t include the possibility of crises (except as an exogenous event) whereas Marxists start from the proposition that instability is inherent (and therefore an endogenous tendency) in an economy based on the capitalist mode of production. That’s one fundamental difference between them. The other is that, once a crisis occurs (such as in 2007-08), the two groups of economists offer very different solutions: whereas mainstream economists spend their time debating whether or not any kind of intervention is warranted (based on neoclassical versus Keynesian assumptions concerning invisible and visible hands), Marxist economists presume that interventions are always-already being made (in terms of determining who pays the costs of the crisis) and that it’s better both to help those who are most vulnerable and to put in place the kinds of institutional changes that would prevent future crises.

So, no, I don’t put a lot of stock in economic forecasting, whether promised by mainstream economists or others. It’s a promise of control that is a lot like selling snake oil. But I’m willing to throw in my lot with an approach that, first, actually includes the possibility of such crises at the very center of the theory and, second, is willing to move outside the paradigm of private property and markets to help those who are hurt by the crisis and to change the rules so that those who created the crisis in the first place no longer have the incentive and means to do it again in the future.

And you don’t need a crystal ball to know that, if such changes are not made, another crisis is awaiting us just around the corner.

Update

Here’s the graph Bruce is referring to in the comments on this post:

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And here’s the same series going back earlier:

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