I know I shouldn’t. But there are so many wrong-headed assertions in the latest Bloomberg column by Noah Smith, “Economics Without Math Is Trendy, But It Doesn’t Add Up,” that I can’t let it pass.
But first let me give him credit for his opening observation, one I myself have made plenty of times on this blog and elsewhere:
There’s no question that mainstream academic macroeconomics failed pretty spectacularly in 2008. It didn’t just fail to predict the crisis — most models, including Nobel Prize-winning ones, didn’t even admit the possibility of a crisis. The vast majority of theories didn’t even include a financial sector.
And in the deep, long recession that followed, mainstream macro theory failed to give policymakers any consistent guidance as to how to respond. Some models recommended fiscal stimulus, some favored forward guidance by the central bank, and others said there was simply nothing at all to be done.
It is, in fact, as Smith himself claims, a “dismal record.”
But then Smith goes off the tracks, with a long series of misleading and mistaken assertions about economics, especially heterodox economics. Let me list some of them:
- citing a mainstream economist’s characterization of heterodox economics (when he could have, just as easily, sent readers to the Heterodox Economics Directory—or, for that matter, my own blog posts on heterodox economics)
- presuming that heterodox economics is mostly non-quantitative (although he might have consulted any number of books by economists from various heterodox traditions or journals in which heterodox economists publish articles, many of which contain quantitative—theoretical and empirical—work)
- equating formal, mathematical, and quantitative (when, in fact, one can find formal models that are neither mathematical nor quantitative)
- also equating nonquantitative, broad, and vague (when, in fact, there is plenty of nonquantitative work in economics that is quite specific and unambiguous)
- arguing that nonquantitative economics is uniquely subject to interpretation and reinterpretation (as against, what, the singular meaning of the Arrow-Debreu general equilibrium system or the utility-maximization that serves as the microfoundations of mainstream macroeconomics?)
- concluding that “heterodox economics hasn’t really produced a replacement for mainstream macro”
Actually, this is the kind of quick and easy dismissal of whole traditions—from Karl Marx to Hyman Minsky—most heterodox economists are quite familiar with.
My own view, for what it’s worth, is that there’s no need for work in economics to be formal, quantitative, or mathematical (however those terms are defined) in order for it be useful, valuable, or insightful (again, however defined)—including, of course, work in traditions that run from Marx to Minsky, that focused on the possibility of a crisis, warned of an impending crisis, and offered specific guidances of what to do once the crisis broke out.
But if Smith wants some heterodox macroeconomics that uses some combination of formal, mathematical, and quantitative techniques he need look no further than a volume of essays that happens to have been published in 2009 (and therefore written earlier), just as the crisis was spreading across the United States and the world economy. I’m referring to Heterodox Macroeconomics: Keynes, Marx and Globalization, edited by Jonathan P. Goldstein and Michael G. Hillard.
There, Smith will find the equation at the top of the post, which is very simple but contains an idea that one will simply not find in mainstream macroeconomics. It’s merely an income share-weighted version of a Keynesian consumption function (for a two-class world), which has the virtue of placing the distribution of income at the center of the macroeconomic story.* Add to that an investment function, which depends on the profit rate (which in turn depends on the profit share of income and capacity utilization) and you’ve got a system in which “alterations in the distribution of income can have important and potentially offsetting impacts on the level of effective demand.”
And heterodox traditions within macroeconomics have built on these relatively simply ideas, including
a microfounded Keynes–Marx theory of investment that further incorporates the external financing of investment based upon uncertain future profits, the irreversibility of investment and the coercive role of competition on investment. In this approach, the investment function is extended to depend on the profit rate, long-term and short-term heuristics for the firm’s financial robustness and the intensity of competition. It is the interaction of these factors that fundamentally alters the nature of the investment function, particularly the typical role assigned to capacity utilization. The main dynamic of the model is an investment-induced growth-financial safety tradeoff facing the firm. Using this approach, a ceteris paribus increase in the financial fragility of the firm reduces investment and can be used to explain autonomous financial crises. In addition, the typical behavior of the profit rate, particularly changes in income shares, is preserved in this theory. Along these lines, the interaction of the profit rate and financial determinants allows for real sector sources of financial fragility to be incorporated into a macro model. Here, a profit squeeze that shifts expectations of future profits forces firms and lenders to alter their perceptions on short-term and long-term levels of acceptable debt. The responses of these agents can produce a cycle based on increases in financial fragility.
It’s true: such a model does not lead to a specific forecast or prediction. (In fact, it’s more a long-term model than an explanation of short-run instabilities.) But it does provide an understanding of the movements of consumption and investment that help to explain how and why a crisis of capitalism might occur. Therefore, it represents a replacement for the mainstream macroeconomics that exhibited a dismal record with respect to the crash of 2007-08.
But maybe it’s not the lack of quantitative analysis in heterodox macroeconomics that troubles Smith so much. Perhaps it’s really the conclusion—the fact that
The current crisis combines the development of under-consumption, over-investment and financial fragility tendencies built up over the last 25 years and associated with a nance- led accumulation regime.
And, for that constellation of problems, there’s no particular advice or quick fix for Smith’s “policymakers and investors”—except, of course, to get rid of capitalism.
*Technically, consumption (C) is a function of the marginal propensity to consume of labor, labor’s share of income, the marginal propensity to consume of capital, and the profit share of income.