Posts Tagged ‘economics’

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I’m always pleased when Marx’s critique of political economy and the theory of value are topics of discussion, especially since students are rarely exposed to those ideas in their usual mainstream economics courses. Their professors generally don’t know about any theory of value other than the neoclassical economics they learned and preach—and, as a consequence, students aren’t taught that there is a fundamental critique of the neoclassical theory of value that stems from Marx’s work.

The result is, in fact, quite embarrassing. When I ask students to compare Marx’s theory of profits with the neoclassical theory of profits, they have no idea what I’m talking about. The way they learn economics from my neoclassical colleagues, profits are competed away. “So,” I ask them, “what you have is a theory of capitalism according to which there are no profits”? Then, of course, I have to start all over, teach them the neoclassical theory of profits (as the normal return to capital, rK, where r is the profit rate and K the amount of capital) and only then explain to them the Marxian critique of neoclassical profits (based on s, the amount of surplus-value that arises through exploitation). I am forced to make up for mainstream economists’ poor understanding and explanation of their own theory.

So, good, we now have a new discussion of Marx’s approach—first in the form of Branko Milanovic’s “primer” and then in Fred Moseley’s response to Milanovic. Both are well worth reading in their entirety—and I agree with many of the ideas they put forward.

But I do have a few major disagreements with their treatments. Milanovic, for example, insists that Marx develops his theory through three kinds of production: non-capitalism, “petty commodity production,” and capitalism. I read Marx differently. My view is that Marx starts with the commodity and then proceeds to develop, step by step (across volumes 1, 2, and 3 of Capital), the conditions of existence of capitalist commodity production, which is the goal of the analysis. These are not different historical stages or kinds of production but, rather, different levels of abstraction. So, conceptually, Marx starts from one proposition (that the value and exchange-value of commodities are equal to the amount of socially necessary abstract labor-time embodied in their production), then proceeds to another (where the value and exchange-value of commodities are equal to the value of capital, both variable and constant, and surplus-value embodied in the commodity during the course of production), and finally to a third level (where value and exchange-value can’t be equal, since the price of production, p, now includes an average rate of return on capital).

My other two concerns pertain to both authors. Milanovic and Moseley assert that Marx’s focus was mainly at the macro level, “the determination of the total profit (or surplus-value) produced in the capitalist economy as a whole.” I didn’t understand that idea back in 2013 and I remain unconvinced today. As I see it, Marx focused on both the micro and macro level and in fact worked to make his theory consistent at the two levels. Starting with the value of individual commodities (as I explained above), Marx concluded that, at the aggregate level, two identities needed to hold: the total value of commodities equaled the sum of their prices, and total surplus-value equalled total profits. That’s both a micro theory and a macro theory, a theory of value, price, and profit at both levels.*

The second, and perhaps most important, idea missing from Milanovic’s and Moseley’s interpretations of Marx’s approach is critique. Both authors proceed as if Marx developed his own theory of labor value, instead of seeing it as a critique of the classicals’ theory of value (which, we must remember, is the sub-title of Capital, “A Critique of Political Economy”). In my view, Marx begins where the classicals leave off (with an “immense accumulation of commodities,” Adam Smith’s wealth of nations) and then shows how the production of wealth in a capitalist society involves the performance, appropriation, and distribution of surplus labor.

That’s Marx’s class critique of political economy, which pertains as much to the mainstream economics of our time as to his.

 

*I don’t have the space here to explain how, for any individual commodity, the amount of value embodied during the course of its production won’t generally be equal to the amount of value for which the commodity exchanges. It is conceptually important that individual commodities have both numbers—value and exchange-value—attached to them, especially when they are not quantitatively equal at the micro level. It speaks to the fact that surplus-value is both appropriated (by capitalists from workers, through exploitation) and redistributed (among capitalists, within and across industries).

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Mark Tansey, “Coastline Measure” (1987)

The pollsters got it wrong again, just as they did with the Brexit vote and the Colombia peace vote. In each case, they incorrectly predicted one side would win—Hillary Clinton, Remain, and yes—and many of us were taken in by the apparent certainty of the results.

I certainly was. In each case, I told family members, friends, and acquaintances it was quite possible the polls were wrong. But still, as the day approached, I found myself believing the “experts.”

It still seems, when it comes to polling, we have a great deal of difficult with uncertainty:

Berwood Yost of Franklin & Marshall College said he wants to see polling get more comfortable with uncertainty. “The incentives now favor offering a single number that looks similar to other polls instead of really trying to report on the many possible campaign elements that could affect the outcome,” Yost said. “Certainty is rewarded, it seems.”

But election results are not the only area where uncertainty remains a problematic issue. Dani Rodrik thinks mainstream economists would do a better job defending the status quo if they acknowledged their uncertainty about the effects of globalization.

This reluctance to be honest about trade has cost economists their credibility with the public. Worse still, it has fed their opponents’ narrative. Economists’ failure to provide the full picture on trade, with all of the necessary distinctions and caveats, has made it easier to tar trade, often wrongly, with all sorts of ill effects. . .

In short, had economists gone public with the caveats, uncertainties, and skepticism of the seminar room, they might have become better defenders of the world economy.

To be fair, both groups—pollsters and mainstream economists—acknowledge the existence of uncertainty. Pollsters (and especially poll-based modelers, like one of the best, Nate Silver, as I’ve discussed here and here) always say they’re recognizing and capturing uncertainty, for example, in the “error term.”

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Even Silver, whose model included a much higher probability of a Donald Trump victory than most others, expressed both defensiveness about and confidence in his forecast:

Despite what you might think, we haven’t been trying to scare anyone with these updates. The goal of a probabilistic model is not to provide deterministic predictions (“Clinton will win Wisconsin”) but instead to provide an assessment of probabilities and risks. In 2012, the risks to to Obama were lower than was commonly acknowledged, because of the low number of undecided voters and his unusually robust polling in swing states. In 2016, just the opposite is true: There are lots of undecideds, and Clinton’s polling leads are somewhat thin in swing states. Nonetheless, Clinton is probably going to win, and she could win by a big margin.

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As for the mainstream economists, while they may acknowledge exceptions to the rule that “everyone benefits” from free markets and international trade in some of their models and seminar discussions, they acknowledge no uncertainty whatsoever when it comes to celebrating the current economic system in their textbooks and public pronouncements.

So, what’s the alternative? They (and we) need to find better ways of discussing and possibly “modeling” uncertainty. Since the margins of error, different probabilities, and exceptions to the rule are ways of hedging their bets anyway, why not just discuss the range of possible outcomes and all of what is included and excluded, said and unsaid, measurable and unmeasurable, and so forth?

The election pollsters and statisticians may claim the public demands a single projection, prediction, or forecast. By the same token, the mainstream economists are no doubt afraid of letting the barbarian critics through the gates. In both cases, the effect is to narrow the range of relevant factors and the likelihood of outcomes.

One alternative is to open up the models and develop a more robust language to talk about fundamental uncertainty. “We simply don’t know what’s going to happen.” In both cases, that would mean presenting the full range of possible outcomes (including the possibility that there can be still other possibilities, which haven’t been considered) and discussing the biases built into the models themselves (based on the assumptions that have been used to construct them). Instead of the pseudo-rigor associated with deterministic predictions, we’d have a real rigor predicated on uncertainty, including the uncertainty of the modelers themselves.

Admitting that they (and therefore we) simply don’t know would be a start.

 

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Are mainstream economists responsible for electing Donald Trump?

I think they deserve a significant share of the blame. So, as it turns out, does Dani Rodrick.

My argument is that, when mainstream economists in the United States embraced and celebrated neoliberalism—both the conservative and liberal versions—they participated in creating the conditions for Trump’s victory in the U.S. presidential election. As I see it, mainstream economists adopted neoliberalism as a set of ideas (about self-governing individuals and an economic system that needs to be understood and obeyed) and a political-economic project (on behalf of corporate bosses) and ignored the enormous costs, especially those borne by the majority of workers, their families, and the communities in which they live. And it was precisely the resentments generated by neoliberalism—which were captured, however imperfectly and in a cynical manner, by Trump’s campaign (and downplayed by Hillary Clinton’s, in the campaigns against both Bernie Sanders and Trump)—that many voters took to the polls one week ago.

Rodrick’s condemnation of mainstream economists is more specific: he focuses on the role that mainstream economists served as “cheerleaders” for capitalist globalization.*

It has long been an unspoken rule of public engagement for economists that they should champion trade and not dwell too much on the fine print. This has produced a curious situation. The standard models of trade with which economists work typically yield sharp distributional effects: income losses by certain groups of producers or worker categories are the flip side of the “gains from trade.” And economists have long known that market failures – including poorly functioning labor markets, credit market imperfections, knowledge or environmental externalities, and monopolies – can interfere with reaping those gains.

They have also known that the economic benefits of trade agreements that reach beyond borders to shape domestic regulations – as with the tightening of patent rules or the harmonization of health and safety requirements – are fundamentally ambiguous.

Nonetheless, economists can be counted on to parrot the wonders of comparative advantage and free trade whenever trade agreements come up. They have consistently minimized distributional concerns, even though it is now clear that the distributional impact of, say, the North American Free Trade Agreement or China’s entry into the World Trade Organization were significant for the most directly affected communities in the United States. They have overstated the magnitude of aggregate gains from trade deals, though such gains have been relatively small since at least the 1990s. They have endorsed the propaganda portraying today’s trade deals as “free trade agreements,” even though Adam Smith and David Ricardo would turn over in their graves if they read the Trans-Pacific Partnership.

This reluctance to be honest about trade has cost economists their credibility with the public. Worse still, it has fed their opponents’ narrative. Economists’ failure to provide the full picture on trade, with all of the necessary distinctions and caveats, has made it easier to tar trade, often wrongly, with all sorts of ill effects.

Rodrick is absolutely right: mainstream economists’ own models include at least some of the losses from trade—in terms of outsourced jobs, declining wages, and rising inequality—but, in their textbooks and public interventions, they routinely ignore those uenqual costs and take the position that globalization and free trade need to be celebrated, protected, and expanded. Lest they create an opening for the “barbarians” who, inside and outside the academy, are critical of the conditions and consequences of capitalist globalization.

Those of us who have been critical of free-trade agreements and the whole panoply of policies associated with globalization and neoliberalism (e.g., here and here) understand they’re not the sole or even main cause for the deteriorating condition the U.S. working-class has found itself in recent years and decades. Neoliberalism is not just globalization, as it includes a wide range of economic and social strategies and institutions that have boosted the bargaining power of employers vis-à-vis workers—from the adoption of labor-saving technologies through the growth of the financial sector to the privatization of public services and the social safety net.

But we also can’t ignore the correlation, since the early-1970s, between globalization (measured, in the chart above, by the sum of exports and imports as a percentage of U.S. GDP, which is the green line on the right-hand axis) and inequality (measured, in the same chart, by the percentage of income, including capital gains, going to the top 1 percent, on the left-hand axis). There are lots of economists, both everyday and academic, who understand that a tiny group at the top has captured most of the benefits of trade agreements and other measures that have allowed U.S. corporations to engage in increased international trade, both importing and exporting commodities that have boosted their bottom-line. Meanwhile, many American workers—such as voters in Pennsylvania, Ohio, Michigan, and Wisconsin—have lost jobs, faced stagnating wages, and suffered as their local communities have deteriorated.

However, mainstream economists, in their zeal to push globalization forward, ignored those problems and concerns. They thus paved the way and deserve a large part of the blame for Trump’s victory.

 

*Readers need to keep in mind that, when Rodrick refers to economists, he’s actually referring only to mainstream economists (which is the only group he seems to recognize). Other, so-called heterodox economists have never been so sanguine about the effects of neoliberalism or capitalist globalization.

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René Magritte, “La clef des champs” (1936)

Plenty of illusions are being shattered these days, such as the idea that a successful recovery from the worst economic downturn since the Great Depression would keep the incumbents in power. A combination of lost jobs, stagnant wages, and soaring inequality put an end to that illusion. Much the same has happened to American Exceptionalism.

Noah Smith has just discovered another shattered illusion: the independence of supply and demand.

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Mainstream economists generally think about the world in terms of supply and demand—at both the micro and macro levels: supply and demand in the market for oranges or labor (which determine the equilibrium price and quantity), as well as aggregate supply and demand for the economy as a whole (which determine the equilibrium level of prices and output). Perhaps even more important, they think about supply and demand as acting independently of one another: a shift in supply or demand in individual markets (which lead to changes in equilibrium prices and quantities) as well as “shocks” to aggregate supply or demand in macro models (which determine changes in the equilibrium level of prices and output). The presumption is that a shift in demand (at the level of individual markets or the economy as a whole) does not cause a shift in supply (at either level), or vice versa.*

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As it turns out, the independence of supply and demand is just an illusion.

As I wrote back in 2009, it’s quite possible that at the micro level—for example, in the case of the labor market—both supply and demand are determined by something else, such as the accumulation of capital.

Thus. . .if the accumulation of capital leads to rightward shifts in both the demand for and supply of labor, wages may not increase (and quite possibly will decrease).

Therefore, supply and demand in individual markets aren’t necessarily independent.

And then, in 2013, I discussed the illusion of the independence of aggregate supply and demand.

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.

So, Smith is right: the shattering of the illusion of the independence of supply and demand means the way mainstream economists teach basic economics is fundamentally wrong.

What he forgets to mention, however, is that an economic system that is governed by supply and demand that are not independent of one another—and thus is subject to considerable instability on a regular basis, with the costs being shouldered by those who can least afford it—is also open to question.

Perhaps Tuesday’s results will serve notice that the time for challenging mainstream economics and the economic and social system celebrated by mainstream economists has finally arrived.

 

*There can, of course, be simultaneous shifts in supply and demand but the shifts themselves are considered independent of one another.

 

Cartoon of the day

Posted: 24 October 2016 in Uncategorized
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Mark Tansey, “Invisible Hand” (2011)

Yesterday, I explained that the 2016 Nobel Prize in Economics Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel was awarded to Oliver Hart and Bengt Holmstrom because, through their neoclassical version of contract theory, they “proved” that capitalist firms—employers hiring labor to produce commodities in privately owned corporations—were the most natural, efficient way of organizing production.

It should come as no surprise, then, that mainstream economists—initially in tweets, then in full blog posts—have heaped praise on this year’s award.

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Paul Krugman couldn’t believe Hart and Holmstrom hadn’t won the prize already, while Justin Wolfers considered them “an unarguably splendid pick.”

Tyler Cowen also expressed his conviction that the new Nobel laureates are “well-deserving economists at the top of the field.” (He then explains, in separate posts, the significance for neoclassical theory of Hart’s and Holmstrom’s research on the theory of the firm.) The other member of the Marginal Revolution team, Alex Tabarrock, follows up by criticizing the one instance in Hart’s work in which he actually criticizes private enterprise. Hart (in a piece with two other economists) argues one of the downsides of private prisons is that they sacrifice quality for cost—but, according to Tabarrock, “private prisons appear to be cheaper than public prisons but they are not significantly cheaper and the quality of private prisons is comparable to that of public prisons and maybe a little bit higher.”

And then there’s Noah Smith, who follows suit by praising “the new exciting tools that have been developed in the micro world,” including by the new Nobel laureates. He refers to that work in microeconomics as the “real engineering”—as against macroeconomics, “whose scientific value is still being debated.”

The fact is, the value of both areas of mainstream economics is still being debated, as it has been from the very beginning. There is nothing settled (except, perhaps, in the minds of mainstream economists) about either the theory of the firm or the causes of recessions and depressions, the determinants of a commodity’s value or the prospects for long-term capitalist growth, whether the labor market or the economy as a whole is in any kind of equilibrium.

Smith overlooks or ignores those debates, most of which occur between mainstream economists and other, nonmainstream heterodox economists. But then, in attempting to explain why this year’s prize went to microeconomists, Smith displays his real misunderstanding of the history of economics—arguing that “macro developed first.”

Economists saw big, important phenomena like growth, recessions and poverty happening around them, and they wrote down simple theories to explain what they saw. The theories started out literary, and became more mathematical and formal as time went on. But they had a few big things in common. They assumed the people and the companies in the economy were each very tiny and insignificant, like particles in a chemical solution. And they typically assumed that everyone follows very simple rules — companies maximize profits, consumers maximize the utility they get from consuming things. Pour all of these tiny simple companies and people into a test tube called “the market,” shake them up, and poof — an economy pops out.

Here’s the problem: macroeconomics didn’t develop first. Indeed, it wasn’t invented until the 1930s, when John Maynard Keynes published The General Theory of Employment, Interest, and Money. This should not be surprising, given the fact that the world was in the midst of the Great Depression, with at least 25 percent unemployment, after neoclassical microeconomists (following their classical predecessors, Adam Smith, David Ricardo, and Jean-Baptiste Say) had attempted to prove that markets would always be in equilibrium, which of course ruled out economic depressions and massive unemployment. Oops!

Since then, we’ve seen a mainstream tradition that combines (in different, shifting ways) neoclassical microeconomics and Keynesian macroeconomics—a tradition that failed miserably both in the lead-up to and following on the second Great Depression.

But no matter, at least from the perspective of mainstream economics, because its leading practitioners—sometimes from the macro side, this year from the micro side—continue, as if by contract, to be awarded Nobel prizes.

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Technically, there is no Nobel Prize in economics. What it is, instead, is the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel, which members of the Nobel family and a previous winner (Friedrich von Hayek) have criticized.

So, where did the prize come from? As Avner Offer explains,

The Nobel prize came out of a longstanding social conflict. On one side, central banks and the better-off striving to keep property intact and prices stable; on the other, everyone else’s quest for economic security. The Swedish social democratic government clipped the wings of the central bank – Sveriges Riksbank – in pursuit of more housing and jobs. In compensation, the government allowed the central bank to keep some funds, which the bank used in 1968 to endow the Nobel prize in economics as a vanity project to mark its tercentenary.

This year’s Nobel Prize in Neoclassical Economics (as I dubbed it 5 years ago) was awarded jointly to Oliver Hart and Bengt Holmstrom. Officially, the 2016 prize recognized “their contributions to contract theory.” Unofficially, as I understand their work, it was all about attempting to solve a longstanding problem in neoclassical economic theory: the theory of the firm.

Historically, neoclassical economists (and, for that matter, not a few heterodox economists) simply assumed capitalist firms maximize profits. But, in the context of a market system, there’s no particular reason a non-market institution like “the firm” should exist (instead of, for example, everyone—workers, managers, suppliers, buyers, and so on—entering into market exchanges in parking lots or coffee shops each morning).* And yet corporations, many of them employing hundreds of thousands of workers and making record profits, have become central to the way capitalist economies are currently organized. Moreover, once you look inside that “black box,” a great deal more is going on. Workers are hired to perform necessary and surplus labor in the course of producing commodities by managers, who run the enterprise on a daily basis and receive a cut of the surplus from the board of directors, who themselves need to be elected by shareholders (who, together with money-lenders, merchants, government officials, and many others, inside and outside the enterprise, receive their own portions of the surplus). Corporations, as it turns out, are pretty complicated—political, cultural, and economic—institutions.

But when neoclassical economists like Hart and Holmstrom look inside the firm what they see is a single issue—a relationship between a “principal” and “agents.” Principals (e.g., capitalists) are presumed to enter into agreements—voluntary contracts—with agents (e.g., workers) to advance a goal (e.g., of maximizing profits). As they see it, contracts are risky because, first, principals and agents often have conflicting interests (e.g., principals want maximum effort while agents are presumed to engage in risk-averse, shirking behavior) and, second, measuring fulfillment of the goal is imperfect (that is, not all the actions of the agents can be perfectly observed). The whole point of contract theory, then, is to devise a relationship such that—through a combination of incentives and monitoring—agents can be made to work hard to fulfill the goal set by the principal.

In one of his most famous and influential papers, “Moral Hazard in Teams” (pdf, a link to the working-paper version), Holmstrom’s starting point is the idea that there’s a problem of “inducing agents to supply proper amounts of productive inputs when their actions cannot be observed and contracted upon directly” (in other words, moral hazard), especially when they work in teams. He then sets up a model in which he demonstrates that “separating ownership from production”—which also provides the incentive for limited monitoring by the owners (i.e., stockholders)—solves the problem of moral hazard and restores efficiency.**

In other words, the Nobel Prize-winning approach to contract theory is used to demonstrate what neoclassical economists had long presumed: that capitalist firms (and not, e.g., worker-owned enterprises) represent the most efficient way to organize production.

That’s why, from a neoclassical perspective, it is only natural that capital hires labor.

 

*In fact, Paul Samuelson (in 1957, in “Wages and Interest: A Modern Dissection of Marxian Economic Models,”American Economic Review) once argued that “In a perfectly competitive market, it really doesn’t matter who hires whom: so have labor hire ‘capital’.”

**Hart, for his part (in a paper with John Moore [pdf]), looked at the issue of property rights in relation to firms by distinguishing between owning a firm and contracting for services from another firm. Their model shows, once again in true neoclassical fashion, that the owner of an enterprise—who exercises “control,” not only over assets, but also over the workers tied to those assets—will have more control, leading to higher efficiency, if they directly employ the workers than if they have an arm’s-length contract with another employer of the workers. That’s because, under single ownership, the employer can “selectively fire the workers of the firm” if they dislike the workers’ performance, whereas under contracted services they can “fire” only the entire firm.