Economics as Myth Making

Well that was an interesting summer.  At least I managed to reduce my pile of unread books slightly.  Only one or two to go.  And now it’s back to … what exactly?  So little seems to change.  There are just so many times I can read sentences beginning with “Neoclassical theory does not explain …”.  I get quite jaded from all the attempts contemporary economists make to separate themselves from past failed theories even if those theories still dominate what is taught to unsuspecting youngsters.  And even if politicians still cling to those failures as intellectual underpinnings for whatever crazy ideological purpose they want to believe in or promulgate.

The current dodge seems to be to pin an arbitrary, but distant, date to neoclassical theory in an effort to bury it, in the minds of the reader, in history.  Phillipe Aghion is an example of this when he says: “Up to the late 1980s, the dominant theory of economic growth, known as the neoclassical model …”  You see what he did there?  He cast poor old Solow et al as ancient history whilst creating the illusion that the neoclassical model is, obviously, an antique of interest only to those who study the history of economics.

Aghion is a major proponent of what is known as modern growth theory.  Which seems to be a brushed up version of Schumpeter and “creative destruction”.   But more on that another time.  What makes my eyes glaze over is the appeal to intuition that passes as insight so often in economics.  Solow is famous, and earned respect within the profession, for hitting on the previously ignored fact that technical progress may have something to do with economic growth.  Ignored, that is, in model making.   In Aghion’s words: “As Robert Solow explained very clearly, generating sustained growth necessitates technical progress that makes it possible to improve the quality of machines — in other words, their productivity.”

Yes.  You can win a Nobel prize for realizing and explaining clearly what the business world had been doing for the better part of two hundred years.

Talk to any self-respecting thoughtful business person and/or worker at most any time since the 1800s and they would have been able to tell you that machines matter, that they are getting progressively smarter and more powerful, and that, in consequence, we can make more with the same or less than we once did.  Those Victorian era chest-beating displays of industry were hardly so subtle that they passed without notice.  Except, I realize, in academic economics where capital and labor remained, and remain, the critical components of production.  Technical progress had to be discovered by economics a hundred or so years later.

Even then it was set aside within a “residual” known rather opaquely as total factor productivity [TFP] which has become both a dead end and a commonly used get-out-of-jail card when an author wants to discuss economic growth.  Solow set the tone for this dodge.  Again, in Aghion’s words: “But Solow did not describe the factors that determine technical progress and in particular the factors that stimulate or inhibit innovation.”  So Solow stopped short.  Very short as it turns out.  But he launched one of economics more absurd artifacts.  TFP gets tossed about in most descriptions of growth.  It has become a plug for economists to use to cover their ignorance of what really matters in growth.  They often admit as much.  TFP is a measure of ignorance. Or, rather, it is a recognition of the inadequacy of economics which falls short of being a comprehensive description of an economy because it fails to delve into all those factors that Solow didn’t explore.

Now I don’t know Solow, but I doubt he had no interest in what causes growth.  After all he spent a great deal of his time and prestige on building models to get at those causes.  His problem is that when he arrived at the boundary of what economic formality allows he stopped.  He peered over the edge and refused to go further.  He could have expanded economics into a more interesting subject matter.  He could have delved into the social, cultural, and political milieu within which technical progress occurs.  Plenty of economic historians have.  But the theorists haven’t.  Solow could have unraveled those production function factors that still bedevil us and dug into more interesting realms.  Energy?  Information? Both capital and labor are simply combinations of those more fundamental elements.  Machines are entirely comprised of them expressed within a physical substrate.  Economics could have hewed more closely to other disciplines.  It could have, for instance, become the study of work throughout time.

Who does work?  Why?  What is work for? How do machines fit into the evolution of work? and so on.  An economy is simply a lot of work being done.  Economics as the study of work would have been able to explore those cultural elements that get hidden in the oddity of TFP.  It could have taken a look at power in the arrangement and organization of work.  And it would have had to encompass the explosion of technical know-how over the past two hundred years or so.  Instead it gave us the mythological monster known as TFP that lurks like a dinosaur on the discipline’s landscape reminding us all of it limitations.

Perhaps Aghion and then others working on new growth theory can get us beyond this limitations.

After which they can deal with another of my mythological favorites.  Marginal productivity is such a joke.

In just two days the Financial Times has displayed the dilemma that economics creates when it finds a shiny intellectual object and stops thinking about something.

Day one [yesterday] has an article talking about the way in which businesses, and big-tech businesses in particular, are struggling  with the remote working phenomenon unleashed by the pandemic.  Oh horrors!  Apparently a goodly number of workers like working remotely and have made the smart decision to maximize their incomes by moving to a home in a lower cost of living area.  How dare they!

Now the paragons of modernity we know as the big-tech companies are wailing about being taken advantage of by their own employees.  They are planning revenge.  They are announcing, many of them, that they will cut the wages of such enterprising employees.  After all, doesn’t it make sense for an employer to pay wages calibrated against the cost of living in various areas?

No.  It doesn’t.

You see, there’s this small artifact of economic theory called marginal productivity.  It argues that an employee gets paid the equivalent of their contribution on the margin.  The location of the employee and the costs that employee face in life are nowhere to be found in that calculation.  Nowhere.

The existence  of marginal productivity is simply a matter of convenience for economists.  It allows them to play with formal models without getting into the messy world of reality.  It allows them to create a myth to launch into the wider world and sound really clever.  That it has no bearing on how wages are actually set is neither here nor there.  It sounds and looks good.  Employees get paid what they contribute.  Simple.  That the big-tech companies defy the myth with their effort to tie wages to cost of living and not productivity is an empirical point we are supposed to ignore.

Day two [today] brings us class war.  It is always thus when workers get uppity and try to get paid more.  The financial types get excited about class war whenever workers get, or seem to get, the upper hand in the wage setting arena.  The pandemic appears to have altered the conditions in which employers operate.  There appear to be worker shortages.  When there are enough workers they seem to want to be paid more.  And they also appear to spurn rotten low paid jobs.  This just won’t do.  It’s a return to what the article calls an outmoded idea: that the relative power of economic classes alters macroeconomic outcomes and that macroeconomic policy tilts relative power.

Well I never.

Let’s just set aside the hand wringing.  Macroeconomic classes exist.  They have relative power.  Policy affects that relative power.  None of this is outmoded.  It is a perpetual reality.  That we choose to ignore that reality is more to do with which side we are on and whether our side is winning than with “outmodedness”.  The financial world is trying hard to get to grips with a shift in power.  More to the point, that shift is away from its chosen center and towards what it regards as hostile territory.  Workers.

The key to the need to raise this shift as ominous comes in the article’s next paragraph which launches the marginal productivity myth in all its glory as being the proper way to set wages.  The implication is that letting power relationships enter the fray is to introduce a distortion.  Never mind that power relationships are the foundation for the social construction of wages. Or that the marginal productivity myth is an artifice of convenience for economists to make their modeling more easy.   Here is the myth being thrown into a discussion of current events as if it had any analytical efficacy.  Its doesn’t.  It was always, like TFP, a plug to cover a gaping hole in economist’s understanding of reality.  Yet here is a journalist using it as a counterweight to the new conditions in the labor market that appear to be tilting in favor of workers.

You can guess where all this distortion will lead.  Inflation.  It is amazing that after four decades or so of wage suppression in the name of shareholder value, when an opportunity to turn the tables occurs, economic myths get wheeled out to be used as weapons against workers.  Had workers been paid according to their marginal productivity the yawning gap between productivity and wages that is one of the most obvious features of the entire post 1980 economy would not be so pronounced.  It would have been reduced if not eliminated.  Yet there it is.  And now there seems to be a window of time in which workers can address the insufficiency of their wages during that period.  The financial world is atwitter with the affront.  It moans about the new class war.  As it hadn’t;t been waging its own class are all those years.

Oh.  And the extent of inflation induced by wage claims is, in a broad sense, a measure of the injustice wrought during the decades of suppression.  I suspect it could be quite a bit.

Meanwhile those myths will be trotted out and presented as shiny analytical objects.  Just don’t breath too hard.  They might turn to dust.