Milton Friedman

/ / , , , /

1,001st Post: Economics, Ideology or Science?

This is my 1,001st post since the site redesign, and the 2,093rd overall. Phew.

And after all that what have I learned about economics?

That it is ideological and not scientific.

That this is so is easy to demonstrate, and I tip my hat to Paul Krugman for giving me the answer, although I am sure he didn’t mean it that way.

In today’s Wall Street Journal there is a brief article postulating what Milton Friedman’s thoughts would have been about QE2. The suggestion is that he would have approved. His entire intellectual history backs up that claim. Indeed there are many comments he made back when Japan started down its current path of deflation and malaise to support that view.

In one instance he made the claim that if only the Japanese would boost their money supply – actually he was talking about the money base which is the physical cash the central bank prints and not the money banks create when they make loans – then their problems would soon go away.

Well.

The Japanese actually did that. They doubled the money base inside three years.

The result?

Nada. Nothing. The money ended up in bank vaults.

Monetary policy failed abysmally. It is one reason that the supremacy of monetarists plummeted in the late 1990’s.

But.

Here we are in 2010 with what policy?

Monetary policy. No fiscal policy.

Argh.

What do I conclude?

That no matter how much evidence accumulates against them, economists will always seek to cling onto their ideas. They do not want to learn. They want to advocate. They are ideologues first and foremost. They search for ways in which to create theories to justify their a priori opinions.

Not all do this. But do we ever hear from them? No. They are crowded out by the noise of the orthodox crowd called the neoclassical economists. These are the most egregious offenders and die hard defenders of the market magic faith. Amongst their ranks stand countless Nobel prize winners. Names like Friedman, Stigler, Schultz, Becker, and Coase – all from Chicago – clutter the intellectual landscape of free market thought. All were driven not by science but by a burning desire to prove the efficacy of markets. At all costs. Even to the extent of making stupid – yes stupid – assumptions. When need be they all threw scientific method overboard in search of a way to ensure their cherished market mechanism was “proven” efficient and socially beneficial.

A cursory look at their work, intellectually gifted as it is, shows, without any doubt that these people were ideologues not scientists. Yet they genuinely imagined, dreamed perhaps, that they had discovered a scientific law or logic. Friedman even defended their way of thinking by coining the phrase “positive economics” to make clear that he thought their method to be scientific.

He was not the first to use an Orwellian twist in his words, but the notion that neoclassical economics is in any way, shape, or form, “positive” is a farce.

Why does this matter to you?

Because these are the people who dominate the textbooks. It is their ideas that permeate policy thinking. It is because they so dominated economics for thirty years that is has become extraordinarily difficult to implement fiscal policy solutions to our crisis. Those long lines of unemployed are a real world manifestation of the error perpetrated by Friedman et al.

As someone who dabbles in economics I feel this intensely. The profession is morally culpable for the malaise our country is in. If these false ideas had not penetrated into modern finance through the works of Modigliani, Miller, Sharpe, Scholes, and Merton – all Nobel prize winners too – our derivatives markets would never have exploded the way they did, and our banks would never have become as risky as they did.

Science is about learning. Learning is about the rejection of hypotheses proven false by experiment and evidence. The last three years have thrown up ample evidence that neoclassical economics and the financial theories based upon it are flat out wrong.

We have been lied to.

They still teach this stuff as part of Econ. 101 and as part of the basic MBA curriculum. It is wrong. We are producing hundreds of thousands of students a year all taught the Friedman error. Is it any wonder that we are having a hard time getting back on track?

One last thing: I just discovered another defense of Keynes. He was a very successful investor. He produced a 12% annualized return on his investments even through the trough of the Great Depression. At a time when the market was producing a -15% return. His ideas fly flat in the face of modern finance with its efficient market hypothesis and its capital asset pricing model. Those modern ideas produced the epic failure that was Long Term Capital Management, a disastrous investment company that counted several of the aforementioned Nobel prize winners amongst its management team. They lost billions [of other people’s money] implementing their own theories. They failed appallingly while other investors have flourished. People like Warren Buffet typify the successful capitalist of our era. He has made a fortune for his investors. He is the model we should be teaching at business school.

And who follows in Keynes’ footsteps? Who agrees with him?

Warren Buffet.

QED.

/ / , , , /

Econ 101: The Problem of Time

Time represents a special problem for economic theory. It gets in the way. It makes things messy. It introduces … gasp … the possibility of uncertainty. This latter being the really big problem.

As those of you who follow my ongoing opposition to textbook economics realize I have a major beef with the notion of markets as specified in the standard texts. That beef being based on the ridiculously unreal assumptions – contortions would a more apt description – that standard theory has to go through in order to “prove” that free markets always clear, and that they represent a preferable mechanism for resource allocation than the major alternative known as central planning.

Those of you familiar with the textbook explanation will notice that in order to arrive at the “correct” solution economists have to rig their theory. They make astounding leaps of faith. They assume, for instance, that all the actors on the economic stage have equal and costless access to all the necessary information needed to make rational decisions. They assume we are all omniscient. Not only that, but they assume we can process all that information instantaneously. We are prodigious calculators in their eyes. They go on and assume that their definition of rational is the only one we would use. This is convenient because it implies that once we have acquired all that information, and once we have calculated what to do, we will act in exactly the same way that an economist would. They don’t expect us to behave this way in actuality, but they expect that our behavior mimics what an economist would have done.

Thus standard theory assumes a world full of super rational automatons acting as if they were all economics PhD’s.

Very realistic.

It gets worse.

That’s where time enters the fray.

The problem is that to “prove” that markets always produce a socially beneficial result standard theory can admit of no uncertainty. It would muddy the waters and complicate things. It would mean that there is no single configuration of the economy that provides the maximum welfare. And the search for the single point is what drives standard theorists. An economy riven through with uncertainties could have more than one acceptable solution. Were that the case it could nor be assured that the market was any better than central planning.

Sometimes standard theory goes to even more absurd lengths to protect the sanctity of the markletplace.

Economists are obsessed with equilibrium – that singular point at which everything settles and welfare is maximized. But to get to equilibrium a market has to go through the motions of getting stuff produced, moved and bought. These are things that take time. But as I said time introduces uncertainty. So it is eliminated. The production, movement, and purchase a of goods and services is assumed to be instantaneous. That way markets can discover the prices at which they can clear. In something called general equilibrium theory, which is still the cornerstone of modern economics even though it has been attacked for decades, the bidding process during which market clearing prices are fixed is carried out by a disembodied “auctioneer” who sits outside the system, but collects and distributes information to producers and consumers. The haggling of a rowdy market is thus reduced to an auction during which everyone knows everything all at the same time. Neat. For those of you who are asking about time: the modernized version of the theory assumes that there are futures markets that embody sufficient information that future delivery of goods can be compressed into a current decision making process. The future is discounted into the present. And the ugly prospect of uncertainty magically melts away.

Even neater.

This is, of course absolutely ridiculous. But it is necessary to jump through these hoops if you want to preserve the sanctity of market magic. What economists have done is to create a system so convoluted and silly that they hope you don’t notice. The mathematics are extraordinarily elegant. The creators of the model won the Nobel Prize. Their creation dominates theorizing to this day.

They saved market magic, and that’s all that counts.

As Milton Friedman argued: it doesn’t matter how crazy the assumptions are as long as the result is correct. That begs the question as to how we know if the answer is correct. His view was that if markets arrive at an optimal solution in the model, we know the assumptions are OK.

I have a heretical view of all this.

I think Keynes was right in arguing that uncertainty is endemic. Markets may or may not be good allocators of resources. We don’t know. They may or may not arrive at equilibrium. We don’t know that either.

But I go further than this: I don’t think time exists.

There is no such thing as time. It is not a property of the universe. It is simply a convention, a scorecard, with which we keep track of change.

My view is that we exist in states of the universe. Each state is unique. Each is a full configuration of the entire system. Think of each such state as a single point in an infinite space of similar points. When we move from point A to point B we experience change: the configuration is slightly different. Since the two points are sequential we denote the movement as the passage of time. But in fact we have simply changed configurations. A history is a long string of points connected by a common thread. That thread being the observer through whose eyes the universe is being observed. As the observer jumps from state to state he or she experiences change. The trajectory thus created follows a path through the state space of the universe. It is not time passing, it is the universe changing.

Now what makes things change?

Entropy and the laws of physics that dictate creativity.

Creativity is the elimination of information. That sounds counter intuitive. But it is simple. When we create something we specify it. By being specific we eliminate all the alternative things we could have done. We reduce the choices to one. Thus when we build something from a lump of iron we start with a huge variety of things we could do. But we end up with just one of those things. We have eliminated the rest. We have reduced the amount of information.

Conversely, when we use things we add back that information. We do this in two ways. The iron thing we just made wears out. The iron returns to its original state albeit via the process of rusting. The iron remains, but the thing we specified is “used up”. The amount of iron available in the universe remains. The thing created does not. This is an approximation. But it explains the principle. This loss of information through the use and consumption of things is the process of entropy at work.

Entropy is often called the “arrow of time” because it has profound implications. It says that any closed system – the universe, of your cup of coffee – will always move from an more organized state towards a less organized state. In other words we lose track of the order. We lose specificity.

Economies can be thought of as such systems.

They are constantly moving from one state to another. Each state is a full configuration of the system. Each is unique. Each has different information content. As entropy tears away at the specifics of our products, we produce more. In a system dependent upon human intentionality like an economy the role of the laws of physics is played by our innovative and productive capacity. We marshall knowledge in order to fend off entropy. We locate, gather, and deploy resources in order to meet our economic goals. Those actions are creative. They allow us to configure the economy in order to meet our requirements. We combine natural resources with energy and our know how to make stuff. that stuff is a specification. It implies the reduction of entropy in the universe. But as we consume that stuff entropy re-asserts itself, and the laws of physics are preserved.

This view of what an economy is doing does not require us to speculate about equilibrium. It requires us to speculate about the search for resources; about the impact of their location; about the way in which we learn to use them; about the way in which technologies are developed; about the level of knowledge in society and the institutional or cultural constraints on its use; and about the structure of the networks or processes through which resources are transformed into products and moved to consumers.

None of this requires us to muddy things with time. Instead we simply observe how the economy moves through its state space as the process of search drives it onward.

But enough.

Time represents a problem to standard theory. Just not in my world.

/ / , , , , , , , , , , , , , /

Its Official! The Recession’s Over … Yawn.

Hang out the flags. Set off the fireworks. The recession is officially over. Whoopee. The National Bureau of Economic Research says so. In fact, by their count, the recession ended in June 2009.

There, don’t you all feel better?

Not really.

The “Great Recession” was officially 18 months long, making it a full 2 months longer than the slumps of 1973/1975 and 1981/1982. Those two recessions were doozies and unemployment surged in both. Banks shuddered. Businesses lost money. Shops were closed. But neither felt like this last one. The reason being that both were followed by decent recoveries. Obviously I have a personal gripe about the 1973/1975 slide since its aftermath was sufficiently meandering to set the stage for the Reagan takeover and all the deterioration in our economy that his slippery illusion has implied.

Still, here we are, on the other side of what history will record as the worst slump since World War II. We are edging slowly away from the abyss. So slowly that many of us cannot tell the difference between being in recession and being in recovery. But let’s not be churlish: we should acknowledge that we are afloat and not sinking. At least those of us still gainfully employed. As for those other folks …

If you are someone who believes in market magic, let’s say you were schooled in textbook economics, then the slump has failed to clear out the dead wood sufficiently for the recovery to be robust. In particular you are really annoyed that wages have not dropped low enough to make it attractive for businesses to hire workers in droves. For you magic lovers the lunacy of government intervention has prevented the market from solving our ills. This slow growth is a direct result of that persistent and foolhardy intervention. If only, you mutter to yourselves, unemployment had reached 20%. Whatever it takes. Maybe 25%, like back in the good old days of depression era economics. Back when workers took their medicine like the undeserving ingrates that they are. Silly things like the minimum wage have stopped the market from “clearing”. Demand for workers is too low only because – you suggest – wages have failed to drop to a market clearing level. Then there’s all those payroll taxes imposed by the silly politicians who seem to think we should set aside cash for workers retirement. Phooey! If workers cannot save for their own retirement they should starve. That’s what the market says. And you believe the market magic myth.

It helps if you are a tenured professor when you articulate this myth. That way the slump never actually gets too close to the comfortable surroundings within which you pursue academic freedom.

But that’s another story.

No one ever said that hypocrisy and academia were not entwined.

Meanwhile those of us who base our economics on reality, and not magic, see it very differently.

We see the entire problem as one of insufficient demand. There are no jobs because businesses are being very sensible. They aren’t hiring until they can expect to make a profit from the labor of those new workers. Until business expectations turn more optimistic unemployment will persist. So the central aim of government is to stoke the economy in order to boost expectations. Once we get the engine rolling it will take off on its own and we can withdraw our support. Since the taxpayers are the ones who benefit from the growth in the economy, they get new jobs, pay raises, and all sorts of other neat stuff, it is not unreasonable for them to chip in up front and pay for the necessary boost to get the engine going. They chip in by taking on the responsibility to pay back the debt the government issues as it primes the pump.

Its a perfect example of “we the people” taking responsibility for our own welfare. Its also reality. It also is an affirmative rejection of the notion that “we the people” have to get hammered before we react to the mess that the bankers made.

We are grown ups. We will fix our own mess thank you. We do not have to wait for the market fairy to awake and wave her magic wand.

I am always astonished at how many good people grow up to reject the idea of Santa Claus or the Tooth Fairy, yet still cling to the Market Magic Myth.

It was always a made up story designed to keep the workers supine. The suffering inflicted by the depressions of the 1800’s and that of the 1930’s was turned into a punishment for the ills of the laboring class. It was converted into a parable about the “natural workings” of an economy. The story telling reached its apogee in the arcane and obscure pages of academic economics. Generations of workers were told that the decentralized mechanisms of the free market produced wealth for all. They would get a share of that wealth if only they obeyed the workings of the mechanism. Sometimes that meant hunkering down and starving as the market sought to work its magic and locate a new wage level. That new level seemed always to be lower than the old. But hey, there were new jobs in new places if only you all were willing to take that new wage.

This was the essence of the myth that became modern economic theory. In the hands of people like Schumpeter – he of the “gales of creative destruction” – and then the postwar wave of right wing theorists like Friedman and Lucas, economics became an apologia for naked capitalism. It gave up the pretense of being a science. Instead it contented itself with a justification of a particular form of economic activity.

Nowhere, and I mean nowhere, is there a scientific argument that free markets work to the benefit of society. Nowhere is there a body of scientific proof that central planning is worse than decentralized planning. On the contrary. You may be shocked to hear that during the 1930’s a great debate raged within economics between those who argued central planning was at least as efficient as capitalistic decentralized planning. The argument became known as the “Socialist Debates”, and engaged some of the most famous thinkers of that time. Oscar Lange defended socialism, while Hayek and von Mises defended capitalism. You might be even more surprised to hear that it was generally agreed that the socialists won the debate. There is no proof to support the contention that markets are better at anything. There never was. There was simply assertion and assumption. The victory was hollow. Poor Lange lost on points because of the horror of authoritarianism in Nazi Germany and then in the Soviet Union. That horror so tainted the discussion that postwar economics in the West became single mindedly pro-market, even in the absence of proof.

Back in the 1930’s it was Keynes who acted as the bulwark. He provided the realist view that saved capitalism from its own doings. He saw that the magic was a myth, and argued for a realist intervention in order to prevent the carnage that an imploding market can inflict on the workforce. By mitigating those effects he realized that he could stabilize democracy and allow the middle class to flourish.

This is, of course, nothing new to you. I bring it up because the Great Depression acted as an inflection point. The great debates back then were left incomplete and the proofs were never provided. Keynesian economics prevailed for three decades. It was only when the 1973/1975 recession seemed to disprove Keynes that market magic theorists like Friedman were able to get back into the discussion. With voters disillusioned by the oil shock and the falling away from the heady postwar growth rates of the 1950’s and 1960’s, it was easy to turn their heads back to the capitalist side of the 1930’s debate. Only this time, the Cold War ensured that there was no socialist or centralized side in the discussion. The debate was entirely one sided.

I think, perhaps, that our Great Recession is another inflection point. It is time to redress the one sided nature of the debate and ask simple questions of the magic believers. Questions like: where’s your proof?

I think of the last thirty years as a great experiment. The economy has been managed, by Republicans and Democrats alike, along free market lines. Regulations have been limited and reduced. Taxes have been cut. Welfare has been gutted. The minimum wage has been held down. Laws protecting trade unions have been eliminated or neutered. The list goes on. It may shock you to learn that it took a personal call from Milton Friedman to the SEC in order to persuade that body to allow the establishment of options trading. Up until his call the SEC saw options trading as a form of gambling. Friedman’s reputation was sufficient for them to open up trading. The derivatives melt down of 2007/2008 was thus a direct heir to his theorizing. It was his set of ideas that underpinned the financial collapse. To Friedman and magic believers derivatives are a way markets mitigate risks. Realists see them as gambling.

The experiment failed.

We now have the proof.

Then again, we always did. Ask any CEO whether they believe in free markets and they will respond with a resounding “yes”. Just as long as we retain patent laws; copyrights; restrictions on unions; import quotas where “necessary”; subsidies for agriculture; price supports etc. And just so long as they can establish centralized strategic plans to guide their businesses.

In other words not one CEO truly believes in market magic. Not one. They all run their businesses along centralized planning lines. General Motors is not a free market. Nor is General Electric. Apple. Microsoft. None. They are centrally planned mini economies.

In fact more economic activity in America goes on within the safe harbor of corporately constructed centrally planned economies than takes place in supposedly free markets. Even the OECD, hardly a socialist haven, supports that observation.

Now I am not going to support socialist economics. I find it fails too. But we must be more realistic about the economy in which we operate. We need to recognize that the free market experiment failed. It was always going to fail. It was based on ideas that were incomplete or highly tailored to the 1930’s. In the hands of ideologues masquerading as economists it became twisted. Economics was conflated with politics. It became the American state religion to argue that unfettered capitalism was the only economic system to believed. And like all state religions it turned from being believed, to being revered, to being enforced without thought.

We forgot why the debates of the 1930’s took place. And we forgot that neither of the two sides was correct. Keynes was. And he was in the middle.

I hope we can forget the extremism of the free market magic myth, and return to practical realistic economics. There are jobs depending upon it. Indeed, our respective futures do.

/ / , , , , , , /

Class Conflict?

It is taboo in America to talk of “class” as if it doesn’t exist. Of course it does, we just don’t like to admit it. I say this because so much of the current crisis seems to have class-like connotations, and more commentators are arguing in ways that indicate they agree.

A case in point is the recent article in The Nation by Joshua Clover – thanks to Phil Cunningham for pointing it out to me. James Kwak at The Baseline Scenario posts a parallel article. Finally Tony Judt, the historian, devoted almost his entire book “Ill Fares The Land” to the increased separation within American society.

The common theme that all three of these writers is their focus on the enormous shift in wealth that the last three decades have wrought. This shift was no accident. It was deliberate, and orchestrated by those who benefitted most. That they were enabled and assisted with enthusiasm by middle class Americans who have been left much worse off remains a mystery in need of thorough explanation.

The facts are clear and well known: wealth has been systematically concentrated by the very upper tier of wage earners, and by corporations whose policies and activities are, in general, dictated by that tier. The professional elite took full advantage of the tax regime put in place by Reagan and then modified by Clinton and the two Bush’s to secure their income stream. They also were the best positioned to exploit the deregulatory environment that has been the predominant governance structure since Reagan also. Pay scales were twisted towards the upper echelons, and those infamous bonuses in banking poured riches into the hands of a very few. A new privileged generation was created, and they are defending their privilege fiercely and astutely. Any talk of class warfare is squelched immediately as “un-American”. The only folks who benefit from dismissal of such talk are those who have the wealth. The rest are left to their anger and increasing sense of disconnection from the old “American Dream”.

I have hammered this issue recently, so I won’t repeat myself except to say that I think that the imbalance in wealth that now is so pronounced within American society is a major, if not the major, contributory factor in our crisis.

That no one on the left in politics has roared against the injustice being done is testimony to how thorough the ideas of the right have taken hold: even our media and academic elites are entrapped by the illusion. Further, politicians of all stripes have succumbed to the money that the power brokers can throw into elections. We have so many elections that the ability of a politician to resist the cash is reduced to zero. Members of Congress are now devoted to fundraising rather than governing. Senatorial races are so expensive that even the six year cycle is not long enough to allow for sufficient fundraising. Our Senate is fast becoming – if it is not already – a rich person’s club. It is no wonder that the banks and big corporations have disproportionate influence. They are the ones with the deepest pockets.

This theme will only loom larger as the wealthy attempt to stave off a return to the better balance of the 1950’s and 1960’s. They stand to lose a great deal, they will not go down without a fight.

But that’s no news.

My point today is to illustrate the gulf that now has opened up in our society.

I was fortunate enough to spend much of the summer this year in Dorset Vermont, a town characterized both by its physical beauty and its comparative wealth. Home prices in Dorset are established by the flood of money from New York City and Boston. True Vermonters cannot afford to live there. The locals are reduced to living on the periphery and providing the services needed by the largely absentee property owners: they mow lawns, clean homes, and shovel snow. They run gift shops and take care of the golf courses. In other words they ensure that the property owners can enjoy their privileges with ease.

This arrangement is two edged. The locals certainly benefit from the jobs generated by the influx of cash. But they are priced out of the community. The town is beyond them. Discontent lurks very close to the surface, and can easily be detected in conversation. While New Englanders are not exactly known for their warm embrace of outsiders, the situation has become more acute as more and more of the town is devoted to large and expensive homes that are occupied only occasionally. My own observation is that most of the homes on one prestigious street are used by their owners once or twice a summer. One at least seems to be simply a Labor Day retreat. The luxury implied by the ability of an owner to use a very expensive home a few days a year is the point to be driven home.

Inequality has always existed. And it always will. But not for decades has the distortion been so great that we have enough families to own enough towns like Dorset that they can reduce so many others to a support function. In the old days the folks providing the services were tied to a family. They were servants. That they are somewhat less closely tied nowadays simply means we can avoid calling them servants. They are now the service economy. But they are just as dependent. They are just as incapable of experiencing the life of luxury as the servants of yore. It is no accident that the majority of jobs generated in the recent past have been in these low wage service functions. The middle income layer has been stripped away either through global shifts to low wage nations, or through the destabilization of “flattened corporate hierarchies”. We have no middle management anymore, so we should not be surprised to have fewer middle income wage earners. In each case – globalization and lean management – the benefits flowed to profits and those with professional skills. Those left at the top of the now narrower pyramid received a disproportionate share of the increase on social wealth created. They used their advanced educations to “rent seek”. Which they did with a vengeance.

That this is now America and is not worthy of commentary is my issue. The division exists and is opening up. Eventually, as it always has in the past, it will breed a backlash. I believe the Tea Party challenge to the Republicans is part of that backlash. Anger is rising. It needs to be well understood and not dismissed.

One last thing: both Joshua Clover and Tony Judt point the finger at Hayek. I would add von Mises, Berlin, and Popper as well. As Judt articulates there were a number of Austrian born theorists back in the 1930’s who devoted their analysis towards a justification, and spirited defense, of a liberal worldview. That they overcompensated in their zeal is easily understood: they were embroiled in a passionate defense of capitalism and democracy in the face of the apparent success of communism – in the Soviet Union – and fascism – in Germany and Italy. During the 1930’s the depression and the manifest failure of capitalism represented a true existential threat to the liberal conception of society. Hence the works of Hayek and von Mises in economics and Popper and Berlin in philosophy. Most postwar neo-liberal economics can be traced back to Hayek or von Mises as reinterpreted by Milton Friedman and Robert Lucas and their cohorts at the University of Chicago.

I can excuse Hayek and von Mises for their mistakes. They were made in a good cause as they fought to save the liberal worldview from the extremism threatening the West back then. I cannot excuse Friedman et al since they were under no similar existential threat, and had the opportunity to see the benefits that the greater income equality of the immediate postwar years had brought to America.

That greater equality was a result of one major idea: that the government can, and should, play a positive role in society by ensuring all its layers of income earners prosper and derive benefit from the productivity increases brought about by technological advance. This idea was best articulated by Keynes whose work both Hayek and von Mises attacked with vigor. They failed to appreciate that capitalism requires limits if it is to not to be antithetical to democracy. Untrammeled capitalism runs headlong into the democratic ideal. Why? Because capitalism is essentially elitist. It inevitably concentrates wealth. Not just in the hands of the successful, but in their offspring. It creates class structure through time. Democracy, in direct contrast, is egalitarian. It presumes a degree of equality. It degrades class, and presumes opportunity is available to all. By involving everyone it inevitably ends up redistributing wealth through social programs and entitlements.

So democracy and capitalism collide in their extreme forms.

It is only when both are modified that they provide mutual support. Capitalism only survives when the middle class benefit from it. Democracy only survives as long as inequality remains within bounds and there is some engine for the provision of greater wealth.

It was Keynes who saved capitalism from its failures in the 1930’s. He insisted on it being limited. Hayek, von Mises, and their later followers reviled and ignored Keynes by insisting on its purity. Their’s was an idealism born of zealotry. It was decoupled from history and reality. It was easily co-opted by the elites for their own ends. It provided an easy story to tell. And it fitted nicely with the pre-existing American mythology of the rugged individual. The Keynesian message was too pragmatic and failed to resonate with voters during the sharply defined Cold War era. Americans sought, and then fell for, an ideal that could not produce its promise in the uncertain and flawed environment of the real world.

Just as the rugged individual was never real, nor was the free market and its supposed cure all qualities.

But by choosing the myth Americans have undone the great leveling that created the wellbeing that characterized the postwar years. The middle class was complicit in its own downfall.

So now we have rampant capitalism and weakened democracy just as Keynes would have predicted. That the two great liberal ideas are now in conflict does not augur well. They need reconciliation. We need to throw out the rotten purities advocated by Hayek, von Mises, Friedman and Lucas. They were an illusion that generated a class conflict.

Which is something we can do without.

/ / , , , , , , /

Warring Economists and The Great Sleep

I sincerely hope that all of you are now busy exploring your economics textbooks. Really. Well at least I hope you are paying close attention the the war being fought within the economics profession. As arcane as it sounds, that war will affect your lifestyle for years to come. We all have a vested interest in the war’s outcome. If the wrong side wins we may well plunge into depression. The stakes are that high.

So while it sounds like a nasty bout of internecine academic sniping, the war between economists is crucial to our welfare.

Nowhere is that war more manifest than at the Federal Reserve Board. And nowhere will the verdict be more important.

If you follow the financial news carefully you will have noted that the big Fed annual shindig took place in Wyoming last week. Bernanke’s speech there was given a ton of coverage as being indicative of how the Fed saw the state of the economy. More to the point his speech was supposed to give us insight into what the Fed was prepared to do if the economy failed to break free of its current becalmed and weak state.

The quick answer is the he said nothing of note.

This failure to make profound announcements has befuddled many. It shouldn’t. The problem is the war between economists.

The simple matter of fact is that the Fed is horribly and, perhaps, irretrievably, divided between neoclassical and Keynesian policy advocates. The division has spilled over into a very public fight, and has embroiled all the usual suspects.

The central question seems to be: do we need more support for the economy? or do we now prepare to undo the work we have done so far? Bernanke himself appears to be stuck between the two.

Looking at the economy from a Keynesian perspective one thing screams out: the unemployment level is too high and we have the tools to make the correction. So why aren’t we?

From the neoclassical perspective the answers are totally different. The actions taken so far have destabilized the economy and we are about to plunge into an inflationary and bad money crisis of our own making.

Essentially the difference boils down to the diagnosis. Do we have a demand deficiency, which is the Keynesian answer; or a supply deficiency, which is the neoclassical answer. Policy responses are radically different depending upon the side you take in the argument.

What is especially disappointing to me is that this debate was resolved a long time ago. My own education typifies that resolution. Anyone who learned economics in the aftermath of the Depression, and relied on Samuelson’s text or a text in the same genre, would look at today’s crisis and know immediately that the response is to prime demand. That means government spending and deficits etc. But all that was expunged after the monetarist debates led by Friedman and the “new classical” approach of Lucas. Their victory meant that anyone educated after the 1980’s would never respond in a Keynesian manner. They would never have read any Keynes. He was eliminated from the curriculum.

So the debate that has resurfaced has already been had. And was already won. That we are wasting time on it is both an indictment of economics, and a truly awful indictment of the post 1980’s years of illusion. The so-called great moderation of the thirty years since Volcker squeezed away inflation was not a function of the victory of the theories of Friedman and Lucas, but was an aberration caused by the coincidence of global and domestic trends that are now being undone.

We are back to the 1930’s.

Let’s hope that Keynes wins again. Otherwise the Great Sleep will continue, possibly for a decade or more.

«< 2 3 4 5 6 >