Keynesian economics

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Carter on Keynes

The biography of Keynes by Zachary Carter ends on a decidedly wimpy note.  The concluding chapter is devoted to the financial crisis of 2008 and the subsequent half-hearted sort-0f-Keynesian policy response.  Whilst Carter seems fine with his condemnation of neoliberal policies and is clear about the abject failure of the notion that financial markets act in either a self-correcting or a rational manner, he then goes on to ask why Keynesianism has proven to be so politically weak:

“But pointing the finger at neoliberalism raises uncomfortable questions for Keynes and his defenders.  Why has Keynesianism proven to be so politically weak, even among ostensibly liberal political parties and nations?  The Keynesian bargain of peace, equality, and prosperity ought to be irresistible in a democracy.  It has instead been fleeting and fragile.  Keynes believed that democracies slipped into tyranny when they were denied economic sustenance.  Why, then, have so many democracies elected to deny themselves economic sustenance?”

Surely the answer is obvious.  Indeed, the answer is littered throughout the previous pages of Carter’s book.

Neoliberalism as it cohered in the second half of the twentieth century was essentially a reactionary effort to undermine democracy.  Carter himself aptly describes what emerged as a pseudo aristocratic mindset bent on protecting major asset owners, large corporations, and a singular version of personal liberty that allowed space for the co-option of government by those forces in the name of “liberty”, but which disallowed space for government action to protect the collective against those same forces.  In other words “liberty” was available to the powerful who owned the back channels into government and less so to those who relied on government to ameliorate the consequences of the activities of the powerful.

Democracy became a name that papered over a plutocratic reality rather than a fact.  The aristocratic counter-attack that gathered momentum in the 1970s and flourished in the decades since was designed precisely to deny the very sustenance that Carter wonders about.  The Keynesian vision, at least the version Carter describes, was firmly in the aristocratic cross hairs because it implied a focus on equality and a more generously shared prosperity.  It was also a grand philosophical vision, however naive, of a post-scarcity world rather than a technocratic focus on efficiency.  As such it ran counter to the essence of twentieth century corporate ideology with its relentless desire to assert the power of capital over that of labor.  Keynesian thought had to go.

Perhaps a more nuanced response to Carter is that Keynes tried to carve out a middle ground in a century where extremes were the norm.   Caught between the siren songs of fascism and Marxism and with early versions of capitalism apparently crumbling around him, Keynes was impelled to salvage a less extreme world.  This effort forced him to accept the real world around him which is why his economics is riven through with pragmatic acceptance of reality and eschews the fantasy worlds that others have preferred to theorize about.  It’s what makes him a more human and not a glittering prophet.

What comes across as a more vexatious problem is why it was that the economics profession was so eager to abandon this realism and infuse what became the commonly accepted, and thoroughly Americanized,  version of Keynesianism with odd bits of classical thought and misleading policy certainty kluged onto a sanitized Keynesian core.  There appear to be two main explanations:  one was the paranoia of Cold War America where even a faint whiff of collectivism was enough to destroy careers and gain the opprobrium of the elite and the media.  This alone forced many a good Keynes follower into the shadows.  Second was the ambition of people like Samuelson and Solow to re-build economics on a mathematical foundation.  This required re-configuring Keynes in ways that his ideas could not easily be confined.  The resultant version of Keynes, as we all know, is hardly Keynes at all.  Samuelson and his followers expunged the key elements of Keynes and slowly, through each new edition of their works, watered it down to accommodate the aristocratic counter attack.   So, ultimately when the aristocrats won the ideological war for the heart and direction of economics is was largely because the Keynesian side had shriveled into a technocratic shell more akin to a combination of maximizing mathematics and accounting rather than being a clear vision of society.

This is truly unfortunate because the loss of ideas concerning the role of radical uncertainty, complexity, and skepticism concerning equilibrium could all have helped move economics along a realistic path.  This is especially so given the enormous advances subsequently made outside of economics on all those fronts.

Naturally economics had to be battered into submission by the plutocratic elite in order to provide intellectual heft to its need for low wages, shareholder supremacy, unemployment, globalization, deregulation, and so on.  Getting it away from its Keynesian focus on all the attributes Carter lists, and turning it into a modest mathematical justification for all that the elite wished turned out to be less of a struggle than it ought to have been.

So, whereas Carter tries to be profound in asking why Keynesianism crumpled so easily, he is simply re-telling a well worn history.  Economics went wrong because it had to go wrong in order to eliminate a source of opposition to the plutocrats.  Keynesianism was allowed to continue to exist in academia only as long as it was tamed and de-fanged.  The irony is that as economics proclaimed itself as more scientific it was in fact becoming more political.

Re-inventing economics requires, by implication, being ready to recognize its political content.

But that’s not new either.

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Ethics, Politics, and Economists

You may have seen the article in the New York Times referring to the discussion within the economics profession about ethics. Or rather the apparent lack thereof. There has been an outpouring of commentary within that part of the blogosphere devoted to economics, so I thought I would add my own and personal perspective.

Almost alone amongst the social sciences economics has no professionally determined code of ethics. This is odd since the subject prides itself on its contribution to social welfare via its theorizing and subsequent policy recommendations. Economists have a disproportionate impact on the lives of their fellow citizens precisely because of the subject matter. Economic wellbeing is a vital topic for everyone. The recent crisis and the policies put in place to lift us out of it are testimony to the impact the ideas of economists can have.

So you would think that the discipline would be careful with its theories, and make sure that they were efficacious, sensible, and socially productive.

Not so.

True to the market magic roots of the dominant form of economics, what I call orthodoxy, its practitioners see no need to have an organized policing of their activities. The cut and thrust of competition, and the scientific notion of replication of testing are presented by many as sufficient restraint on wayward behavior. Robert Lucas is quoted in the NYT article giving exactly this reason for the lack of need for a formal ethical standard. Economics people like him argue is a science not a technology, and thus those who make policies based upon its ideas should take care themselves if they engineer society based upon Lucasian or related theory. Caveat emptor rules the day. These same folks have no interest in a collective responsibility for their subject. Why would they? Their most cherished assumption is based upon the concept that individualism is paramount. Thus to them a collective or group exercising authority to restrain unethical behavior is an unnecessary intrusion into the private world of the individual. For them ethical standards begin and end with the individual, not with a group.

They thus elide responsibility for their group. That the world was plunged into the abyss because politicians and bankers put orthodox economic ideas into practice is not, apparently, an ethical consideration. Nor is the need to reveal potential conflicts of interest individual economists may have when being asked to render a professional opinion.

So economists are free to give opinions, which they do with abandon; they are free to write popular books examining everyday topics through the often jaundiced and simplified lens of orthodox economics; they can join boards; they can go on television, write editorials, engage in debate, and otherwise seek to bend the real world to conform to their theoretical constructs; and above all, they can seek to profit from their theories by engaging in business either directly, or as consultants, all without ever revealing their prior connections, entanglements, or other involvement.

In short they can come and go from their mountain top without ever having to explain themselves fully.

I take deep issue with this.

Aside from the more mundane need to reveal sources of funding and other potential conflicts of interest that may or may not distort an economists research agenda and advice, there is the matter of the impact economic ideas have on the common good.

Doctors are enjoined to do no harm.

Economists are free to do as much damage as they like. One of the most worrying trends of the last three decades has been the total commitment of orthodox economic ideas to supporting a generally right wing political agenda. This may be unwitting. It cannot be unnoticed. Only the most blind of professors could have ignored the incessant anti-government rhetoric, the attacks on regulation, and the attempts to undermine the social safety nets put in place during the years of Keynesian hegemony. It is a nice but specious distinction to argue that such attacks are simply the result of an improved theory. It is convenient to overlook the ideological taint that permeates such theory, but the surely taint exists.

Some economists complain that non-orthodox economists are too invested in left of center politics. It may well be true that some heterodox economists are not exactly friends of the Republican party. But that merely shifts the question it does not answer it. Heterodox economists are not those claiming scientific status. They are not claiming to be “positive”. They, mostly, recognize the intractable connection between politics and economics. It is the orthodox, the market magic folks, who make such claims and thus hide their ideological roots beneath the skirt of scientific righteousness.

So as the debate about ethical standards roils on I feel foolish to have to point out that ideas have consequences. This is hardly a revelation. But to hear people like Lucas speak you would think it is shockingly new. For someone with his stature to belittle the need for the discipline to act with the utmost care, and to enforce even a simple standard of ethical behavior, is in my opinion, a dereliction of duty. He teaches his ideas to future leaders of business and politics. He has a responsibility to ensure that those ideas do no harm. He may well think they conform to that standard. I disagree. They are failed and destructive. To me that disagreement lies at the heart of the discussion. To perpetuate failed ideas; to prolong the damage they can do; and to seek to influence young minds without reflection on the failure of those theories is plainly irresponsible.

To admit of no error is not human. Nor is it sound science.

As a minor part of the community, I say: stop.

Ethics deserves a discussion.

Economics requires a standard.

We may disagree on many things, but we should agree to do no harm.

I hope Professor Lucas relents and engages more fully in the discussion. He owes that much to the subject.

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Coase, Uncertainty, and The Firm

The Economist notes Ronald Coase’s one hundredth birthday. I should not allow this to go uncommented upon. To me Coase asked one of the most simple yet subversive questions of all time in economics: why do firms exist?

To regular people outside the wonderland of orthodox economic theory, this question usually induces something between an indifferent yawn, and a totally indifferent shrug. Business firms are such a huge factor in our daily lives that we take them for granted. Most people work in one, or know plenty of others who do. So why ask such a dull and, frankly, obvious question? Surely economists have that one covered.

Umm, no.

I know this, because the “theory of the firm” was my entry point back into economics a decade or so ago. Having spent years in the business world I simply assumed that somewhere in the literature, maybe hidden from view, was a great deal of theorizing about the firm. I wanted to delve into it because I was convinced that said theory would guide me towards an answer to my own question, which was far more parochial: what will happen to the structure of the firm once information technology is fully embraced?

I came across Coase early in this search, and was happy to see he first posed his sly little enquiry in 1937. My search was immediately stalled. His question elicited no response. Economists were, and largely still are, totally uninterested in the firm and in the actual operations of business. Indeed in one paper two luminaries, Alchian and Demsetz, argued it was of no consequence, although I am happy to report they have backtracked subsequently.

How can this be?

Wonderland admits no organization other than the magic of markets. Ergo: no firms. If markets are so magical that they solve all the world’s economic coordination problems, which is what orthodox economists believe, then firms are an anomaly. Worse, they are an embarrassment.

I have a vague recollection of a character in Dickens called Podsnap, a bureaucrat who solves the unsolvable by waving his hand and dismissing the issue as a minor nuisance beneath his august attention. Maybe he was an economist because this is the standard method they adopt towards business. It is a mucky black box unworthy of their higher and more rarified examination.

That the black box is where stuff gets done is of no matter. Only business school people deal with earthly things like firms. True economists soar above, and grapple with important issues like revealed preferences, utility, marginal costs, Pareto efficiency, convex curves – how we love those – and other features of proper, albeit not real, economies. They leave real things to peons. The ugly paradox here is that business schools teach orthodox economics, apparently oblivious to the implied contradiction. No wonder business people hold economists in such low regard.

So Coase was ignored.

Of course I simplify, but the story is largely true.

Much later, only in the last two decades or so, has a true attempt been made to deal with the firm. Oliver Williamson, and his ilk, have developed the Coasian idea of transaction costs to allow the firm to be retrofitted onto orthodoxy without upending the entire sorry mess. The idea being that firms exist because there are costs of coordination that create efficacy in active, rather than passive,management. Remember the whole point of market worship is that its magic allows economies to be passively coordinated thus rendering the heavy, and altogether active, coordination of a government mute at best and harmful at worst. So active management simply doesn’t fit the orthodox narrative. It is a distinct no no.

Personally I reject Williamson as being an attempt to avoid answering the question correctly. The real answer, for me at any rate, is that firms exist because of uncertainty. And uncertainty is a dirty word in the lexicon of economics. A really bad, bad, dirty word.

You see, if uncertainty exists out there in the real world, then all that elegant math stuff economists rely upon to prove, yes prove, that markets possess magical powers, immune even to kryptonite, then uncertainty cannot be. It just cannot be.

So they don’t talk about it.

True, economists have spent vast amounts of energy trying to weasel a different view of what uncertainty is. Sometimes they call it risk. As in risk modeling. As in the financial crisis and risk management. Which turned out to be more risk than they could manage. That’s because they muddle risk and uncertainty. Risk is something we know enough about to mitigate. Uncertainty is something we simply don’t know. It is an ontological rather than epistemological problem. Not that learning doesn’t help.

Regular people are faced with uncertainty all the time. So they execute various strategies to fend off its consequences. They cooperate. They search to extend their known landscape. They move about. They listen and try to parse out meaning from noise. They organize. They build walls to protect themselves. They invent technologies so they can peer deeper into the dark. They design elaborate rituals to appease the spirits of gods. They speculate.

And they start business firms.

Firms themselves do many of these things too. Above all else they plan. They are centrally planned economies. They execute against a plan, which is an alternative reality they hope approximates the actual reality as it unfolds. If their plan and the real world are close enough, as history plays out, then the firm survives. No plan is ever accurate, but the point is that be accurate enough. Efficiency is not required. Sufficiency is. Perfection unnecessary, survival paramount. Redundancy is an virtue. Exactitude a luxury. Having some spare capacity to guard against forecasting error is useful. Having latitude and degrees of freedom are vital. Being supremely fit and lean are nice, but only if you know what’s going to happen. If you don’t, then its better to be a bit flabby, but versatile.

In other words it’s all about being able to hypothesize a direction, and being able to adapt as information flows in.

This is what firms do. It all sounds so utterly non-scientific and ordinary.

Firms are, in the words of Loasby, hedges against uncertainty.

They are thus a constant dagger pointed at the heart of orthodox economic theory. No wonder Coase went unanswered.

On a lighter note, here’s a neat question to pose all your CEO, MBA, and fervent right wing business friends: “Do you believe in free market theory?”. Probable answer: a resounding yes. Follow up question: “Then why is your company organized as a centrally planned economy a la the Soviet Union?”. Probable answer: blabbering, murmuring, and a change of topics.

There is not one CEO of a large business firm, that I know of, who truly believes in the magic of free markets. Otherwise one of them would have organized his or her firm to conform to that theory. So don’t listen to them. Further, since an enormous proportion of all economic activity in every country on earth takes place within the safe and centrally planned confines of a business firm, it is equally safe to say that the evidence is in. Markets suck at coordination. Planning rocks.

Now how we teach this basic economic reality to economists is another question.

Coase: you devil. Stop asking awkward questions!

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Time Warp Economics

One of my ongoing complaints about economics is that it seems hidebound and horribly out of date. It seems stuck in the steam age with its references to land, labor and capital. Its models conjure up images of the titans of industry forging new railways across open plains and building vast steel works or cotton mills in once pristine valleys. There are landlords preying on peasants, while workers labor away in Dickensian conditions. Words straight from those bygone years litter its lexicon. The very notion of the margin was born from the forced usage of the worst farmland as the population grew, and from the distances wagons had to travel to market towns in northern Germany.

Not that there’s anything wrong with this, as long as we add more modern stuff along the way.

And that’s the problem.

Even reading the 1950’s work on pricing is an adventure back into an archaic world. Nowhere, or at least not very prominent, are concepts drawn from all the advances of the last couple of decades. It may be useful to talk about production functions and cost plus prices, but they remind me of astrolabes while I live in an era of GPS devices.

Leafing through an average economics paper or book I am left imagining a world largely bereft of mega banks; international companies managed by large self serving bureaucracies; internet sales; digital transmissions; or computer use. Very little seems to be made of the vastly more rapid flow of information, or that many of our products nowadays are entirely information based. It’s as if we never left the industrial era.

This may not matter. But I suspect it does. I suspect that a finer breakdown of labor would reveal very different influences on wage patterns and inequality. Models that treat labor as one big glob probably miss this detail. The same goes for capital.

It may well be that the basic 1800’s categories are sufficient to explain a 21st century economy. But I would like to be sure.

We are often told that capitalism adapts. If so, why are we looking at it through the same old lens? Land, labor, capital. Is that it?

It seems to me that the economy moves from one state to another. Each state being the result of some vastly complex computation based upon a massive set of variables. The space of those states is thus practically infinite. Yet the movement of the economy from one state to another is heavily constrained. We made it thus. We set boundaries by establishing institutions and cultural norms. Its movement is constrained by geography and the resource limits that are associated with location. Our ability to exploit those resources hinges on our knowledge and technology. The networks through which we communicate limit the flow of knowledge and capital. Society with its classes and other fractures gets in the way of smooth operation. And, of course, each configuration of the economy limits the possibilities for the next. Then we must account for the feedback between our current activity and each of these constraints.

It is tempting, in that face of this complexity, to simplify. We build models to explore pieces that interest us. Sometimes we dare to encompass the entire economy in one such simplification, and impute properties like equilibrium to tame the beast sufficiently for our imaginations to explore. We imagine that properties at one level of granularity flow untouched onto other levels either above or below. We remain faithful to the foundations of the discipline.

But if we don’t update our thinking, if we ignore progress, we run the risk of becoming anachronistic. Our models look quaint next to the reality they are supposed to explicate. We are condemned to add ever more sophisticated spheres to our Ptolemeic systems in order to keep up with emerging knowledge. We scramble for ever more ludicrous assumptions, and when all else fails we simply assert axiomatically that the world is the way we need it to be for our steam driven models to remain in touch with the electronic age. It is flat if we only have the tools to examine flat worlds.

One example: it is odd that it took such an effort to insert technology into our models as a driver of growth. In our zeal to cut the problem down to manageable size we eliminated most everything resembling an actual economy, and ended up focusing on allocation or heavily constrained optimization. That is pointless, because we are no longer examining anything that exists. Anyone familiar with complexity, self-organization and evolution is comfortable with systems that mutate, adapt and change from within. Technology is an obvious component of such change. It is entirely ordinary to consider it. Not extraordinary.

The mechanistic, individualistic, reductionist time warp that orthodox economics is trapped in does a disservice to our future. It is inappropriate. It is inaccurate. It is dated. So is the reliance on the same set of alternatives. Kalecki, Keynes, Sraffa, Robinson, the entire lot need to be freshened up. With them we moved from a goods based analysis to one inclusive of credit, money and finance. Now we need to embrace information. We need to move on and not keep arguing over the same time worn issues that occupied our forbears.

Here’s an idea: the information content of the economy has exploded. The products we make now are information intense. The algorithm needed to explain those products is more complicated and lengthy than that needed to explain the average product made seventy years ago. Our thinking about what an economy is needs to keep up.

And that goes for all you DSGE fans too.

Then again I may be wildly wrong. After all an astrolabe would still help you navigate the world. Sort of.

But I know it’s not flat.

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Krugman Fails To Take Up The Challenge

Sifting amongst the debris left after the recent collapse of economic orthodoxy is not easy. The big guns of the academy are clinging on for all they are worth to the idea that a few fixes and we are all back on track. They have the most to lose in reputation and standing, so I suppose this stubborn refusal to admit the extent of the defeat is understandable. But it is not acceptable. Things have to change in a more dramatic way for economics to rehabilitate itself as a credible body of thought upon which policies can be based. It is simply not enough to continue the old “freshwater” versus “saltwater” debate – that please recall is the argument between various grades of orthodoxy, the former ensconced in Chicago and other universities far from the coasts, and the latter based primarily on those two coasts.

Paul Krugman is a great example of the problem.

He presents a strong argument and defense of a Keynesian approach to macroeconomics. This is the part of economics that deals with the big issues that occupy policy makers, especially in times of recession. In this he finds himself ranged against the more orthodox ideas of the Chicago style thinking that has invaded and taken over most of the high ground in the discipline. So he thinks of himself as an insurgent of “heterodox” thinker, and likes to do combat as a rebel.

This is curious since the rebellion is simply an attempt to reinstate the Keynesian theoretical constructs that were so successful in the immediate post war years until they were dethroned by monetarist and then hyper rationalist versions of what is called neoclassical economics. That neoclassical set of ideas was largely initiated by Paul Samuelson in 1948, when he published his enormously successful textbook and sought to incorporate Keynes within the pre-existing classical tradition.

The problem this melding produced as its legacy is that there is an inherent and implacable break between Keynesian and classical economics. Keynes spoke to aggregate issues: before him there was no notion of “aggregate demand” as a concept to be studied, managed, or fitted into policy. He argued that uncertainty was axiomatic and that the classical notions of perfect competition and so on were thus invalid. Unfortunately Keynes did not follow through and give us a full replacement for the old classical system. He was a practical and conservative person dealing only with the larger issues: indeed he invented what we now called “macroeconomics” so he could propose solutions to those larger issues, especially the devastation wrought by the Great Depression.

To put it bluntly: economics became a mess.

At the big picture level the emergence of Keynesian thinking split the subject apart. The saltwater versus freshwater fight is the result of this division.

But at the lower level much of the classical tradition survived untouched. The magic of markets; the workings of rational agents making perfectly rational decisions; the possibility of a “Pareto Optimum” – that mystical point at which an economy reaches its most efficient allocation of resources; and the other paraphernalia of classical “microeconomics” remained supreme.

So economics was cleft in two. The Keynesian constructs at policy level were based upon a worldview at odds with the micro analysis economists still relied on to understand the workings of the marketplace.

One response within economics was to replace Keynesian macro with a cobbled together version based upon classical micro. The mantra became “macro built upon a micro foundation”. This new classical tradition is the basis for freshwater thinking.

The other response was simply to ignore the contradictions between Keynesian macro and classical micro. This was the basis for saltwater macro.

Krugman falls into the second group. He voices little concern about the contradictions. Indeed he accepts them.

The obvious parallel is with physics, where the physics of very small things, known as generally as quantum mechanics, is incompatible with the physics of very large things, which is the relativity of Einstein. If physics can exist with a great divide, Krugman argues – I am putting words in his mouth – so too can economics.

This, frankly is rubbish.

Why?

For two reasons:

One, is that physics at each level is supported by empirical testing to an extraordinarily high degree of accuracy.

Two, is that physicists the world over are striving to connect to the two traditions. they do not find it acceptable to have deep contradictions within their thought, and so have set out to look for the necessary theoretical breakthroughs needed to reconcile them.

Not so in economics,according to Krugman. We, apparently will have to make do with the odd supposition that aggregate constructs are subject to inherent, and axiomatic, uncertainty. While our understanding of the deeper workings of the markets, firms, and consumer behavior from which those aggregates are composed are subject to no such thing. On the contrary those lower order objects behave supremely rationally in a world admitting of no uncertainty at all.

Talk about a muddle.

That this muddle persists is indefensible. It is time to eliminate the error left in the aftermath of the Samuelson synthesis. If Krugman won’t take up the challenge, then others will. Building a new micro based on the acceptance of uncertainty as its central axiom is the work we now need to undertake. Much has been done, much is yet to be done. One thing is clear: the challenge must be met.

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