LARS P. SYLL

Understanding capitalism

Frank Roosevelt, a member of the Sarah Lawrence economics faculty since 1977, likens his field to the elephant a group of blind scholars famously tried to describe. Each felt a different part of the animal, and so described a different beast.

“There is no objective truth in economics,” says Roosevelt. “Nobody understands the whole picture. Everybody gets a piece of it.”

In February, Oxford University Press published the third edition of the introductory economics textbook Understanding Capitalism: Competition, Command, and Change, Roosevelt’s six-and-a-half-year project of rewriting and revision. It’s an untraditional book. Roosevelt is an untraditional economist.

“I’m not like ninety-nine percent of economists in the world—I’m in the one percent that is self-styled ‘radical,’” he says. “‘Alternative’ is a more sanitized word.”

Each year, about a million college students take introductory economics courses; their textbooks are selected from among some two dozen on the market. But this apparent magnitude of choices, Roosevelt says, belies the sameness in their explanation of economics. “Class,” for example, is not an independent entry in the index of the most popular traditional textbook. “In our book,” says Roosevelt, “class is not only in the index, but it has more references to it than almost any other word.

”There are power groups, power interests, and much of the world is made up of power relationships. Class is about power relations. We think introductory courses should educate people about the economic system in which we live. This concept is central to this book, and that’s what makes it different.”

As a student in the 60’s, Roosevelt was involved in the Civil Rights and anti-war movements, and co-founded a group called the Union for Radical Political Economics. The first edition of Understanding Capitalism (1985) was written by two friends from the Union’s early days, Samuel Bowles and Richard Edwards. Roosevelt began using it right away, giving it equal course time with more traditional textbooks and introducing, he concedes, “a lot of cognitive dissonance” into his classes.

J.B.

Game theory and the shaping of neoliberal capitalism

Neoliberal subjectivity arises from the intricate pedagogy of game theory that comes to the fore in the Prisoner’s Dilemma game and is interchangeable with contemporary paradigmatic instrumental rationality. Rational choice is promoted as an exhaustive science of decision making, but only by smuggling in a characteristic​ confusion​ suggesting​ that everything of value​ to agents can be reflected in their appraisal of existential worth even though this is patently not the case in life viewed as a ‘fixed game.’ Without a critical and scrupulous pedagogy that carefully identifies as optional the assumptions necessary to operationalize strategic rationality, a new neoliberal understanding of capitalism will dominate the worldview​ of the student of game theory and inhabitant of neoliberal institutions.

When criticising game theory you often get the rather uninformative and vacuous answer that we all have to remember that game theory — as is mainstream neoclassical theory at large — is nothing but ‘as-if-theory’ built on ‘as-if-rationality.’ As Ariel Rubinstein has it, however, this only shows that “the phrase ‘as if’ is a way to avoid taking responsibility for the strong assumptions upon which economic models are founded” …

Sraffian economics — a critique

After being tasked with editing David Ricardo’s Collected Works in 1930, Piero Sraffa, with the assistance of Maurice Dobb, published them between 1951 and 1973. This work earned him the 1961 Söderström Gold Medal from The Royal Swedish Academy of Sciences.

For the edition, Sraffa wrote an interesting and thought-provoking introduction. Its purpose was to demonstrate that classical economists based their theory on the concept of surplus, defined as the remainder of the product after deducting the necessary production costs. Ricardo’s contribution to the classical tradition was primarily to specify in more detail the relationship between the shares of the various social classes in this surplus—the social net product—and its development and changes over time. Sraffa shows how Ricardo wrestled with the problem of how to define the surplus in a way that allows for an unambiguous determination throughout his adult life.

What has been fiercely debated among historians of economic thought is Sraffa’s thesis that Ricardo, up until 1815 and Essay on Profits, solved this problem by constructing a ‘corn model.’ According to Sraffa, Ricardo reasoned as follows:

In agriculture, only labour and corn (seed) is used to produce more corn. The real wage is assumed to be given at a certain level and defined as a specific quantity of corn. This means that inputs and outputs are homogeneous and can therefore be measured in physical terms. The rate of profit can then be defined as the quantity of output (expressed in corn) minus the quantity of input (expressed in corn) divided by the quantity of input (expressed in corn). This can be reconciled without taking into account the other sectors of society. Since, according to the “equality assumption,” there can only exist one rate of profit, the individual rates of profit in the other sectors must adjust to that of agriculture, which thereby determines the general rate of profit in the economy.

How Ricardo, according to Sraffa, determines the rate of profit in Essay on Profits implies that there is no need for a theory of value to determine the distribution of the net product between profit, rent, and wages. However, as soon as Ricardo departs from the assumption that the economy is fundamentally single-sectorial, it becomes necessary to determine the profit on capital as it is determined in the market through commodity prices. When attempting to extend a corn model to include other production sectors that are mutually interdependent, problems arise. These force one onto partially new paths: one reaches a crossroads where the choice lies between divisible and indivisible production systems. It involves a possible conception of production as natural on the one hand and a necessary concept of the social character of production on the other.

In a single-sector model, distribution and production can be reduced from social entities to natural ones, but the idea of production confined to one sector contradicts the very concept of capitalist production, which is the production of value without physical boundaries. Therefore, it becomes necessary to go beyond the corn model to achieve a more accurate understanding of distribution and value within the framework of the capitalist society. In doing so, one will also partially break with the views of some earlier classical economists on the nature of the economy and instead see production as socially determined. The importance of a theory of value becomes clear to Ricardo through the contradictions that this creates within the theory of distribution. According to Sraffa, what Ricardo is attempting to demonstrate in Principles is that the conclusions he has reached regarding distribution within the single-sector model are also generally valid in an interdependent multisectional economy.

In the corn model, labour functions merely as a mediating link in the natural production process where corn is transformed into more corn. There is no conception of labour as socially equivalent. By having all production occur in the corn sector, all labour is transformed into corn labour. This is, to use Marx’s terminology, to reduce abstract labour to concrete labour and therefore to reduce the social character of labour to labour as nature. The root of the confusion between labour and labour power, which will complicate much of the subsequent work on the theory of value, can be found here.

The perception of production as a natural process essentially means that production loses its economic character and instead takes the form of general metabolism. It becomes a logical category with the meaning of transforming inputs into outputs. However, production in this general form cannot serve as the basis for economic relations because it is indifferent to the specificity of these relations.

In the distribution theory attributed to Ricardo by Sraffa, the starting point is the corn model because only through it can Ricardo separate the determination of the value of goods from their distribution. Capital in this model takes the form of circulating capital, specifically a wage fund of labour advanced, which is also the share of the previous production period that accrues to labour. In an economy of this kind, the simplicity of the distribution problem is a function of its character as the distribution of material entities. To measure the net product, we only need access to the natural unit of corn. It is worth noting further that the distribution of the good has nothing to do with the exchange of the product, and the secret of the corn model actually lies in this assumption of the absence of commodity exchange. Since there is only one product, there is, of course, no reason for the exchange of this universal product among the different actors.

Ricardo’s solution to the distribution problem in Essay on Profits is to dissolve the distributive parts into their natural class components. To present these shares as natural, the distribution must be separated from the value form of the product. Even in his later works, Ricardo, according to Sraffa, would attempt to reduce his theory of value to the only thing he assumes it is based on, namely the distribution of material products. Wages and rent acquire the character of natural distribution variables because they are not produced. Profit, which is the return on capital, on the other hand, expresses that production in a capitalist society is the production of capital. However, Ricardo tries to reduce profit to a natural factor by considering capital as an accumulation of material objects, as a capital stock.

Once capital and its self-increase in the form of profit have been reduced to natural categories, the only task remaining is to determine the proportions in which wages and profit should stand to each other. Establishing this proportion, and above all its development, is Ricardo’s main concern in Principles. The task of economics becomes to determine the distribution of a given value production. The inability of the corn model to treat distribution as the distribution of value is related to an unwillingness to view distribution as fundamentally a social process. The social form must be subordinated to natural reality.

However, Sraffa’s interpretation of the ‘early Ricardo’ is based on rather vague grounds, and he admits (in the Introduction to Ricardo’s Collected Works, vol. I, p. xxxi) that his rational reconstruction was never “explicitly expressed by Ricardo.” Upon closer examination of Sraffa’s arguments, it proves to be untenable. When Sraffa claims that Ricardo provided an exact formula for determining the profit rate in the agricultural sector, it is more accurate to say that he indicated the dependence of the profit rate on the size of the surplus. In Essay on Profits, capital is calculated in terms of corn — capital is estimated in quarters of corn — but nowhere is it assumed that it would consist only of corn, let alone that corn would be the sole input or the only commodity included in the wage basket.

Ricardo expressing the profit rate in terms of corn quantities does not imply any specific assumption about the composition of the wage basket. Both Sraffa and his later associate Piero Garegnani claimed that Ricardo assumed wages to consist solely of corn and that Malthus criticized him for this in their correspondence after Essay on Profits. However, this is not the case. Malthus’ criticism pertains to Ricardo’s choice of corn as the numéraire and not the composition of the wage basket.

What Ricardo actually does is assume that absolute prices, and consequently relative prices, of corn and other input goods remain constant, and that due to diminishing returns in agriculture, there is a falling profit rate through “the general rise of wages.”

While Ricardo’s analysis does not address price changes, this is not because, as Sraffa believes, he assumes homogeneity in product and capital (i.e., that capital is identical to the produced goods), but rather due to the specific price assumption mentioned. In Essay on Profits, the reduced profitability in the industrial sectors is a result of the diminishing returns in agriculture raising wages without correspondingly increasing industrial product prices.

Before Essay on Profits, Ricardo subscribed to Adam Smith’s ‘adding-up’ theory, according to which the price of a good was obtained by adding wages, profit, and rent. It is even likely that in the years preceding Essay on Profits, he believed that increases in production costs in agriculture would be reflected in corresponding price increases in corn. As Malthus pointed out in a letter to Ricardo on March 12, 1815, otherwise, it would be difficult for Ricardo to maintain his assumption of a falling profit rate in the agricultural sector. The problem of demonstrating the fall in the profit rate under different assumptions about how corn prices affected industrial product prices led Ricardo into a “labyrinth of problems.”

As his strongest ‘evidence’ that Ricardo had a corn model, Sraffa cites a letter from Ricardo (in Collected Works, vol vi, p. 117) where he states that the rate of profit and rent have to depend on the proportion between the production and the consumption necessary for that production. However, this is irrelevant as the definition only pertains to the ‘rate of product’ from which the rate of profit can be determined. Central to Ricardo’s explanation of the falling tendency of the profit rate is the difficulty or ease of procuring food, which depends on the necessity of cultivating poorer lands on which, with the same quantity of labour, the same quantity of products cannot be obtained. The only permanent cause of a fall in the rate of profit is thus increasing — not constant — production costs.

Thus, it is hardly possible to address Ricardo’s problems of value, distribution, and growth without considering diminishing returns in agriculture. However, Sraffa’s interpretation of Ricardo is fundamentally based on the exclusion of diminishing returns. The first signs of this can be found in his 1925 article Sulle relazioni fra costo e quantità prodotta:

It can be said that all classical writers accept implicitly, as an obvious fact, that cost is independent of quantity, and they do not bother to discuss the contrary hypothesis.

And a year later, In a letter to Keynes in June 1926, he again claim that Ricardo’s theory presupposes constant returns.

For Sraffa, diminishing returns in agriculture are something that only has relevance for distribution theory, and changes in the distribution of the net product due to diminishing returns are assumed not to affect relative prices, as this would affect all commodity costs to the same extent. However, Sraffa’s own analysis from 1960 shows that the relationship between output and production costs affects distribution and relative prices (through its impact on the rate of profit, which influences relative prices depending on the technical conditions of production concerning the numéraire commodity).

Where did Sraffa get the inspiration for his interesting but fundamentally flawed interpretation of Ricardo’s focus on corn? In Production of Commodities by Means of Commodities (1960:99), we find the explanation:

It was only when the Standard system and the distinction between basics and non-basics had emerged in the course of the present investigation that the above interpretation of Ricardo’s theory suggested itself as a natural consequence.

This interpretation, therefore, turns out to be a projection of Sraffa’s own research struggles onto Ricardo. As a description of Ricardo’s thinking, it must be considered overly speculative and poorly supported textually. However, the fact that it led to a renewed interest in classical economics is proof of Sraffa’s intellectual acuity and his ability to highlight the relevance of the ‘classics.’ For this, we owe him recognition.

Just as post-war mainstream economics has been criticized for being founded on an axiomatic-deductive mathematical methodology, I think it is fair to also question Ricardo’s most well-known modern follower, Sraffa, since the core of his neo-Ricardianism is based on the same kind of methodology.

To solve the problem of finding a measure of value that is not affected by changes in income distribution, Sraffa — in Production of Commodities by Means of Commodities — constructs his ‘standard commodity.’ Expressed in terms of this specific ‘commodity,’ the relationship between the profit rate and wages becomes linear. In the standard system, the profit rate is determined as a ratio of commodity quantities independent of their prices. Sraffa’s standard commodity plays the same role as corn in the ‘corn model.’ However, if we compare his solution to Ricardo’s problem in Principles, Sraffa only solves a part of it. Ricardo sought a measure that would be invariant to both changes in production and changes in distribution. Due to its static nature, the standard commodity is only invariant to the latter.

Now, some of Sraffa’s neo-Ricardian followers have claimed that by using the standard commodity, we could treat income distribution independently of prices and that whatever shortcomings there may be in the labour theory of value, it leaves — as Pasinetti puts it — “the possibility of treating income distribution independently of prices completely intact.” This claim must be strongly questioned. From an informational standpoint, the standard system adds nothing. In this system, the wage and profit shares are not clearly and simply related to the ‘real’ shares, as the ‘real’ income is not ‘invariant’ to changes in the profit rate. Our conclusion must be that the analysis of income distribution, contrary to what has been claimed, is worsened by using the standard commodity as the numeraire.

In doctrinal-historical contexts, it is sometimes claimed that the standard commodity would be a modern variant of Ricardo’s ‘corn’. However, this is hardly accurate, as ‘corn’ in Ricardo’s theory is a consumption good, whereas there is no reason to assume that the standard commodity represents the workers’ wage basket in Sraffa’s analysis.

Furthermore, the standard commodity is a poor approximation. As soon as we have technology choices and joint production, it is not possible to treat income distribution independently of prices. If we follow Ricardo and Marx and calculate profits on the entire advanced capital, price equations must be written in a form that causes the relationship between distribution variables to cease being linear and instead assume a hyperbolic form.

Sraffa perceives his standard commodity not only as a means to treat distribution independently of prices but also as a means to determine the source of relative price changes when distribution changes. Just like Ricardo, Sraffa fails in the second objective, as price changes depend on both technology and distribution. In Sraffa’s standard system, it is also impossible to separate the direct price effect of a change in the production conditions of the wage basket from the indirect price effects caused by changes in the profit rate accompanying altered production conditions. The redundancy of the standard system is also evident in the fact that the inverse relationship between wages and the profit rate, which the standard commodity is supposed to demonstrate, can be shown independently of it.

Regarding the issue of economies of scale, it turns out that even for the standard commodity, Sraffa must actually assume constant returns to scale (unless he wants to make the unrealistic assumption that workers and capitalists have the same composition of their demand). Otherwise, the standard commodity can only be constructed for a given combination of wages and profits.

This would mean that the cherished idea of a linear relationship between wages and the profit rate advocated by Sraffa would become meaningless. For prices, this would imply that they only hold at a specific point in time without possessing the ‘gravitational force’ that the ‘natural’ prices of classical economists possessed.

Sraffa’s work certainly undermined a significant portion of neoclassical economics claims, especially in its Marshallian formulation. However, contrary to Sraffa’s own belief, his work does not show that income distribution is independent of supply and demand. These forces can only operate in a world where consumption and production can vary, which is excluded in Sraffa’s model. While the model is consistent, the question is how much it can tell us about a changing world where dynamics, money, and expectations play a crucial role.

Sraffa’s critique of the neoclassical productivity theory based on aggregated production factors is a severe blow to this theoretical framework. However, it doesn’t have much impact on general equilibrium theory because it does not rely on the ability to measure capital independently of the profit rate.

Sraffa’s doctrinal-historical work demonstrates great intellectual acuity and interpretive power. However, by projecting his own research efforts onto his predecessors, the sustainability of his interpretations becomes dubious.

On the political front, one could argue that since Sraffa does not address production relations — on the contrary, he overlooks them to focus on distributional relations — his message implies a call for a more equitable income distribution rather than demanding the abolition of wage labour. It could be argued that his analysis, therefore, ultimately results in an apology for capitalism itself.

Hyman Minsky and the IS-LM obfuscation

As a young research stipendiate in the U.S. yours truly had the pleasure and privilege of having Hyman Minsky as a teacher. He was a great inspiration at the time. He still is.

The concepts which it is usual to ignore or deemphasize in interpreting Keynes — the cyclical perspective, the relations between investment and finance, and uncertainty, are the keys to an understanding of the full significance of his contribution …

The glib assumption made by Professor Hicks in his exposition of Keynes’s contribution that there is a simple, negatively sloped function, reflecting the productivity of increments to the stock of capital, that relates investment to the interest rate is a caricature of Keynes’s theory of investment … which relates the pace of investment not only to prospective yields but also to ongoing financial behavior …

The conclusion to our argument is that the missing step in the standard Keynesian theory was the explicit consideration of capitalist finance within a cyclical and speculative context. Once capitalist​ finance is introduced and the development of cash flows … during the various states of the economy is explicitly examined, then the full power of the revolutionary insights and the alternative frame of analysis that Keynes developed becomes evident …

The greatness of The General Theory was that Keynes visualized [the imperfections of the monetary-financial system] as systematic rather than accidental or perhaps incidental attributes of capitalism … Only a theory that was explicitly cyclical and overtly financial was capable of being useful …

If we are to believe Minsky — and I certainly think we should — then when people like Paul Krugman and other ‘New Keynesian’ critics of MMT and Post-Keynesian economics think of themselves as defending “the whole enterprise of Keynes/Hicks macroeconomic theory,” they are simply wrong since there is no such thing as a Keynes-Hicks macroeconomic theory!

There is nothing in the post-General Theory writings of Keynes that suggests that he considered Hicks’s IS-LM anywhere near a faithful rendering of his thoughts. In Keynes’s canonical statement of the essence of his theory in the 1937 QJE article there is nothing to even suggest that Keynes would have thought the existence of a Keynes-Hicks-IS-LM-theory anything but pure nonsense. So, of course,​ there can’t be any “vindication for the whole enterprise of Keynes/Hicks macroeconomic theory” — simply because “Keynes/Hicks” never existed.

To be fair to Hicks, we  shouldn’t forget that he returned to his IS-LM analysis in an article in 1980 — in Journal of Post Keynesian Economics — and self-critically wrote:

The only way in which IS-LM analysis usefully survives — as anything more than a classroom gadget, to be superseded, later on, by something better — is in application to a particular kind of causal analysis, where the use of equilibrium methods, even a drastic use of equilibrium methods, is not inappropriate. I have deliberately interpreted the equilibrium concept, to be used in such analysis, in a very stringent manner (some would say a pedantic manner) not because I want to tell the applied economist, who uses such methods, that he is in fact committing himself to anything which must appear to him to be so ridiculous …

When one turns to questions of policy, looking toward the future instead of the past, the use of equilibrium methods is still more suspect … It may be hoped that, after the change in policy, the economy will somehow, at some time in the future, settle into what may be regarded, in the same sense, as a new equilibrium; but there must necessarily be a stage before that equilibrium is reached …

We now know that it is not enough to think of the rate of interest as the single link between the financial and industrial sectors of the economy; for that really implies that a borrower can borrow as much as he likes at the rate of interest charged, no attention being paid to the security offered. As soon as one attends to questions of security, and to the financial intermediation that arises out of them, it becomes apparent that the dichotomy between the two curves of the IS-LM diagram must not be pressed too hard.

In his 1937 paper, Hicks actually elaborates on four different models (where Hicks uses I to denote Total Income and Ix to denote Investment):

1) “Classical”: M = kI   Ix = C(i)   Ix = S(i,I)

2) Keynes’ “special” theory: M = L(i)   Ix = C(i)    I = S(I)

3) Keynes’ “general” theory: M = L(I, i)   Ix = C(i)   I = S(I)

4) The “generalized general” theory: M = L(I, i)   Ix =C(I, i)  Ix = S(I, i)

It is obvious from the way Krugman and other ‘New Keynesians’ draw their IS-LM curves that they are thinking in terms of model number 4 — and that is not even by Hicks considered a Keynes model! It is basically a loanable funds model, that belongs in the neoclassical camp and which you find reproduced in most mainstream textbooks.

Hicksian IS-LM? Maybe. Keynes? No way!

Paul Krugman and the power of folk economics

And then there’s Paul Krugman who … has stumbled on folk economics. And I’ll give him credit, since the “folk” he refers to “needn’t be members of the working class. They can be, and often are, members of the elite: plutocrats, powerful politicians and influential pundits.” Absolutely! … But then he reverts to classic Krugman: mainstream economists get it mostly right, and all they really need is the “IS-LM model” to analyze economic crises (such as the 2007-08 crash) and devise the appropriate public (fiscal and monetary) policies. There he stands, completely self-satisfied with his colleagues in mainstream economics, against the “‘folk’ who hold plausible-sounding but wrongheaded views of the economy.” Of course, for Krugman, IS-LM is not itself a part of a folk economics, a narrative of economic events that is produced by and serves as a simple story that is convincing to other mainstream economists, precisely because it stirs their concern or emotions. Where, for example, is the role of inequality or exploitation or distributions of surplus-value captured by finance in causing the crash, or of policies that seek to maintain but not move beyond capitalism in response.

David Ruccio

Krugman’s comments on the issue of ‘folk economics’ is interesting because it sheds light on a kind of inconsistency in his own art of argumentation. Krugman has often criticized mainstream economics for using to much (bad) mathematics and axiomatics in their model-building endeavours. But when it comes to defending his own position on various issues, he usually himself ultimately falls back on the same kind of models. Models that actually, when it comes to methodology and assumptions, have a lot in common with the kind of model-building he otherwise criticizes. And although Krugman repeatedly says that he is a strong believer in “simple models,” those models certainly are far from simple.

And then, of course, not really trying to clinch the deep theoretical issue at stake, Krugman for the n:th time puts forward his IS-LM gadget interpretation of economics.

Being able to model a ‘gadget world’ — a world that somehow could be considered real or similar to the real world — is not the same as investigating the real world. Even though all theories are false, since they simplify, they may still possibly serve our pursuit of truth. But then they cannot be unrealistic or false in any way. The falsehood or lack of realism has to be qualified.

Constructing gadgets like IS-LM macroeconomic models as ‘stylized facts’ somehow ‘successively approximating’ macroeconomic reality, is a rather unimpressive attempt at legitimizing using fictitious idealizations for reasons more to do with model tractability than with a genuine interest of understanding and explaining features of real economies. Many of the model assumptions made in Krugman’s IS-LM models and ‘New Keynesian’ DSGE models are restrictive  rather than harmless and could a fortiori anyway not in any sensible meaning be considered approximations at all.

Top 100 Economics Blogs

10. Naked Capitalism

46. Stumbling and Mumbling

63. Lars P Syll | Non-ergodic, realist and relevant economics

66. Real-World Economics Review Blog

74. Greg Mankiw’s Blog

Mainstream economics has sadly made economics increasingly irrelevant to the understanding of the real world. Trying to contribute in making economics a more realist and relevant science, yours truly launched this blog in March 2011.

Now, ten years later and with millions of page views on it, yours truly’s blog is ranked on Top 100 Economics Blogs.

I am — of course — truly awed, honoured and delighted.

Behavioural economics and complexity economics

What is to take the place of neoclassical economics and its neoliberal policy offshoot? There is no shortage of candidates, grouped under the broad banner of economic heterodoxy. Some of these successor doctrines – behavioral economics and complexity economics are examples of note – take the neoclassical orthodoxies as a point of departure. They therefore continue to define themselves in relation to those orthodoxies. Others avoided the gravitational pull altogether – or, as in the exceptional case of Keynes, made a “long struggle to escape”. The behaviorists depart from neoclassicism by giving up strict assumptions of rational and maximizing behavior. Complexity theorists explore the dynamics of interacting agents and recursive functions. Both achieve a measure of academic reputability by remaining in close dialog with the orthodox mainstream. Neither pays more than a glancing tribute to earlier generations or other canons of economic thought. The model is that of neoclassical offshoots – New Institutionalism, New Classical Economics, New Keynesianism – that make a vampire practice of colonizing older words and draining them of their previous meaning. The dilemma of these offshoots lies in having accepted the false premise of the orthodoxy to which it proposes to serve as the alternative. The conceit is of a dispassionate search for timeless truth, once again pursued by “relaxing restrictive assumptions” in the interest of “greater realism”. Thus, for example, in complexity theories agents follow simple rules and end up generating intricate and unpredictable patterns, nonlinear recursive functions give the same result, the variance of returns turns out to be non-normal, and so forth. But once the starting point is taken to be the neoclassical competitive general equilibrium model, these exercises are largely drained of insight and relevance. The behaviorists can tell us that real people do not appear to fit well into the portrait of autonomous, selfish, commodity-obsessed pleasure-seekers that is “economic man”. The complexity theorists can tell us, as Arthur (2021) does, is that a system constructed from confections of interacting agents may be unstable. These things, even the dimmest observer of real-existing capitalism already knew.

James Galbraith / RWER

Although discounting empirical evidence cannot be the right way to solve economic issues, there are still, in my opinion, a couple of weighty reasons why we — just as Galbraith — perhaps shouldn’t be too excited about the so-called ’empirical’ or ‘behavioural’ revolution in economics.

Behavioural experiments and laboratory research face the same basic problem as theoretical models — they are built on often rather artificial conditions and have difficulties with the ‘trade-off’ between internal and external validity. The more artificial conditions, the more internal validity, but also less external validity. The more we rig experiments to avoid the ‘confounding factors’, the less the conditions are reminiscent of the real ‘target system.’ The nodal issue is how economists using different isolation strategies in different ‘nomological machines’ attempt to learn about causal relationships. One may have justified doubts on the generalizability of this research strategy since the probability is high that causal mechanisms are different in different contexts and that lack of homogeneity and invariance doesn’t give us warranted export licenses to the ‘real’ societies or economies.

If we see experiments or laboratory research as theory tests or models that ultimately aspire to say something about the real ‘target system,’ then the problem of external validity is central (and was for a long time also a key reason why behavioural economists had trouble getting their research results published).

A standard procedure in behavioural economics — think of e.g. dictator or ultimatum games — is to set up a situation where one induce people to act according to the standard microeconomic — homo oeconomicus — benchmark model. In most cases, the results show that people do not behave as one would have predicted from the benchmark model, in spite of the setup almost invariably being ‘loaded’ for that purpose. [And in those cases where the result is consistent with the benchmark model, one, of course, have to remember that this in no way proves the benchmark model to be right or ‘true,’ since there, as a rule, may be many outcomes that are consistent with that model.]

For most heterodox economists this is just one more reason for giving up on the standard model. But not so for mainstreamers and many behaviouralists. To them, the empirical results are not reasons for giving up on their preferred hardcore axioms. So they set out to ‘save’ or ‘repair’ their model and try to ‘integrate’ the empirical results into mainstream economics. Instead of accepting that the homo oeconomicus model has zero explanatory real-world value, one puts lipstick on the pig and hope to go on with business as usual. Why we should keep on using that model as a benchmark when everyone knows it is false is something we are never told. Instead of using behavioural economics and its results as building blocks for a progressive alternative research program, the ‘save and repair’ strategy immunizes a hopelessly false and irrelevant model.

By this, I do not mean to say that empirical methods per se are so problematic that they can never be used. On the contrary, I am basically — though not without reservations — in favour of the increased use of behavioural experiments and laboratory research within economics. Not least as an alternative to completely barren ‘bridge-less’ axiomatic-deductive theory models. My criticism is more about aspiration levels and what we believe that we can achieve with our mediational epistemological tools and methods in the social sciences.

The increasing use of natural and quasi-natural experiments in economics during the last couple of decades has led several prominent economists to triumphantly declare it as a major step on a recent path toward empirics, where instead of being a deductive philosophy, economics is now increasingly becoming an inductive science.

Limiting model assumptions in economic science always have to be closely examined since if we are going to be able to show that the mechanisms or causes that we isolate and handle in our models are stable in the sense that they do not change when we ‘export’ them to our ‘target systems,’ we have to be able to show that they do not only hold under ceteris paribus conditions and a fortiori only are of limited value to our understanding, explanations or predictions of real economic systems.

‘Ideally controlled experiments’ tell us with certainty what causes what effects — but only given the right ‘closures.’ Making appropriate extrapolations from (ideal, accidental, natural or quasi) experiments to different settings, populations or target systems, is not easy. ‘It works there’ is no evidence for ‘it will work here.’ Causes deduced in an experimental setting still have to show that they come with an export-warrant to the target system. The causal background assumptions made have to be justified, and without licenses to export, the value of ‘rigorous’ and ‘precise’ methods is despairingly small.

Taking assumptions like utility maximization or market equilibrium as a matter of course leads to the ‘standing presumption in economics that, if an empirical statement is deduced from standard assumptions then that statement is ‘reliable’ …

The ongoing importance of these assumptions is especially evident in those areas of economic research, where empirical results are challenging standard views on economic behaviour like experimental economics or behavioural finance … From the perspective of Model-Platonism, these research-areas are still framed by the ‘superior insights’ associated with early 20th century concepts, essentially because almost all of their results are framed in terms of rational individuals, who engage in optimizing behaviour and, thereby, attain equilibrium …

While the mere emergence of research areas like experimental economics is sometimes deemed a clear sign for the advent of a new era … a closer look at these fields allows us to illustrate the enduring relevance of the Model-Platonism-topos and, thereby, shows the pervasion of these fields with a traditional neoclassical style of thought.

Jakob Kapeller

So — although it is good that behavioural economists are rewarded ‘Nobel prizes’ and that much of their research has vastly undermined the lure of axiomatic-deductive mainstream economics, there is still a long way to go before economics has become a truly empirical science. The great challenge for future economics is not to develop methodologies and theories for well-controlled laboratories, but to develop relevant methodologies and theories for the messy world in which we happen to live.

An economic theory that does not go beyond proving theorems and conditional ‘if-then’ statements — and do not make assertions and put forward hypotheses about real-world individuals and institutions — is of little consequence for anyone wanting to use theories to better understand, explain or predict real-world phenomena.

Building theories and models on patently ridiculous assumptions we know people never conform to, does not deliver real science. Real and reasonable people have no reason to believe in ‘as-if’ models of ‘rational’ robot-imitations acting and deciding in a Walt Disney-world characterised by ‘common knowledge,’ ‘full information,’ ‘rational expectations,’ zero transaction costs, given stochastic probability distributions, risk-reduced genuine uncertainty, and other laughable nonsense assumptions of the same ilk. Science fiction is not science.

For decades now, economics students have been complaining about the way economics is taught. Their complaints are justified. Force-feeding young and open-minded people with unverified and useless autistic mainstream theories and models cannot be the right way to develop a relevant and realist economic science.

Much work done in mainstream theoretical economics is devoid of any explanatory interest. And not only that. Seen from a strictly scientific point of view, it has no value at all. It is a waste of time. And as so many have been experiencing in modern times of austerity policies and market fundamentalism — a very harmful waste of time.

An alternative to mainstream orthodoxy that has been discussed much lately is so the called complexity economics and its agent-based modelling.

Agent-based models are formal models usually constructed using mathematical programming and performing simulations and ‘artificial experiments’ with the intention of being able to (more explicitly than in conventional mainstream game theory) describe aggregate effects and dynamics of interacting individuals and socio-economic structures without standardly having to assume equilibria, non-emergence, Walrasian auctioneers, representative agents, rational expectations, etc., etc..

Agent-based models come in different degrees of realism and are usually conceptualised as different kinds of self-organising complex systems. But one thing they all have in common is reliance on mathematical formalism. In essence the agent-based modelling endeavour in macroeconomics is an attempt at providing new alternative mathematical models where many of the bizarre and ridiculous known-to-be ‘unrealistic’ assumptions in standard DSGE models are replaced with other less ‘unrealistic’ assumptions. But the idea that mathematical modelling as such is always appropriate to apply is never seriously questioned. And that’s where I find it hard to follow. One set of mathematical tractability assumptions are substituted for another. But what if the mathematical modelling in itself is the problem? What if the use of mathematical-formalistic modelling in itself biases your research efforts in specific directions? If it is the mathematical-formalistic approach in itself that is the problem, we only end up with different models based on the same unquestioned mathematical modelling strategy. From my own critical realist perspective I can’t see that mathematical modelling is the self-evidently appropriate way to perform analyses of societies and economies. The kind of ‘closures’ demanded of the target systems for warranting the analyses, I would argue, simply often aren’t there.

As a critique of mainstream economics, yours truly fully appreciates the work done by the ‘complexity’ economists. But although their alternative agent-based models in many ways are superior to the more traditional mainstream ‘Walt Disney’ kind of models, I am not convinced that their unquestioned attachment to mathematical-formalist modelling is the right way to move forward in making economics a more realist and relevant science.

Top Economics Blogs

Mainstream economics has sadly made economics increasingly irrelevant to the understanding of the real world. Trying to contribute in making economics a more realist and relevant science, yours truly launched this blog in March 2011.

Now, ten years later and with millions of page views on it, yours truly is — together with people like e.g. Greg Mankiw and Paul Krugman — ranked on INOMICS’ The Top Economics Blogs list.

I am — of course — truly awed, honoured and delighted.

Neoclassical economics and the severity of the coronavirus crisis.

This training in economics makes politicians and bureaucrats incapable of understanding a crisis like this. They are, however, very susceptible to the advice of economists. They therefore enacted policies that reduced our capacity to cope with a pandemic, crafted systems of production and distribution that drastically amplified its damaging impact when it did arrive, and ridiculed warnings of people like Garrett as “alarmist” and “Malthusian”. For these reasons, Neoclassical economics itself bears a heavy responsibility for the severity of the coronavirus health and economic crisis.

Neoclassical economists will of course ridicule this claim. One thing I’ve learnt from fifty years of fighting these well-meaning but deluded bastards is that they’re great at taking credit when the economic system is doing well, but quick to deflect criticism by feigning impotence when a crisis actually arises. After it, they will merrily throw around their favourite explanation for why they couldn’t have seen the 2007 Great Financial Crisis coming, that it was caused by an “exogenous shock” …

This isn’t because Neoclassical economists are inherently liars or weasels by the way: it’s because they have a paradigm that they sincerely believe does describe capitalism accurately, and as a result they can’t comprehend that in fact it doesn’t. So whenever their paradigm fails, as it did in 2007, they look for reasons why it didn’t really fail—such as that the crisis couldn’t have been predicted, and that criticizing them for not anticipating it was like criticizing a mathematician for not predicting next week’s winning Lotto numbers …

Economists cannot avoid responsibility for the fact that production is heavily globalized, both via the promotion by economists of free trade over self-sufficiency, and by their support for the relocation of production from the West to the Third World. Consequently, a disease like this hit the whole world when it hit just one country—though it helped that the one country initially was China, to which much of the world’s production was outsourced.

In the aftermath to this crisis, we have to revoke the carte blanche that economists were given to reshape the economy in the image of their textbooks. It’s time to let real sciences manage humanity’s impact upon this planet.

Steve Keen

Hyman Minsky and the IS-LM obfuscation

As young research stipendiate in the U.S. yours truly had the great pleasure and privilege of having Hyman Minsky as a teacher. He was a great inspiration at the time. He still is.

The concepts which it is usual to ignore or deemphasize in interpreting Keynes — the cyclical perspective, the relations between investment and finance, and uncertainty, are the keys to an understanding of the full significance of his contribution …

The glib assumption made by Professor Hicks in his exposition of Keynes’s contribution that there is a simple, negatively sloped function, reflecting the productivity of increments to the stock of capital, that relates investment to the interest rate is a caricature of Keynes’s theory of investment … which relates the pace of investment not only to prospective yields but also to ongoing financial behavior …

The conclusion to our argument is that the missing step in the standard Keynesian theory was the explicit consideration of capitalist finance within a cyclical and speculative context. Once capitalist​ finance is introduced and the development of cash flows … during the various states of the economy is explicitly examined, then the full power of the revolutionary insights and the alternative frame of analysis that Keynes developed becomes evident …

The greatness of The General Theory was that Keynes visualized [the imperfections of the monetary-financial system] as systematic rather than accidental or perhaps incidental attributes of capitalism … Only a theory that was explicitly cyclical and overtly financial was capable of being useful …

If we are to believe Minsky — and I certainly think we should — then when people like Paul Krugman and other ‘New Keynesian’ critics of MMT and Post-Keynesian economics think of themselves as  defending “the whole enterprise of Keynes/Hicks macroeconomic theory,” they are simply wrong since there is no such thing as a Keynes-Hicks macroeconomic theory!

There is nothing in the post-General Theory writings of Keynes that suggests him considering Hicks’s IS-LM anywhere near a faithful rendering of his thoughts. In Keynes’s canonical statement of the essence of his theory in the 1937 QJE-article there is nothing to even suggest that Keynes would have thought the existence of a Keynes-Hicks-IS-LM-theory anything but pure nonsense. So, of course,​ there can’t be any “vindication for the whole enterprise of Keynes/Hicks macroeconomic theory” — simply because “Keynes/Hicks” never existed.

To be fair to Hicks, we  shouldn’t forget that he returned to his IS-LM analysis in an article in 1980 — in Journal of Post Keynesian Economics — and self-critically wrote:

The only way in which IS-LM analysis usefully survives — as anything more than a classroom gadget, to be superseded, later on, by something better — is in application to a particular kind of causal analysis, where the use of equilibrium methods, even a drastic use of equilibrium methods, is not inappropriate. I have deliberately interpreted the equilibrium concept, to be used in such analysis, in a very stringent manner (some would say a pedantic manner) not because I want to tell the applied economist, who uses such methods, that he is in fact committing himself to anything which must appear to him to be so ridiculous …

When one turns to questions of policy, looking toward the future instead of the past, the use of equilibrium methods is still more suspect … It may be hoped that, after the change in policy, the economy will somehow, at some time in the future, settle into what may be regarded, in the same sense, as a new equilibrium; but there must necessarily be a stage before that equilibrium is reached …

We now know that it is not enough to think of the rate of interest as the single link between the financial and industrial sectors of the economy; for that really implies that a borrower can borrow as much as he likes at the rate of interest charged, no attention being paid to the security offered. As soon as one attends to questions of security, and to the financial intermediation that arises out of them, it becomes apparent that the dichotomy between the two curves of the IS-LM diagram must not be pressed too hard.

In his 1937 paper Hicks actually elaborates four different models (where Hicks uses I to denote Total Income and Ix to denote Investment):

1) “Classical”: M = kI   Ix = C(i)   Ix = S(i,I)

2) Keynes’ “special” theory: M = L(i)   Ix = C(i)    I = S(I)

3) Keynes’ “general” theory: M = L(I, i)   Ix = C(i)   I = S(I)

4) The “generalized general” theory: M = L(I, i)   Ix =C(I, i)  Ix = S(I, i)

It is obvious from the way Krugman and other ‘New Keynesians’ — what a gross misnomer — draw their IS-LM curves that they are thinking in terms of model number 4 — and that is not even by Hicks considered a Keynes-model! It is basically a loanable funds model, that belongs in the neoclassical camp and which you find reproduced in most mainstream textbooks.

Hicksian IS-LM? Maybe. Keynes? No way!

What is missing in Keynes’ General Theory

The cyclical succession of system states is not always clearly presented in The General Theory. In fact there are two distinct views of the business cycle, one a moderate cycle which can perhaps be identified with a dampened accelerator-multiplier cycle and the second a vigorous ‘boom and bust’ cycle … The business cycle in chapter 18 does not exhibit booms or crises …

In chapter 12 and 22, in the rebuttal to Viner, and in remarks throughout The General Theory, a vigorous cycle, which does have booms and crises, is described. However, nowhere in The General Theory or in Keynes’s few post-General Theory articles explicating his new theory are the boom and the crisis adequately defined or explained. The financial developments during a boom that makes a crisis likely, if not inevitable, are hinted at but not thoroughly examined. This is the logical hole, the missing link, in The General Theory as it was left by Keynes in 1937 after his rebuttal to Viner … In order to appreciate the full potential of The General Theory as a guide to interpretation and understanding of moderrn capitalism, we must fill out what Keynes discussed in a fragmentary and casual manner.