Paul Krugman — finally — admits he was wrong!

23 Oct, 2019 at 14:49 | Posted in Economics | 51 Comments

Paul Krugman has never suffered fools gladly. The Nobel Prize-winning economist rose to international fame—and a coveted space on the New York Times op-ed page—by lacerating his intellectual opponents in the most withering way. In a series of books and articles beginning in the 1990s, Krugman branded just about everybody who questioned the rapid pace of globalization a fool who didn’t understand economics very well. “Silly” was a word Krugman used a lot to describe pundits who raised fears of economic competition from other nations, especially China. Don’t worry about it, he said: Free trade will have only minor impact on your prosperity.

economist-krugmanNow Krugman has come out and admitted, offhandedly, that his own understanding of economics has been seriously deficient as well. In a recent essay titled “What Economists (Including Me) Got Wrong About Globalization,” adapted from a forthcoming book on inequality, Krugman writes that he and other mainstream economists “missed a crucial part of the story” in failing to realize that globalization would lead to “hyperglobalization” and huge economic and social upheaval, particularly of the industrial middle class in America. And many of these working-class communities have been hit hard by Chinese competition, which economists made a “major mistake” in underestimating, Krugman says.

It was quite a “whoops” moment, considering all the ruined American communities and displaced millions of workers we’ve seen in the interim. And a newly humbled Krugman must consider an even more disturbing idea: Did he and other mainstream economists help put a protectionist populist, Donald Trump, in the White House with a lot of bad advice about free markets?

Michael Hirsh

Yours truly has for years been complaining about Krugman on this issue, so of course, it’s great that he finally admits he was wrong!

Another issue on which yours truly is having a beef with Krugman is his view that his hobbyhorse IS-LM interpretation of Keynes is fruitful and relevant for understanding monetary economies. Is it time for Krugman to come out on this also and admit he has been wrong?

My own view is that IS-LM is not fruitful and relevant and that it does not adequately reflect the width and depth of Keynes’s insights on the workings of monetary economies:

Almost nothing in the post-General Theory writings of Keynes suggests him considering Hicks’s IS-LM anywhere near a faithful rendering of his thought. In Keynes’s canonical statement of the essence of his theory — in the famous 1937 Quarterly Journal of Economics 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. John Hicks, the man who invented IS-LM in his 1937 Econometrica review of Keynes’ General Theory — “Mr. Keynes and the ‘Classics’. A Suggested Interpretation” — returned to it in an article in 1980 — “IS-LM: an explanation” — in Journal of Post Keynesian Economics. Self-critically he wrote that ”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.” What Hicks acknowledges in 1980 is basically that his original IS-LM model ignored significant parts of Keynes’ theory. IS-LM is inherently a temporary general equilibrium model. However — much of the discussions we have in macroeconomics is about timing and the speed of relative adjustments of quantities, commodity prices and wages — on which IS-LM doesn’t have much to say.

IS-LM forces to a large extent the analysis into a static comparative equilibrium setting that doesn’t in any substantial way reflect the processual nature of what takes place in historical time. To me, Keynes’s analysis is in fact inherently dynamic — at least in the sense that it was based on real historical time and not the logical-ergodic-non-entropic time concept used in most neoclassical model building. And as Niels Bohr used to say — thinking is not the same as just being logical …

IS-LM reduces interaction between real and nominal entities to a rather constrained interest mechanism which is far too simplistic for analyzing complex financialised modern market economies.

IS-LM gives no place for real money, but rather trivializes the role that money and finance play in modern market economies. As Hicks, commenting on his IS-LM construct, had it in 1980 — “one did not have to bother about the market for loanable funds.” From the perspective of modern monetary theory, it’s obvious that IS-LM to a large extent ignores the fact that money in modern market economies is created in the process of financing — and not as IS-LM depicts it, something that central banks determine.

IS-LM is typically set in a current values numéraire framework that definitely downgrades the importance of expectations and uncertainty — and a fortiori gives too large a role for interests as ruling the roost when it comes to investments and liquidity preferences. In this regard, it is actually as bad as all the modern microfounded Neo-Walrasian-New-Keynesian models where Keynesian genuine uncertainty and expectations aren’t really modelled. Especially the two-dimensionality of Keynesian uncertainty — both a question of probability and “confidence” — has been impossible to incorporate into this framework, which basically presupposes people following the dictates of expected utility theory (high probability may mean nothing if the agent has low “confidence” in it). Reducing uncertainty to risk — implicit in most analyses building on IS-LM models — is nothing but hand waving. According to Keynes we live in a world permeated by unmeasurable uncertainty — not quantifiable stochastic risk — which often forces us to make decisions based on anything but “rational expectations.” Keynes rather thinks that we base our expectations on the “confidence” or “weight” we put on different events and alternatives. To Keynes, expectations are a question of weighing probabilities by “degrees of belief,” beliefs that often have preciously little to do with the kind of stochastic probabilistic calculations made by the rational agents as modelled by “modern” social sciences. And often we “simply do not know.”

6  IS-LM not only ignores genuine uncertainty, but also the essentially complex and cyclical character of economies and investment activities, speculation, endogenous money, labour market conditions, and the importance of income distribution. And as Axel Leijonhufvud so eloquently notes on IS-LM economics — “one doesn’t find many inklings of the adaptive dynamics behind the explicit statics.” Most of the insights on dynamic coordination problems that made Keynes write General Theory are lost in the translation into the IS-LM framework.

The IS-LM approach is not fruitful or relevant for understanding modern monetary economies. And it does not capture Keynes’ approach to the economy other than in name. If macroeconomic models — no matter of what ilk — make assumptions, and we know that real people and markets cannot be expected to obey these assumptions, the warrants for supposing that conclusions or hypotheses of causally relevant mechanisms or regularities can be bridged, are obviously non-justifiable. A gadget is just a gadget — and brilliantly silly simple models — IS-LM included — do not help us working with the fundamental issues of modern economies any more than brilliantly silly complicated models — calibrated DSGE and RBC models included.

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  1. See also Alan Duh’s 2008 paper “From Galbraith to Krugman and Back: Galbraith, Krugman and ‘Good Economics’” for Krugman’s more general slow-motion Road to Damascus.
    http://www.uq.edu.au/economics/abstract/369.pdf

    • I remember very well how dismissive Krugman was of economists who refused to tow the neo-classical line and were sceptical of the value of models in economics. Angus Maddison had warned in 1988 that the benefits of advocating deeper cuts in the regulation of trade and capital flows was becoming ‘axiomatic’, and he was by no means the earliest. Krugman crowed that Galbraith was not a serious economist and not considered as such among the economics profession, of which he (Krugman) was gladly proud to be a member. Had Krugman been more historically literate and had engaged within the economic history community (at least outside the US) he would have been aware of the effects of China on world trade patterns and the patterns of production at least by the early 2000s. (Particularly good on this subject were the Japanese.) I noticed how Krugman could not see the elephant in the room at this time on his blog – if I had time I would dig up some of his remarks.

      Having said all that, although people were discussing the ‘China shock’ by the early 2000s, they had also in some respects moved on from this. Deindustrialisation in the North in fact started before China, as did inequality and the weakening of industrial labour. The tautologous debate that separates globalisation and automation – in heterodox literature a highly linked process, is also another consequence of the neo-classical profession’s atomistic fallacies and a-historicism.

  2. Lars,
    .
    “……much of the discussions we have in macroeconomics is about timing and the speed of relative adjustments of quantities, commodity prices and wages….”
    .
    So how can these be dealt with in a theoretical sense and in a policy (practical) sense?

    • My answer: traders bet on relative adjustments of quantities, commodity prices and wages through derivative indexes. And traders in my experience on twitter at least know that all of these are psychological, not something policy can address except as providing an insurance policy against sudden psychological panics. Fed policy provides traders in financial markets with insurance, but sometimes they act too late and recessions follow the financial panic.
      .
      The implication for policy is not to try to manage quantities or prices but to supply money as needed as insurance against sudden price spikes. Quantities are throttled due to money demand, so let central banks supply money to individuals so businesses get reserves from customers not financial markets …

  3. Why am I having a Greenspan in a Congressional hearing flash back.

  4. “This is all the more bizarre because the young Krugman came to prominence demonstrating that [national] competitive advantage could be created, something that any non-economist student of economic history could have told him.”

    This is very true, and it highlights the enormous costs of excessive formalism. Once the algebra is removed, the banality and vacuity of economics is exposed. As a result advisers to policy makers are created who are poorly equipped to understand and deal with the complexity of the world’s problems.

    Krugman played a major role in destroying what was once a far more holistic and pluralistic discipline. The social and political costs are clear for all to see.

  5. […] Paul Krugman — finally — admits he was wrong! Lars P. Syll (UserFriendly) […]

  6. ‘Academic’ economists are in a filter bubble – or maybe they just know who butters their bread. Economic History was dropped from the curriculum decades ago.

  7. I would not hold my breath waiting for Krugman to actually fall off his donkey, let alone embrace a revelation. He will always argue that, “if” he was wrong, he was wrong for the right reasons, tripped up merely by the weight given to this or that consideration, and therefore he is justified in repeating the same faulty process of reasoning from abstract insight uninformed by fact.
    .
    Years ago, Krugman wrote a brief essay still available online, titled “Serf’s Up” in which he endorsed a potted summary of the ideas of Evsey Domar concerning the economic “origins” of feudal serfdom. Everything that goes wrong with Krugman’s style of thinking from abstract “insight” was on display, including the refusal to acknowledge historic fact.
    .
    There are no present-day controversies at stake in musing on the nature of feudalism as a set of economic institutions and how and why the shock of the Black Death may have undermined them. So, we get to see Krugman’s intellectual process on display in a pure form without the distraction of taking sides in politics. And the Krugman on display is an idiot. There is no nice way of saying it. Arrogant as always but completely unable to reason thru interpretation of fact.
    .
    Krugman’s latches on to a pseudo supply-and-demand framework of the relative scarcity of land and labor almost instantly, and never notices how without political context it must be. He denies the relevance of historic fact: feudal serfdom, manorial agriculture, and feudal land-holding came into being in a process somewhat obscure but in some respects sudden during the High Middle Ages and ended piecemeal in a prolonged legal and political evolution, in which the Black Death does indeed appear as punctuation.
    .
    The reality of economic institutions was complex and historical and contextual and Krugman hates it. He cannot and will not deal with it as it was. He retreats into completely counterfactual imagination.

    Imagine a pre-industrial society where population is pressing on limited land supplies, and the marginal product of labor – and hence the real wage rate under competitive conditions – is barely at subsistence. In that case, why bother establishing property rights in human beings? It costs no more to hire a free worker than to feed an indentured laborer. Indeed, by 1300 – with Europe very much a Malthusian society – serfdom had withered away from lack of interest.

    “the real wage rate under competitive conditions”!!! This man really is an idiot. (I don’t know Paul, but what with the castles and all I might have guessed that extraction of a surplus by and for violence from an otherwise self-sufficient and largely autarkic community might have something to do with it.)

    • Thanks Bruce. Great comment 🙂

  8. Bruce,
    .
    I believe your account of Krugman’s of the demise of serfdom is exaggerated as is Lars generalized account of Krugman’s economics.
    .
    Where does Krugman deny the relevance of historic fact? In fact, a reading of his article in reference is to the contrary.
    .
    In any event, it is the economist’s job to seek out explanations from the perspective of an economist. This does not mean he eschews historical and socialogical explanations. His focus is on economic factors. These are not the truth but part of the whole truth, which embraces cultural, socialogical even religious factors, and probably a multitude of other factors.
    .
    Inevitably abstraction is required. It is the beginning of understanding, not the finality.
    .
    I think both you and Lars, carping on about deemed inappropriate abstraction, risk throwing out the baby with the bathwater.

    • Henry, the baby is not neo-classical theory, including Krugman’s geometric gadgets.

      The baby is the facts.

      The facts are to be found in primary and secondary, quantitative and unquantifiable, documentation.

      “Inevitably abstraction is required. It is the beginning of understanding, not the finality.”

      Absolutely not. And especially not in the early stages of understanding.

      Understanding has to be built up, piece by piece as you put the jigsaw together. You have to face complexity head on. Models and theories are likely to lead you in the wrong direction. They might seem to be correct at first, but that is even more dangerous.

      I learned this the hard way when I was doing a PHD. I found economic theory was a major handicap to understanding how a certain country I was investigating found its way into and out of the Great Depression. I had to learn a difficult foreign language to make headway. And another thing I had to do, which was more difficult than you can imagine, was to put everything I learned in economics away, because it was precisely what was not in neo-classical models which is what I needed to know, These models were a major barrier. They simply led me down the wrong path and got me into even more confusion.

      If there is a place for theory, it is as a reference point on which you compare your findings AFTER you have done your ground up investigation.

    • Oh Henry! Economics should be more than your bundle of excuses for ignorance of history, sociology, analytic and empiric methods and just plain reality. I do not object to the “perspective of an economist” — it is my perspective after all. I object to sloppy or deceptive thinking and misreporting.
      .
      I thought my direct quotation of Krugman was itself sufficiently ridiculous on its face, but apparently I have to explain. Since you refuse to see the ridiculousness, my attempt to “explain the joke” is likely to prove futile, but I will try.
      .
      First, let’s be clear that I was earlier ridiculing criticizing Krugman and not necessarily implicating Domar. But, let’s consider the actual Domar for a bit. Domar in his famous 1970 essay and later was engaged in a kind of induction, bootstrapping an analytic model out of the examples of Polish-Lithuanian and Russian imperial expansion into the Ukrainian grasslands, where serfdom was deliberately adopted by the central state or Crown as part of land distribution, settlement and defense policies and using it as a kind of “hypothesis”, that he “tested” informally by trying out just-so stories derived from his analytic model as accounts of serfdom or slavery in both these and other historical contexts.
      .
      There are serious problems with Domar’s model of serfdom, as a theoretical analysis, as well as his use of just-so stories as an empirical method. Some of those problems are typical of the bad practices endemic to mainstream economics: he makes convenience assumptions to simplify calculation (tractability is everywhere the enemy of truth, my friend!): a production function with two factors and constant returns to scale among others. Forgivable in an initial sketch, one might suppose, but it makes Domar’s analytic model into a rigid tautology. In Domar’s case, he needs large-scale agriculture as a feature of the situation (because historically it was), but he has assumed constant returns to scale so he cannot generate large-scale endogenously within his model; he has to insert it by arbitrary assumption. Using a production function similarly makes the problem one of resource allocation, when in historical fact, the administration of violence, internally and externally, was a critical factor in how and why institutions were structured as they were. Domar knows this was the case in Eastern Europe and takes some notice of the military’s needs with hand-waving in his just-so stories. One of the standard criticisms of Domar by historians centers on the institutionalization of and by violence. Whether the efficient administration of the estate’s agricultural operations mattered is pretty much ignored, as it has to be in any model that incorporates a production function in place of a model of production. I will tell you that historians of slavery in the American South think the ability under slavery to organize gang-labor to undertake land development and work in dangerous or unhealthy circumstances was a major advantage of slavery over free, wage labor; an advantage that you cannot “see” with the model Krugman is using because it has been assumed away by inserting a production function that recognizes only factor allocation.
      .
      Ultimately the assumption of a production function is the tautological source of the assertion that the relative scarcity of land and labor is the controlling factor driving the survival of the institution of serfdom; he’s assumed what he claims to have proven — economists do this all the time in their models, but it does not make it right. But, a production function is not a logically complete model of production and there’s no standard for determining how scarce land and labor need to be relative to one another — relative scarcity just hangs in the air with no foundation. And, no obvious way to recognize other logically possible causative factors embedded in the actual organization of production, which involves technology and command-and-control management in addition to the mere allocation of (priced) factors.
      .
      When Domar turns to serfdom in Western Europe, he is handicapped by the absence from the historic record of the kind of clear and discrete enactments of deliberate policy instituting serfdom, manorial agriculture or feudal land ownership. The paucity of records makes the evolution of the situation ambiguous: custom rules, but how long has a particular custom ruled? It is tempting to suppose that the collapse of the Late Roman Empire left a legacy with effect five hundred years later, but that’s likely to be fanciful in its details. Serfdom in Russian Ukraine is punctuated with Imperial decrees at both ends. Not so much, England or Scotland or France or Germany. Domar claims that serfdom has already “started” to decline in Western Europe in the High Middle Ages, but it is hard to say what this means exactly. Is it the claim that some aspects of the custom fell out of fashion? Or, that the legal theory of feudal land tenancy and mutual obligation evolved? And, truthfully, the end of serfdom is often similarly obscure. Wat Tyler is still protesting serfdom as well as the The Statute of Labourers in 1381 so the claim that it was gone before 1300 must be somewhat exaggerated. The French Revolution freed an estimated million serfs, almost half in the ill-named Franche-Comté.
      .
      We know that agricultural productivity rises significantly from around the 10th century in northwest Europe, with better ploughs and the introduction of the three-field system into manorial agriculture; this is what generates the agricultural surplus that feeds the growth of trade and military adventuring of the High Middle Ages. Charlemagne had no fixed capital city in large part because no region of his empire could feed his court for an indefinite term. Not Paris, not Aachen, not Regensburg. 300 years later Frankish knights were embarking on the 1st Crusade like tourists on a lark, confident they could manage the logistics and finance of long-distance travel without losing their property or position at home. We know that feudalism changes character and spreads thru Western Europe and the Mediterranean with relative suddenness with the motte and bailey castle. This “technology” is what gives William the Conqueror’s conquest its finality. And, yes, let’s notice the violent domination of England for 300 years by a French-speaking elite, who owned the manors of manorial agriculture within which serfs may or may not have held tenancies, before we speak counterfactually and ahistorically, as Krugman does, of “the real wage rate under competitive conditions”. (How many people does Krugman imagine earned their living primarily as a money wage in England in 1300? And, does he imagine the Lord of the Manor was accustomed to “hiring” people to grind his grain or forage his sheep? to fix his bridges and roads? Not to mention from where the kings, nobles and knights draw their arms and armies.)
      .
      Manorial agriculture, like plantation agriculture, was founded in autarky: the peasants on the manor were mostly self-sufficient in their subsistence, while the lords and gentry were extracting a surplus to feed their servants, men-at-arms and taste for the finer things. Long-distance trade and international finance was just a thin skim for a tiny elite of monarchs, landed nobles, bishops and monks, and bankers and merchants holed up in walled cities. The “economy” of medieval knights centered on violence and pillage and the anarchy of the 11th, 12th, 13th and 14th centuries declined only gradually and uncertainly, when it declined at all. The Rhine had its robber barons. Edward III had to contend with gangs of minor lords and gentry marauding across the Midlands, whom he “pacified” mostly by giving them wars to fight in Scotland and France. The Hundred Years War was a recurring series of fights for dominance and loot among French and English (nee Norman) nobles and gentry.
      .
      Krugman’s essay begins with the Black Death, often taken by historians as a trigger for the decline of the feudal order and the emergence of modern institutions, a process that continued into the 17th and 18th centuries at least. Krugman’s interpretation on the basis of the analytic model taken from Domar is colored by Domar’s tractability assumptions, such as constant returns to scale and a purely allocative production function, compounded I think it would be fair to surmise, by Krugman’s habitual imposition of analytic stasis on institutional dynamics that have no stable long-term equilibrium. When do you think he imagines the money-wage “free labor” economy emerges in historical time?
      .
      Agriculture — particularly the manorial agriculture of the 14th century — does not demonstrate constant returns to scale, in part because there are significant congestion and depletion effects as labor is added by population growth. The marginal product of labor is depressed by the declining total productivity of the system, as marginally arable land is brought into production, soil fertility declines with depletion, the health of laborers declines with restricted nutrition. Reversing these effects, the Black Death triggered very steep increases in agricultural productivity; the marginal productivity of agricultural labor rose significantly as did the agricultural surplus available to feed urbanized trade, artisan production, warfare, piracy and “civilization”. That rapid and sudden increase in both the marginal product of labor in agriculture and in the agricultural surplus available for trade is the shock the Black Death administers to the stagnation of medieval feudalism nearing its Malthusian limits, a shock that appears to have accelerated into the rise of civilization into the Renaissance of the quattrocento and more prosaically, the expansion of trade and the money economy (not incidentally driven by mercenary “bastard feudalism”), cash agriculture, undermining the autarky of the manor.
      .
      The most serious fault in Krugman’s treatment, imho, is one of omission: it is the way his analysis elides the role of violence in structuring the institutional order. If the “perspective of the economist” is to pretend that it is all peaceful (albeit purely metaphoric) markets all the time leading to self-organizing emergence of optimal equilibrium institutions, then the perspective of the economist is worthless fantasy. Domar, because he starts from an example of serfdom imposed as a matter of state policy and in part as a remedy for violent political competition, is more aware and cannot be accused of omitting violence entirely from his treatment nor of being unaware of the importance of deliberate intent in creating and shaping institutions.
      .
      I apologize for the absurd length of this comment as well as the arrogance to imagine it might influence anyone.

      • Bruce,

        Interesting potted history of feudalism. Unfortunately it is irrelevant to the discussion about Krugman. We are not talking about the history of feudalism per se, we are talking about a possible abstract explanation from an economic perspective.
        .
        It seems to me you protesteth too much.
        .
        ” Economics should be more than your bundle of excuses for ignorance of history, sociology, analytic and empiric methods and just plain reality.”
        .
        Economics is about economics, sociology is about sociology, psychology is about psychology, etc., etc.. Of course all of these fields of study intersect and impinge on one and other. Would you expect a psychologist to focus solely on economic factors if he/she was endeavouring to explain human behaviour. I’ve studied psychology. I studied many things. Some people study psychology but the behaviour of rats in mazes. Should we apply that to the study of feudalism? Should Krugman have applied psychological thinking in his brief encounter with feudalism? No. He is an economist with an economist’s perspective.

        “I thought my direct quotation of Krugman was itself sufficiently ridiculous on its face, but apparently I have to explain.”
        .
        When completely decontextualized, as you had it, it appears questionable – the way it was decontextualized was unfair, I believe.
        .
        Your comments about the production function were interesting. However, the production function again is an abstraction. It is a beginning place for understanding how production is organized and its outcomes. I can’t see the problem.
        .
        Instead, I think the problem is that people who criticize one model or the other fail to explain how they would go about building an understanding of a problem in question.
        .
        I think it is time that the complainants put up.

        • Why does not Krugman have to “put up”?
          .
          His model of feudal manorial agriculture is one where the lord of the manor paid worker-serfs. That is not how manors worked. The serfs were tenants who owed service to the lord and thru the lord to the community to produce public goods for the community as a whole and had to use manor facilities (the lord’s mill possibly) and had some use of the manorial commons. Both farmer-serfs and farmer-lord received portions of the residual. No one was paid a marginal-product wage.
          .
          The legal tie of the serf to the manor did not come under pressure by overpopulation historically in the 14th century, because as famine loomed in the 14th century there was no where for a serf to go. Only when both marginal product and surplus rose, with the black death, were there alternative opportunities blocked by the legal status of the serf and his property rights in his tie to the manor. (Yes, the serf had property rights!)
          .
          It was actually the minor gentry — lords of the manor rather than serfs — who conspicuously shirked their roles in the social and political hierarchy, forming criminal gangs engaged in banditry against the king’s peace (and its wealthy representatives embedded in the tiny money economy) in the years before the black death. In England at least.

          • Bruce,
            .
            “Why does not Krugman have to “put up”?”
            .
            He does doesn’t he? He is constantly explaining his position on the methodology of economic thinking.
            .
            Whereas his critics on this blog rarely if ever offer anything definitive in return.
            .
            I have no interest in defending Krugman and I have no interest in defending his model of serfdom but I believe the people who criticize his way of thinking constantly have eventually to explain, in some detail, how they believe economic problems should be approached. They should also explain, in detail, how they believe economic theory should be taught to freshman.

            • Henry there was a time before scientism and economics became synonymous where the endeavor was not a rote study based on ideological underpinnings. It was a multidisciplinary undertaking by those that sought a deeper understanding of the human condition and how to avoid past failures.

              .

              E.g. what is economics today compared to its roots in sociopolitical theory.

      • “the perspective of the economist is worthless fantasy”
        .
        Economists should be given about the same weight as psychics when making public policy …

  9. Nankore,
    .
    I do believe you are picking at nits.
    .
    I essentially agree with a good deal of which you say and if you read my comment carefully you will see that I do.
    .
    I will disagree with you on what the “baby” might be in this case.
    .
    There has to be some foundation on which to begin to build an understanding of economic behaviour. That foundation has to be abstraction. The world is too complex for it to be otherwise. It is only a foundation on top of which can be built complex structures involving more complex economic considerations, involving other disciplines.
    .
    Lars, Bruce and now yourself seem to me to be fixated on the notion that model making is a waste of time. Economists do seem to devote a good deal of time on this. And I agree, the result is much less than satisfactory. However, it is a necessary evil.
    .
    I can’t imagine ever understanding microeconomics without the standard perfect competition general equilibrium model, with all its unreal assumptions, as a foundation.
    .
    Throw that approach out and you are as if in a storm tossed sea without compass and with a cloudful sky.
    .
    BTW, there are models other than neoclassical ones. Are they to be jettisoned also?

    • BTW, there are models other than neoclassical ones. Are they to be jettisoned also?

      No, in fact they are more likely to be helpful. But I maintain my position that you build up arguments from facts. We understand the processes of causation of what led to WWII by doing this. We do not start with an international relations theory of conflict that multipolar systems are unstable – even if that actually provides part of the answer. Economics is no different. If you start with a theory and let that be your compass, you could miss the forest for the trees and even get seriously led down the same track.

      The same with ISLM/representative agent models and Krugman’s explanation of Japan’s zero interest rates. It is more useful to start investigating Japan than an ISLM or sticky price rational expectations optimisation model. Of course a lot of this work would have been done for you – and you should use, not ignore it just because it is done outside a neo-classical economics department. So you need to engage with Japanese historians and others, or speak to people who have the necessary language skills to access that information.

      Neo – classical theory is often not a useful foundation. And often in order to force reality into this view of the world you add a lot of artificial, contradictory and confusing clutter. Reality is complex enough without adding this! Neo-classical theory tells us about micro-economics, which is essentially a neo-classical creation. But is this really the way to go about understanding capitalism, a social construction?

      What is missing is a proper ontological and epistemological account of why neo-classical theory needs to be the foundation of all economic analysis. A proper investigation into this will probably find that its explanation of capitalism is linked to hegemonic power regimes. It is absolutely no coincidence that it arose in England during its imperial era, and was taken up by the US after 1945.

      • Nanikore,
        .
        Again, I have to say we are in agreement about most things.
        .
        “No, in fact they are more likely to be helpful.”
        .
        So you’re not actually railing against economic models in general just neoclassical ones? Why is it that abstract non-neoclassical models are OK and neo-classical models are not OK? Abstraction is abstraction.
        .
        It seems to me you about constructing strawmen so you can pull them down.
        .
        As I say, I agree with a lot of what you say, however, it’s not exactly what we are discussing.
        .
        As far as I am concerned, models have a use, pedagogically and as foundation for complex problem solving.
        .

        • “As far as I am concerned, models have a use, pedagogically and as foundation for complex problem solving.”
          .
          I don’t know any other social science that works this way. Interestingly a lot of game theory and econometrics (eg Dickey Fuller Tests) actually came out of or were first used in agricultural, geography and other social science departments. But interestingly they were first to abandon them. By the 60s they had gone. Game theory was also used in political science (eg to explain the Cold War) but its limitations were recognised and it has largely kept on the fringe and (very rightly) in technical appendixes.

          Around the 1960s the limitations of formalism were recognised. Habermas’ book I would imagine was important here.

          Nevertheless there is a debate here about the usefulness of formalism of social sciences. That debate should not be ignored by economists.

          When you say economics is economics, you are not saying economics is about the economy. Economics is in fact defined by a methodology. Moreover, economics is unusual in that it is defined by a singular methodology built around the notion that societies consist of individuals with unlimited wants but with limited resources. Ie people are greedy. But why isn’t this psychology and sociology? It would be seen as very bad sociology and psychology. And it should be seen as very bad economics.

          In teaching I have said on earlier posts that economics should look more like political science and international relations, at least as it is taught in the UK. (Or more like capitalism has been taught in continental Europe before hegemonic power reasons it had to submit to dictums from the Superpower and MIT.) The German and Japanese economies are highly successful examples of late industrialisers. The intellectual foundations behind their development (eg Frederick List) have nothing to do with, and were largely uninformed by Marshall or Samuelson.

          In IR courses in the UK, students take one course out of four in theory. The rest are historical or geographical etc in nature (eg Middle East or East Asian politics). In the theory course Marxian (including Post Modernist etc) , Liberal and Realpolitik theories are all considered. Students are taught critical reasoning skills. When you go to their books and journals you do not see a whole lot of model and ‘as if’ assumptions. Analysis is built from the ground up (or it starts where others left off).

          Economics courses are basically courses in applied mathematics. I am not sure this is the right way to understanding capitalism, a social system. And it most certainly not be considered the only way.

          “On what basis do you choose which facts are relevant?”

          Of course this is the great Post Modernist question. How can the object be separated from the subject?

          But who said that neo-classical theory is the right, and only right starting point? That is also totally arbitrary.

          Interestingly the military historian Max Hastings argues there is always a need for fresh books and investigations on old subjects. Sometimes their conclusions will repeat what has already been known, but the exercise is nevertheless still important.

          People will have different starting points, and they will not always have the same conclusions. But that is how we are really going to get somewhere. Insisting that everyone starts and ends with Model (aka Neoclassical theory), which we even know to be false, is going to greatly inhibit the scope of knowledge. And the results in economics speak for themselves – right through to policy. What have we really learned about capitalism from (neo-classical) economic theory?

          Even those innovative unconventional monetary policies that started in Japan – do you think they were thought up by neo-classical economists?

          • Sorry about the syntax, spelling and other errors above, hopefully it is sort of understandable!

    • I have written an absurdly long comment above and won’t repeat myself here. But, I do want to say that I do not think analytic model building is a waste of time. I think it absolutely necessary to building or discovering knowledge. (And, I have often scolded Professor Syll for his too broad hostility to “axiomatic deductive methods” as “unrealistic” — criticisms in which I do not concur, on epistemological grounds.)
      .
      I think Professor Krugman — and mainstream neoclassical economics as a discipline generally — make some grave and characteristic methodological errors in how they do analysis and how they apply it to interpreting the world. Krugman in particular is guilty of applying analytic models without the necessary intermediation of operational models, substituting hand-waving and arrogance about his “insight” for careful consideration and measurement of facts. Krugman is also guilty of imposing an assumption of market equilibrium on a world that never evidences long-run stasis.
      .
      The use of a production function as an implicit theory of production is indefensible. Output is not a function of input. Sorry, it is not. And, to assume that it is defies logic. This stubborn insistence that efficiency is adequately characterized by allocative efficiency alone and that capital accumulates and uncertainty, management and thermodynamics do not matter has attracted devastating critiques but economists like Krugman and Stiglitz hide behind walls of hand-waving and ad hoc nonsense. (And, among economists, they are accounted the relatively reasonable and realistic!)
      .
      Faulty analysis is what I attack — that and the arrogant insistence that sense-less hand-waving at stylized factoids is rigorous.

  10. Nanikore,
    .
    ” But I maintain my position that you build up arguments from facts.”
    .
    On what basis do you choose which facts are relevant?
    .
    For instance is the fact that Pluto was transiting Capricorn in the mid 1200s at the height of feudalism a relevant fact? If not why not?

    • Nanikore,
      .
      Perhaps I can it more relevant to you by saying that Pluto was transiting Pisces at the time of the 1929 Crash. Again, was this a relevant fact, if not why not?

      • Some economic historians have identified climatic influences as being a contributor to the dark ages. Who knows perhaps that has something to do with planetary movement.

        You have to think big. Which means thinking outside the Edgeworth Box.

        • Nanikore,
          .
          “But who said that neo-classical theory is the right, and only right starting point?”
          .
          Not I.
          .
          We are not talking about neoclassical models, we are talking about any kind of model and abstraction, so I thought.
          .
          However, it seems you are happy to use non neoclassical models and abstraction which essentially founders all your arguments.
          .

          • Henry, to establish causation you have to identify why and how things happen. That can’t come from abstraction. If we are talking liquidity traps that means for example looking at banks balance sheets, central bank balance sheets, going through archives, going through the annual reports of corporations and banks, finding out how these institutions worked and why and when there were changes in bank behaviour (if there was). This provides your documented evidence. You would need to understand something about Japan’s organ banking *kikan ginko) system. Now, you can’t do this all on your own, but people have already done a lot of it. If you do not speak Japanese you need to go through people like Hugh Patrick who can. They can also explain Japan’s High Speed Growth Era System, which is critical background knowledge (this by the way is not a system that worked through the neo-classical price mechanism – interest rates for example were set at 5 per cent and unchanged for over two decades).

            So you have established the causal mechanisms, step by step, through the facts.

            No abstraction. No models.

            Now, once you have done that you may say that a certain type of theory may explain Japan’s experience the best. And people do. Many people say that Marxian or Schumpeterian theories offer the best explanation (eg Ishii Kanji and Ryouichi Miwa). That does not mean they are socialist revolutionaries. Quite to the contrary actually and for example they are great exponents of the contributions the Gold Standard enabled for Japan’s economic development.

            But the point is by working this way you have not let Model dictate your analysis, and your analysis does not consist of meaningless or tautological abstraction.

            • Now, once you have done that you may say that a certain type of theory may explain Japan’s experience the best.

              Sorry that is confusing. You have already done the explaining in your analysis. A better way of saying this is that after you have done this a certain theory ‘conforms’ to that explanation the best.

        • Nanikore,
          .
          Sorry I screwed up posting my comments.
          .
          Anyway you haven’t really answered the question:
          .
          On what basis do you choose which facts are relevant?
          .
          This is a specific question directed to you and how you go about, say, assembling your “facts” for your Phd dissertation.

          • Well I have to admit that my PHD was not done the most efficient way. (It was a learning experience in many ways.) I was working under a top econometrician and I had a lot of historical data. I went to theory to try and find explanations for my findings but increasingly saw that this was not satisfactory. I knew I had to really understand something about the country I was investigating. That required that I became proficient enough in the language to access the knowledge I needed. Although an econometrician, I was very fortunate to work under someone who let me do what was largely an economic- history thesis.

            The better way of doing this would have been to know something about the country first – then go off and find the data and do the fieldwork.

  11. Lars,
    .
    You said:
    .
    ” Almost nothing in the post-General Theory writings of Keynes suggests him considering Hicks’s IS-LM anywhere near a faithful rendering of his thought.”
    .
    You have said such things before, in particular back in March.
    .
    To which I responded with the following:
    .
    ” We are all aware of the famous letter of Keynes to Hicks, regarding Hicks 1937 paper, in which Keynes writes “I found it very interesting and really have next to nothing to say by way of criticism”.
    .
    Keynes also wrote in the letter, “At one time I tried the equations, as you have done, with I in all of them. The objection to this is that it overemphasizes current income. In the case of the inducement to invest, expected income for the period of the investment is the relevant variable.”
    .
    He seems to have rejected the approach because he could not feed expectations into the equations. Although, in the GT (p.141 to 146) Keynes talks about how changes in expectations shifts the MEC (and hence the IS curve).
    .
    Dimand has noted that Keynes first presented a simultaneous equations approach in his Middlemas lectures at Cambridge in 1933 and also in a 1934 draft of the GT.
    .
    So it might seem that Lars’ claim “there is nothing to even suggest that Keynes would have thought the existence of a Keynes-Hicks-IS-LM-theory anything but pure nonsense” is a little too strong.
    .
    The plot is thicker than it might at first seem.”

    Personally, I think you should substantially weaken your claim about Keynes not having considered the IS/LM approach – it is obviously erroneous.

  12. Skippy,
    .
    “….what is economics today compared to its roots in sociopolitical theory.”
    .
    That’s a fair point, however, I would say there’s always been some level of abstraction, Ricardo’s demand curve for instance. Of course, today things have gone to the other extreme and abstraction and reality have parted company.
    .
    However, I would argue abstraction still serves a purpose and as I keep saying, it’s a beginning, not a finality.
    .
    I don’t see the point of throwing the baby out with the bathwater.
    .
    Economic thinking needs every assistance it can get, keeping abstraction and keeping in touch with reality.

    .

  13. Nanikore,
    .
    “So you have established the causal mechanisms, step by step, through the facts.
    No abstraction. No models.”
    .
    I’m sorry, I don’t quite believe you – I am not saying you are lying – I am saying you can’t see the forest for the trees.
    .
    You mention liquidity trap for instance – you are already applying a Keynesian concept, a key component of the Keynesian model.
    .
    I argue that the facts you select are filtered thru preconceived models – you are putting the cart before the horse in a very subtle way, yet say you don’t.
    .
    Why didn’t you consider Pluto’s Piscean transit, for instance – because it does not conform to the Keynesian model or any standard economic model for that matter (that I know of!).
    .
    So I am very skeptical about your claim of “No abstraction. No models.”

    • Sorry Henry these comments are getting mixed up. Yes liquidity trap is Keynesian terminology. As I said you will find things in your historical investigation that confirm some theory (but you must not let that frame it or dictate it). Post Keynesian theory in particular holds up well in many cases. But if you start with theory, most likely you will confirm that theory and miss the forest for the trees and the elephant in the room. Krugman called the situation of low interest rates in Japan a liquidity trap. I would suggest to you that the causes of post crash situation including low interest rates and miniimal demand effects from macro policy in Japan have much deeper causes than those contained in the ISLM model. It has been a long time since I have done this stuff, but the explanations are to be found in people like Yutaka Kosai and Juro Hashimoto. Japan’s system (including its monetary policy) essentially ran through credit allocation mechanisms. The interest rate does not play the same role in allocating resources as the US or the ISLM model (if it applies anywhere). Kosai identifies the problems arising from when this system was deregulated in the context of when high growth naturally tapered off after a cycle set off by huge capital investment following WWII devastation.

      • “Japan’s system (including its monetary policy) essentially ran through credit allocation mechanisms.”

        That is liquidity is provided through direct credit allocation mechanisms (ie credit rationing by the Bank of Japan or via funding for targeted capital projects). So you have to understand what the interest rate (call rate or ODR of the Bank of Japan) actually means and what role it actually plays given that it is largely not the primary credit allocation mechanism – not withstanding there were major changes following deregulation.

        So in Krugman’s case when he was looking at the causes of zero interest rates in Japan and answering your question about “how do you start going about assembling the facts”, the answer is the very first step is to go to the Japanese language literature with the help of a Japanologist familiar with it to understand how monetary policy worked pre and post deregulation and what the function of the interest rate has been.

        For myself an historical approach is the best way to understand why and how things happen.

        But if you go to a theory for your answer, ISLM or anything else chances are it will not give you the right answer or the real reasons because it is not informed by historical fact. If it does, it is purely coincidental.

        • Nanikore,
          .
          Thanks for the detailed explanation.
          .
          I am not saying ignore reality – where I have I said that?
          .
          The basic version of IS/LM assumes an exogenous money supply – in a sense the kind of supply system you have described for Japan. The model won’t tell you how Japanese money supply is run but it can tell you want happens as money supply is changed and its impact on interest rates and investment are – as long as you know the parameters of the various functions – big if, of course.
          .
          Knowing the Japanese institutional (supply) arrangements won’t tell who is going to step up and take the money and at what interest rate. That is the other side of the equation.
          .
          Knowing the institutional arrangements is not enough.
          .

          • IS and LM can both go up. They don’t have to intersect. In Japan, endogenous money creation has accompanied increased investment and saving. The IS-LM model fails to describe a world where money is created by balance sheet expansion, independently of savings or investment.

            • Why?

              • Because money has emergent properties. You can invest and simultaneously have a liquidity preference too. You buy a Treasury as an investment and use it to borrow money to buy that same Treasury. You re-hypothecate collateral meaning it shows up as an asset on multiple counterparties’ balance sheets, thus multiplying the collateral’s value, which gives you liquidity through an investment.
                .
                IS-LM, so far as I can tell, assumes money is zero-sum (that is why the curves intersect) but money is observably emergent (the two lines can be parallel) …

                • I think this lends to what Hudson has said about the basic ideological binary foundations to price discovery being false.

          • “Knowing the Japanese institutional (supply) arrangements won’t tell who is going to step up and take the money and at what interest rate. That is the other side of the equation.”

            Thanks for your reply Henry, and I agree. But to know who does and does not step up you need primary and secondary documentation. For example bank annual reports that say “clients are not taking out loans because of X; and corporate bank reports saying “we have no need or a need for credit because of Y”.

            Just saying things like “there is a straight LM curve and this and that is exogenous” is not an answer. It is a tautology. To get good policy you need to know what is actually going on what is causing what. And in most cases you are dealing with interrelated phenomenon which does not allow you to control variables.

            Institutional arrangements are also not ignorable. Japanese interest rates, including deposit rates were fixed. It was the quantity of the loans that varied which was based on decisions made from the top – the Bank of Japan and Ministry of Finance. BOJ loans consisted of banks (who were reliant on BOJ credit – that is the so-called ‘overloan’ phenomenon). Again it was not interest rates that were allocating this credit or determining the amount of credit supplied. It was things like how much credit the BOJ decided to give to these banks, and other semi-government agencies and corporations. There seemed to be an infinite demand for this credit, which was not allocated by interest rates. In some respects of course, they were obliged to take it.

            You seem to think that you need an ISLM model or some model in front of you to go about your analysis. I’m not so sure. I think a good understanding of how the Japanese system worked is a better starting point.(I have to admit though it has been over a decade since I have done this, and I don’t have the materials with me where I am.) In the ISLM model there is stuff in there you don’t need to know, and stuff that you do need to know which is not in there. I am not sure it is a sensible way to go about looking at post-WWII Japan. Much better is to pick up a model-free undergraduate text book (written for Japanese economics and social sciences undergraduates) on the Japanese economy.

        • Nanikore,
          .
          ” In the ISLM model there is stuff in there you don’t need to know, and stuff that you do need to know which is not in there.”
          .
          Yes, I accept and agree with this.
          .
          The IS/LM model is not designed to model real institutional environments.
          .
          However, if you wanted to model interest inelastic money demand and supply curves (this seems to be how you describe the Japanese credit allocation system.) then these can be plugged in.
          .
          (And by ruling out loanable funds kind of model (saving and investment and paramount) as the interest rate setting mechanism you have applied a model filter. You cannot escape models. They are always lurking somewhere in the background.)

          • “You cannot escape models. They are always lurking somewhere in the background.)”

            Sorry, Henry I replied to this but somewhere it has got lost. What I basically said that this is exactly the problem. Whatever and wherever people see Model. And by doing so they are almost certainly missing the forest for the trees. If we are going to understand how Japan was so successful, and why things went wrong (if they did) we really have to know something about Japan, and for example, how it’s macroeconomic policy actually works.

            For this purpose a well-written book on Japanese economic history such as that used by Japanese undergraduates is the best starting point. This is far better of approaching the subject than an ISLM model (or worse).

            There are models (or rather theories) than can explain aspects of Japan’s experience – Neoclassical, Marxian., but that is not important. The important thing is do you have an adequately informed knowledge of how that economy actually works, with or without models. Are you also aware of the limitations of that knowledge and where there are areas of debate.

            Theories are useful reference points for comparisons. But I don’t always agree with one-size-fits all explanations and starting points. I do not however oppose theory courses for undergraduates as long as not only neo-classical theories are taught, but others such as neo-Marxian ones are as well. Indeed this is helpful for developing critical reasoning skills. The economics profession has tried to develop a ‘standard model’ – and I know why they do it. And at all costs they are going to try and keep it. But ultimately I think we have paid a high price for this, and the consequences are becoming more and more serious.

            • “However, if you wanted to model interest inelastic money demand and supply curves (this seems to be how you describe the Japanese credit allocation system.) then these can be plugged in.”

              The critical issue though is why are they inelastic and what are the consequences. Again, it requires you know something about Japan.

              • Yes, I agree.
                .
                It is important to know why they are inelastic but then you need a model to appreciate the implications of inelastic demand and supply curves.

  14. Well I have to admit that my PHD was not done the most efficient way. (It was a learning experience in many ways.) I was working under a top econometrician and I had a lot of historical data. I went to theory to try and find explanations for my findings but increasingly saw that this was not satisfactory. I knew I had to really understand something about the country I was investigating and access it’s historical and other literature. That required that I became proficient enough in the language to access the knowledge I needed. Although an econometrician, I was very fortunate to work under someone who let me do what was largely an economic- history thesis.

    The better way of doing this would have been to know something about the country first – then go off and find the data and do the fieldwork.

    • Clarification: the econometrician being the supervisor!

  15. Robert,
    .
    “You can invest and simultaneously have a liquidity preference too. ”
    .
    Buying a treasury is not investment in IS/LM terms.

    • In the real world, Treasuries are investments and firms construct synthetic Treasuries. Negative interest rates are also in evidence in the real world, while IS-LM theory does not predict them, indeed even assumes they can’t exist. I have not studied IS-LM theory but I’m sure it cannot predict or allow negative interest rates.


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