Finding a New Macroeconomics: (6) Mainstream “Normality,” and the Distraction of Behavioralism

The academic economics profession ought to have been most intimately involved in analyzing and debating a broken capitalist system whose deep crisis had confounded all its confident expectations. It has done nothing of the sort. Instead it proceeds as if — and indeed mostly still insists that nothing has happened to disturb its fifty-year celebration of capitalism’s efficiency and growth. A few professors of economics (e.g., Paul Krugman) and business (e.g., Nouriel Roubini) have commented on the absurdity of that insistence. But most of them could get no further than to recycle Keynes’ 1930s critiques of a depressed capitalism and his recommendations for deficit spending and monetary stimuli by government.  And, of course, the few right-wing economists who have taken the crisis seriously, utilized it to push yet again for less government economic intervention.  —  Richard Wolff [1] 

There is much truth in Wolff’s assessment of America’s celebratory attitude toward capitalism, especially within the academic community, and he properly links that attitude to our current predicament.  The idea that market economies are wonderful and efficient has been deeply ingrained in our thinking, so much so that efforts to understand why we are back in a depression, even for liberal economists who care deeply about the growth of inequality, have proceeded with a “business as usual” approach to economic analyses, even as we become aware of the urgent need for a fundamental rethinking of “business as usual” macroeconomics.

New generations of economists grow out of a culture in which there is much inertia on economic thinking.  The daily news reports on the latest stock market information are almost entirely useless; and the radio and TV discussions of economic and financial issues that flood the airwaves are at best superficial and confusing, and at worst wrong. There is a big advantage for people like me who learned economics in the early 1960s, for we are in a position to understand what has happened over the last fifty years; and those of us who have not been within the academic community can take a hard, objective look from the outside at everything that is going on. I have been conducting such an investigation of inequality growth over the last two and one-half years, and I have reached some startling conclusions.

“Economics” today evokes for me the image of a huge, disabled tanker drifting toward a major catastrophe. My tiny tugboat is unable to affect its course; and there are thousands of tugboats in the water, all pushing and pulling in different directions.

An Immature Science

Economics, as a social science, never matured enough to be helpful in countering serious decline and depression. It never got a complete handle on how market economies really work. John Maynard Keynes took the best shot at figuring it out, but in explaining why unfettered capitalist economies are unstable, he failed to account for the most influential factor, the distribution of wealth and incomes. [2]

He thought he had isolated three independent variables that together explain aggregate income and employment — the interest rate, the marginal efficiency of capital, and propensity to consume — and he even accounted for the dynamic “multiplier” effect of rising or falling demand, as changes in aggregate consumption change aggregate income. His General Theory, however, failed to account for the huge effect on demand of income redistribution. The “propensity to consume” and the “consumption function” are not independent of income distribution. As income concentrates more and more at the top of the income ladder, aggregate consumption declines sharply, creating a vicious cycle of contraction as increasing inequality causes further declines in consumption, production, and income (GDP) growth.

Thus, market economies are vastly more unstable than Keynes perceived them to be; concentration of income and wealth at the top causes income growth to decline more rapidly, with more chilling effects on employment and investment than those caused by the garden variety shifts in aggregate demand economists are used to contemplating. As Simon Kuznets warned in 1955, we could not become aware of the magnitude of such effects until the distributional data became available. We are now learning, unfortunately, that these effects are far greater than most of us could have imagined.

The last post in this series established that the progressiveness of taxation is directly, mathematically related to the degree of inequality in the distribution of wealth and incomes.  Just as a faucet controls the amount of water moving through a pipe, the progressiveness of taxation controls the amount of income and wealth concentrating at the top.

This previously well-understood fact has been all but forgotten today. No well-known economist (to my knowledge) has publicly joined in my argument that, after 30 years of growing inequality, closing the taxation faucet to curtail the flow of incomes and wealth to the top has become essential to recovery, and ultimately to the survival of our economy.

The Krugman Conundrum

Paul Krugman, America’s most influential Keynesian, has a tugboat of his own, much bigger than mine — but unfortunately it is not entirely pointed in the right direction.  His tugboat is preoccupied with battling an entire fleet of pirate ships that have seized and disabled the tanker, and he could use some help.  But while his colleagues have resorted to championing more progressive taxation on fairness grounds, Krugman himself has not even expressly acknowledged the relevance of progressive taxation to growth and recovery.  Here is a recent comment on tax progressiveness from his New York Times column:

Consider the question of tax rates on the wealthy. The modern American right, and much of the alleged center, is obsessed with the notion that low tax rates at the top are essential to growth. Remember that Erskine Bowles and Alan Simpson, charged with producing a plan to curb deficits, nonetheless somehow ended up listing “lower tax rates” as a “guiding principle.”

Yet in the 1950s incomes in the top bracket faced a marginal tax rate of 91, that’s right, 91 percent, while taxes on corporate profits were twice as large, relative to national income, as in recent years. The best estimates suggest that circa 1960 the top 0.01 percent of Americans paid an effective federal tax rate of more than 70 percent, twice what they pay today. [3]

This is a good comment as far as it goes, but it does not expressly connect the progressiveness of taxation to income growth; it merely rejects the false idea that lower taxes at the top will increase growth. Nor does it mention the casual conflation of taxation of top incomes with taxation of bottom incomes embedded in the “guiding principle” of lower tax rates, a gimmick used successfully to leverage the false promise of “trickle-down” into real economic analysis.

We owe Paul Krugman much gratitude, and a great deal of credit, for his own obsession with debunking “austerity” and “trickle-down,” two insanely magical ideologies that have dragged economics back into the dark ages of the 17th Century, well before philosophers like Adam Smith and John Baptiste Say began to work some basic tautologies into coherent economic theories. [4]  As I said, he’s not getting enough help from other economists in those efforts. But perhaps especially for that reason, as America’s premiere warrior against economic insanity, Krugman has a responsibility to clarify the implications of progressive taxation.

Krugman is among those actively recycling the traditional Keynesian playbook, arguing that fiscal and monetary policy alone can accomplish recovery, and rather easily. [5] The next post will show that the Keynesian playbook cannot work today, because it does nothing to stem the transfer of wealth to the top in the normal course of the economy’s operation, and that “taxing the rich” is essential to escaping from our very serious inequality cycle.  Yes, I am saying that Paul Krugman is wrong on that score.  

Of course, he is right that the “austerity” hysteria must be subdued. But Krugman also argues:

The chances of a real turn in policy, away from the austerity mania of the last few years and toward a renewed focus on job creation, are much better than conventional wisdom would have you believe. And recent experience also teaches us a crucial political lesson. It’s much better to stand up for what you believe, to make the case for what really should be done, than to try to seem moderate and reasonable by accepting your opponents’s arguments. Compromize, if you must, on the policy — but never on the truth. [6]

So, I am encouraged to say, here is the uncompromising truth: The only time cutting government participation in the economy would make any sense would be when the economy is overheated, and it is a terrible idea to do it in a recession. Krugman, Reich, and the other opponents of “austerity” policy are absolutely right about that. But, as explained in the next post, we’re not in a situation where merely increasing government participation might thaw out the stalled economy sufficiently for a recovery.  We’re in an inequality-generated depression, which is sucking the life out of the economy faster than it could possibly be resuscitated by more government borrowing and spending. We need much more progressive taxation; it’s time to tax the rich.

Krugman’s Perspectives Revisited

Paul Krugman’s public influence on economic issues today is unmatched.  He is the premiere voice of American mainstream Keynesianism, providing his views to millions of readers every Monday and Friday in the New York Times, and he is the most followed and talked about economist in America. So understanding his views on inequality, and its causes and cures, is extremely important. When he became the lead New York Times correspondent in economics in 2007, he attributed the decline of inequality after WW II (the “Great Compression”) to Roosevelt’s New Deal policies, and he said this:

Because of “movement conservative” political dominance, taxes on the rich have fallen, and the holes in the safety net have gotten bigger, even as inequality has soared. And the rise of movement conservatism is also at the heart of the bitter partisanship that characterizes politics today. Why did this happen? Well, that’s a long story. . . . For now, though, the important thing is to realize that the story of modern America is, in large part, the story of the fall and rise of inequality. [7]

It appeared that inequality would be a major focus of his blog, and that he would become a major authority on the topic.  But as Timothy Noah reported [8] in 2012: 

In his 2007 book The Conscience of a Liberal, Paul Krugman concluded that there is “a strong circumstantial case for believing that institutions and norms. . . are the big source of rising inequality in the United States.” Krugman elaborated in his New York Times blog:

The great reduction in inequality that created middle-class America between 1935 and 1945 was driven by political change: I believe that politics has also played an important role in rising inequality since the 1970s.  It’s important to know that no other advanced economy has seen a comparable surge in inequality. [9]

The problem with this emphasis on an “institutions and norms” explanation for rising inequality is that it takes us “out of the game,” leaving us out of touch with real economic, distributional explanations.  When we focus on politics as an exclusive explanation for rising income inequality, we ignore important economic phenomena.  Just observing, as Krugman did, that the United States had the biggest advance in income inequality doesn’t tell us much; it is more important to know that no other advanced economy has seen a comparable decline in the taxation of top incomes: The Piketty and Saez data, as shown in the fourth post of this series, show that the United States economy has both the highest level of inequality and the lowest marginal income tax rates among all advanced economies.

Krugman already had this bias toward “institutions and norms” explanations back in 2007, and he never lost it. In 2012, he concluded that inequality is a “political” problem. [10] This implies a belief that income and wealth distribution do not have macroeconomic implications, a belief intimately connected with another perspective that also obscures the foundation for a better understanding of the economics of inequality — the “normality” presumption that economies are self-correcting, as described by James Galbraith in an earlier post in this series:

The deepest belief of the modern economist is that the economy is a self-stabilizing system. This means that, even if nothing is done, normal rates of employment and production will someday return. Practically all modern economists believe this, often without thinking much about it. [11]

That assumption clearly masks the macroeconomic damage done by the concentration of income and wealth at the top.

The Rise of “Behavioral Economics”

Around the turn of the 21st Century, with inequality already a very serious problem and America about eight years from crashing into its next depression, the new field of “behavioral economics” was gaining traction in academic circles.  Camerer and Loewenstein explain the theory behind behavioral economics:

Behavioral economics increases the explanatory power of economics by providing it with more realistic psychological foundations. * * *  At the core of behavioral economics is the conviction that increasing the realism of the psychological underpinnings of economic analysis will improve economics on its own terms — generating theoretical insights, making better predictions of field phenomena, and suggesting better policy. This conviction does not imply a wholesale rejection of the neoclassical approach to economics.  [12]

It is a creditable idea, certainly, to use other social sciences to refine economic analysis “on its own terms,” but behavioral economics must be limited to that objective. It should only be used to enhance economic analyses, not to justify ignoring core economic concepts and relationships.

Consequently, the intersection of behavioral economics with the economics of inequality has had disastrous consequences. When economists should have been concentrating on the macroeconomic implications of the Piketty and Saez data series, many were focusing on social and political explanations for the growth income inequality. This trend overpowered consideration of fundamental macroeconomic explanations, and in some cases led to a “wholesale rejection” of economic analysis.

In Krugman’s case, turning to behavioral economics may have been related to his contemporary view, expressed in a June 10, 2009 lecture, that most macroeconomics of the past 30 years has been “spectacularly useless at best, and positively harmful at worst.” [13] Thus, even unprovoked by some breakthrough in behavioral economics, there already had been something of a wholesale rejection of traditional macroeconomics. As The Economist smugly put it:

These internal critics argue that economists missed the origins of the crisis; failed to appreciate its worst symptoms; and cannot now agree about the cure. In other words, economists misread the economy on the way up, misread it on the way down and now mistake the right way out. [14]

The Economist didn’t provide any answers either. But while the confused economics profession was waiting for the emergence of a more complete macroeconomics, the answer was not to seek behavioral and psychological explanations for why incomes and wealth are concentrating high within the top 1% while most incomes are declining, poverty is rising, and the middle class is evaporating.  But that is essentially what has happened.

Political decisions and social considerations lie behind all of economics. But “behavioral economics” is only intended to enhance our understanding of economic theories and phenomena, not to replace them.  Unfortunately, as the field of economics has been near-fatally wounded by supply-side, pixie-dust fantasies, other social sciences have moved in to replace economics altogether in the inequality debate.  But in the process of taking over the inequality debate, such models have corrupted the basic premises of behavioral economics itself.

Joseph Stiglitz focuses more directly on the underlying economic aspects of the problem of inequality growth.  With respect to institutional, political and social causes and even some of the more directly economic causes like globalization and technological change, Stiglitz politely argues:

[T]here is a growing consensus among economists that it is hard to parse out cleanly and precisely the roles of different forces. * * * To me, much of this debate is beside the point. The point is that inequality in America (and some other countries around the world) has grown to where it can no longer be ignored. [15]

We cannot ignore the basic features of the inequality engine if we hope to fix it.

We can take it for granted that the United States will need the political will to save our economy from its current course.  Some popular discourses on inequality today, however, invite us to simply blame inequality on politics, without adding anything of economic value to the discussion.  That is not a productive way for economics to suddenly start thinking about income and wealth distribution issues after years of ignoring them altogether.

John Maynard Keynes never got a got glimpse of the distant shore. Now that our stranded tanker is drifting closer to the rocky shoals of disaster, however, all of our little tugboats must work together to change its course.  

JMH – 4/20/2013 

_________

[1] Richard Wolff, Occupy the Economy: Challenging Capitalism, City Lights Books, SF (2012), Introduction, pp. 9-10.

[2] Wall Street is the source of our biggest problem, as “Occupy Wall Street” properly understood. But from a purely economic standpoint, the private banking system is just represents a collection of private business practices that, far more than most, enables the extraction of pure economic rent from the bottom 99%’s economy.

[3] “The Twinkie Manifesto,” by Paul Krugman, The New York Times, Op-ed, November 19, 2012 (here).

[4] The final post in this series will show how terribly, harmfully wrong “trickle-down” really is.

[5] Paul Krugman, End This Depression Now!,  W.W. Norton & Company, NY (2012) pp. 208-230.

[6] Id. at 224. 

[7] “Introducing This Blog,” by Paul Krugman, The Conscience of a Liberal, The New York TimesSeptember 18, 2007 (here).

[8] Timothy Noah, The Great Divergence, Bloomsbury Press , N.Y. (2012), pp. 113-114.

[9] “Introducing This Blog,” supra.

[10] Paul Krugman, End This Depression Now!,  W.W. Norton & Company, NY (2012), Ch. 5, “The Second Gilded Age,” pp, 71-90.

[11] James Galbraith, Presidential Address, Association for Evolutionary Economics (January 5, 2013).

[12] “Behavioral Economics, Past Present and Future,” by Colin F. Camerer and George Loewenstein, CalTech and Carnegie-Mellon University, 2002 (here).

[13] “What Went Wrong With Economics,” The Economist, July 16, 2009 (here).

[14] “The other-worldy philosophers,” The Economist, July 16, 2009 (here).

[15] Joseph E. Stiglitz, The Price of Inequality: How Today’s Divided Society Endangers Our Future, New York and London, W. W. Norton & Company, 2012, pp. 79-80.

This entry was posted in - FEATURED POSTS -, - MOST RECENT POSTS -, Economics, Wealth and Income Inequality. Bookmark the permalink.

One Response to Finding a New Macroeconomics: (6) Mainstream “Normality,” and the Distraction of Behavioralism

  1. vorfahrt says:

    Well said. Thanks for your recent series on economics. That’s the taks of our generation at his time- reduce income inequality and let the middle class participate in economic gains again. It is going to to be mighty difficult, but we have no choice, we’ve got to turn the corner now. I wish us all good luck! Joe

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