Economics: The Lost Science

As the year 2013 draws to a close, this post summarizes the concerns that have been driving me these past two years about the deterioration of the “science” of economics. The year 2014 will be a watershed year for economics and for society, I predict, and I am hopeful that in this coming year our governments, our politicians, and our social scientists will gain a much better understanding of how far away from reality the “science” of economics has wandered. I’ll be in this process until the end, because nothing is more important to our future and to the future of civilization.

What I have learned in the past two years about the development of the field of economics for more than two and one-half centuries has been both enlightening and sobering. It reminds me of Fraggle Rock, an upbeat TV series (1983-1987) for children young and old brilliantly conceived by Sesame Street creator Jim Henson. Fraggle Rock featured an underground community of small Muppets called “Fraggles”.  Muppet Wiki (here) offers this interpretation of the concept:

The vision of Fraggle Rock articulated by Jim Henson was to depict a colorful and fun world, but also a world with a relatively complex system of symbiotic relationships between different “races” of creatures, an allegory to the human world, where each group was somewhat unaware of how interconnected and important they were to one another. This allegorical world allowed the program to entertain and amuse while seriously exploring complex issues of prejudice, spirituality, personal identity, environment, and social conflict. * * *

Fraggle Rock generally refused to over-simplify any individual issue, instead simply illustrating the consequences and inherent difficulties of different actions and relationships. Though the Fraggles do learn important lessons, they rarely are aware that they are learning them.       

Living in Fraggle Rock was a community of “Doosers,” tiny construction workers randomly creating structures that build one upon another with no apparent design or purpose.  For me, that program has become a near-perfect metaphor for our economic society: We — the general population and the media — are the Fraggles, and the Doosers are the social engineers — the economists. Each Doozer is working on a piece of a larger construction, but there is no one developing a “big picture” design, or establishing a goal for all the work. Important lessons go unlearned, and the work enthusiastically reflects a worry-free outlook that pervades the entire community.  

As I have emphasized frequently of late, Harvard Economist Raj Chetty, in a recent New York Times Op-ed “Yes, Economics is a Science” (here), made this candid admission in his defense of the discipline: 

It is true that the answers to many “big picture” macroeconomic questions – like the causes of recessions or the determinants of growth – remain elusive.

That this should still be so is amazing, when the basic features of a market economy’s functional mechanisms had occurred, untested, to Adam Smith 237 years ago (Wealth of Nations, Book II, Ch 3). Yet we see today a discipline almost entirely dominated by ideological fantasies like “trickle-down,” an upside-down notion which unabashedly proclaims “less is more” and, somehow, enlists support from the victims of the extreme inequality it engineers.  

I owe my ability to become aware of these things, and contribute to a better understanding of all of this, entirely to the chance circumstances of my education and experience: I received my post-graduate education in economics in the 1960s, before the insights of John Maynard Keynes were buried beneath a neoclassical avalanche that, I must confess, I only vaguely anticipated. Meanwhile, my entire career in the economic trenches, as opposed to the ivory towers of academia, has re-enforced my perception that market economies are inherently unstable systems governed by few guiding “laws” beyond the obvious fact that people will struggle to meet their needs for survival.

This post will focus in particular on the prevailing ideologies of “equilibrium” and “stability,” outcomes that depend entirely on simplifying assumptions like perfect knowledge, perfect efficiency, and perfect competition that never exist in the real world, and are therefore never more than fantasies. Even in today’s age of advanced communication technology, there is almost no such thing as reliable collective knowledge, for reasons candidly, and ironically, discussed back in 1945 by one of history’s chief economic ideologues, Fredrich Hayek. 

These realities are  enough to cause at least a vague sense of anxiety about the future, but we would all remain substantially in the dark about what is actually happening to us were it not for a vast body of data on income and wealth distribution, the growing availability of which we owe to the hard work of a small handful of economists including Edward Wolff, Thomas Piketty, and Emanuel Saez. These data can ease the problem of collective uncertainty significantly by providing a third dimension to what would otherwise be a two-dimensional perception of economic phenomena. Distributional thinking over the last three years has opened my mind to a much clearer picture of the functioning of the economic system than I could ever have imagined during my long career. It is also, unfortunately, a much more disturbing picture.  

My parents taught me in my youth about the pitfalls of two-dimensional thinking when they introduced me to “Flatland” (here), a satirical novella published in 1884 by the English schoolmaster Edwin Abbott Abbott (1838-1926). As I write this, I’m making a New Year’s resolution to re-read Flatland; Abbott’s geometric metaphor made a lasting impression on me, and I see parallels everywhere.

Keynesian Insights

Keynes’s The General Theory of Employment Interest and Money (1935) is a perfect example. Keynes set out to advance economic thought beyond the static ideas of “classical” thinking, and hopefully to explain depressions and what might be done to avoid them. The economic theories he saw the need to correct had coalesced around the broad conclusions that aggregate economic disruptions were temporary, and that forces of supply and demand would operate to return economies to a state of “equilibrium” in which exactly what people wanted would exactly be provided, at competitively determined market prices. Downturns in activity would be self-correcting, always returning to full employment “equilibrium.” From the first paragraph of his first chapter, Keynes pointedly rejected that point of view:

I have called this book the General Theory of Employment, Interest and Money, placing the emphasis on the prefix general. The object of such a title is to contrast the character of my arguments and conclusions with those of the classical [fn] theory of the subject, upon which I was brought up and which dominates the economic thought, both practical and theoretical, of the governing and academic classes of this generation, as it has for a hundred years past. I shall argue that the postulates of the classical theory are applicable to a special case only and not to the general case, the situation which it assumes being a limiting point of the possible positions of equilibrium. Moreover, the characteristics of the special case assumed by the classical theory happen not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience.

For Keynes, the classical theory was his Flatland, specifying a single outcome (full employment) within an entire range of potential outcomes, like a stopped clock that only gives the correct time twice a day. At the end of Book I (Ch. 3) he summed it up more elaborately:

The celebrated optimism of traditional economic theory, which has led to economists being looked upon as Candides, who, having left this world for the cultivation of their gardens, teach that all is for the best in the best of all possible worlds provided we will let well alone, is also to be traced, I think, to their having neglected to take account of the drag on prosperity which can be exercised by an insufficiency of effective demand. For there would obviously be a natural tendency towards the optimum employment of resources in a Society which was functioning after the manner of the classical postulates. It may well be that the classical theory represents the way in which we should like our Economy to behave. But to assume that it actually does so is to assume our difficulties away.

That, as my recent series of posts on “The Neoclassical Boondoggle and the ‘Mutilated Economy'” have attempted to demonstrate, is exactly what our “supply-side” theories have been doing – assuming our difficulties away – and in the exact way Keynes articulated, by overlooking “the drag on prosperity which can be exercised by an insufficiency of effective demand.” It is only now, as our “recovery” from the Crash of 2008 lingers on in a slowly deepening depression held in check only by extensive monetary expansion and federal borrowing that surely cannot end well, that neoclassical economists are revealing a growing confusion about the failure of their theories to work.   

It wasn’t until I began a thorough study of the works of the “classical” economists that it dawned on me, in rereading some of Keynes’s most important chapters, that he was not challenging the static ideas of the original classical philosopher/economists so much as attacking the rigid, doctrinaire form they had taken in the “neoclassical” school that arose out of the doctrines of Alfred Marshall and Arthur C. Pigou, and the Austrian School’s Friedrich Hayek. Following in the footsteps of such more recent economists, modern economists like Milton Friedman have not only falsely discredited the Keynesian “demand-side” paradigm, but have transformed ideas about efficiency and competition that originated as theoretical presumptions into rigid tenants of neoclassical faith. Today, in retrieving his opening passage, I took a hard look for the first time at Keynes’s opening footnote:

1. “The classical economists” was a name invented by Marx to cover Ricardo and James Mill and their predecessors, that is to say for the founders of the theory which culminated in the Ricardian economics. I have become accustomed, perhaps perpetrating a solecism, to include in “the classical school” the followers of Ricardo, those, that is to say, who adopted and perfected the theory of the Ricardian economics, including (for example) J. S. Mill, Marshall, Edgeworth and Prof. Pigou.

As Keynes seemed to imply, it was not the early, ambitious theorizing of David Ricardo (1772-1823), or of Ricardo’s contemporaries such as Jean-Baptist Say or T.R. Malthus, but the unwarranted, faith-based optimism of Ricardo’s successors that prompted his reference to Voltaire’s 1759 satirical novella, Candide (here).   

Keynes was the most incisive economic thinker we have seen in the short history of the “science” of political economy, and it was the trashing of his wisdom by neoclassical ideologues that banished contemporary economics to the wastelands of pseudo-science.

Instability 

Keynes developed a model that made no explicit allowance for income and wealth redistribution, and took no account of its causes and effects. His General Theory did, howeverprovide the theoretical basis for understanding the causes and implications of inequality growth. The essence of his theory was fairly straightforward. The aggregate amount of productive activity (income), he said, is driven by aggregate demand, not aggregate investment, and the degree to which provision would be made for future consumption out of current income could not be inferred from the amount of current saving:

From the time of Say and Ricardo the classical economists have taught that supply creates its own demand; meaning by this in some significant, but not clearly defined, sense that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product. * * *

Those who think in this way are deceived, nevertheless, by an optical illusion, which makes two essentially different activities appear to be the same. They are fallaciously supposing that there is a nexus which unites decisions to abstain from present consumption with decisions to provide for future consumption; whereas the motives which determine the latter are not linked in any simple way with the motives which determine the former.

It is, then, the assumption of equality between the demand price of output as a whole and its supply price which is to be regarded as the classical theory’s ‘axiom of parallels’. (The General Theory, Book I, Ch. 1)

There was no dispute that the whole of economic activity consists of the provision for current and future consumption. Because saving is not automatically converted into spending for investment in capital stock (the means for providing for future consumption), and some income is hoarded (reflecting “liquidity preference”), there is the possibility of declining income. Hoarding amounts to a contraction of the active money supply, and results in stagnation.    

Keynes’s General Theory also explained how wealth and income become further concentrated with declining demand. His model predicted that with a reduced aggregate propensity to spend the reduction of economic activity would lead to lower income growth, and still lower investment and spending, until stimulation from the injection of more money (hence demand) into the economy put an end to the ensuing decline. In the best discussion of the inequality problem available to date (The Price of Inequality, 2012), Joseph Stiglitz identified this basic Keynesian explanation of inequality growth:

Moving money from the bottom to the top lowers consumption because higher-income individuals consume a smaller proportion of their income than do lower-income individuals (those at the top save 15 to 25 percent of their income, those at the bottom spend all of their income).  (K. p. 85)

In fact, those at the very top save far more than 15-25 percent of their income, which is one big reason why inequality growth is growing so rapidly today. 

When you add these twin engines of inequality growth to the natural tendency of inequality to grow because of returns on naturally concentrated wealth, you have all the ingredients of a viciously unstable inequality spiral. This leads to depression. It is apparent, then, that unfettered capitalist economies are inherently very unstable. Stiglitz is among the very few contemporary economists who recognize this instability:

Widely unequal societies do not function efficiently, and their economies are neither stable nor sustainable in the long term. * * * 

Taken to its extreme—and this is where we are now—this trend distorts a country and its economy as much as the quick and easy revenues of the extractive industry distort oil- or mineral-rich countries.  (K. p. 83)

Robert Reich has also identified inequality growth to be the overriding problem of the U.S. economy, and his recent movie “Inequality for All” provides an excellent overview of the problem (here). James Galbraith also has some excellent insights, and I’m hoping for more in 2014 from him and his University of Texas Inequality Project (here). There are others as well, and 2014 will hopefully be the year of the great reawakening, which I can sense may be on its way. There is not a whole lot of time left.

Unfortunately, most economists remain under the Friedmanian spell, assuming that perfect competition, perfect knowledge, and perfect efficiency all really exist. Stiglitz addressed Friedman’s perpective as well:

The influence of the Chicago school should not be underestimated. * * * Chicago school economics argues that markets are presumptively competitive and efficient; (The Price of Inequality, Kpp. 44-45) 

While [Milton Friedman’s] pioneering work on the determinants of consumption rightly earned him a Nobel Prize, his free-market beliefs were based more on ideological conviction than on economic analysis. I remember long discussions with him on the consequences of imperfect information or incomplete risk markets; my own work and that of numerous colleagues had shown that in these conditions, markets typically didn’t work well. Friedman simply couldn’t or wouldn’t grasp these results. He couldn’t refute them. He simply knew that they had to be wrong; . . . .  even if the theoretical results were true, they were “curiosities,” exceptions that proved the rule; 

Friedman’s monetary theory and policy reflected his commitment to making sure that government was small and its discretion limited. The doctrine that he pushed, called monetarism, held that government should simply increase the money supply at a fixed rate (the rate of growth of output, equal to the rate of growth of the labor force plus the rate of growth of productivity).  That monetary policy could not be used to stabilize the real economy— that is, to ensure full employment— was not of much concern. Friedman believed that on its own the economy would remain at or near full employment. Any deviation would be quickly corrected as long as the government didn’t muck things up. (Id. at 257. Emphasis added.)

That Chicago School supply-side economics cannot explain or cope with inequality should be obvious. To believe that a market economy will always return on its own to “full employment” regardless of the distribution of income and wealth, would require the belief that the distributions of income and wealth have no macroeconomic significance. Not surprisingly, as I have discussed, that is the position taken by all supply-side neoclassical economists.

Equilibrium

My recent posts have focused on the slowly growing recognition among economists that the U.S. economy, despite spectacular income and wealth gain within the top 1%, is in a gradually worsening depression. This continuous, steady economic decline has challenged the strong faith of mainstream economics in a general macroeconomic “equilibrium,” the notion that an unfettered market economy can and will recover from downturns of its own accord. Perspectives on nearly all economic issues have been, for more than a century, deeply influenced by false perceptions of a tendency to move toward equilibrium. The notion of economic equilibrium, however, should be regarded as an illusion, descriptive not of the real world but of a perfect one. 

The “general equilibrium” concept is historically traced to Marie-Esprit-Léon Walras (1834-1910). We have seen in previous posts discussing Paul Krugman’s perception of a “mutilated economy” that mainstream neoclassical economists like Larry Summers and neo-Keynesian economists like Krugman are not yet ready to surrender their faith in general equilibrium theory, a faith that ought to be shattered by the mounting evidence of the extreme instability associated with income and wealth redistribution. 

The equilibrium concept was promoted by the inventors of “microeconomics” (the study of individual firms and markets), a group including Alfred Marshall (1842-1924) and Arthur Cecil Pigou (1877-1959). The idea that individual markets can experience an equilibrium condition of supply and demand is not quite as incredible as the idea of a general equilibrium. However, as economics textbooks routinely explain, actual real-world equilibrium at any level requires efficient markets, perfect competition, and perfect knowledge; yet all of these factors are extraordinarily imperfect in real life.

In the third chapter of his Principles of Economics (1890), “Equilibrium of Normal Demand and Supply,” Alfred Marshall did not seem to gloss over these prerequisites, yet somehow he did:

[W]e are investigating the equilibrium of normal demand and normal supply in their most general form; we are neglecting those features which are special to particular parts of economic science, and are confining our attention to those broad relations which are common to nearly the whole of it. Thus we assume that the forces of demand and supply have free play; that there is no close combination among dealers on either side, but each acts for himself, and there is much free competition; that is buyers generally compete freely with buyers and sellers compete freely with sellers. But though everyone acts for himself, his knowledge of what others are doing is supposed to be generally sufficient to prevent him from taking a lower or paying a higher price than others are doing. This is assumed provisionally to be true both of finished goods and their factors of production, of the hire of labour and the borrowing of capital. We have already inquired to some extent, and we shall have to inquire further, how far these assumptions are in accordance with the actual facts of life. But meanwhile this is the supposition on which we proceed.

Despite this apparent sense of caution, several pages later Marshall was virtually declaring equilibrium a universal fact of life:

When Demand and supply are in equilibrium, the amount of the commodity which is being produced in a unit of time may be called the equilibrium-amount, and the price at which it is being sold may be called the equilibrium-price.

Such an equilibrium is stable; that is, the price, if displaced a little from it, will tend to return, as a pendulum oscillates about its lowest point; and it will be found to be a characteristic of stable equilibria that in them the demand price is greater than the supply price for amounts just less than the equilibrium amount, and vice-versa. ***

When demand and supply are in stable equilibrium, if any accident should move the scale of production from its equilibrium position, there will instantly be brought into play forces tending to push it back to that position; just as, if a stone hanging by a string is displaced from its equilibrium position, the force of gravity will at once tend to bring it back to its equilibrium position. The movements of the scale of production about its position of equilibrium will be of a somewhat similar kind. (Emphasis in original.)

So here we find Marshall converting the obvious general observation that sellers will prefer a higher price and buyers a lower one, in the space of a few pages, into a grandiose notion of efficient markets instantly responding in every way to the laws of supply and demand, under the relentless influence of forces no less constant and powerful than gravity. No sooner had he written the mandatory footnote than he erased it. 

“General equilibrium” ideology, of course, depends on much more than these assumptions of supply and demand equilibrium: the Keynesian dynamic theory developed 35 years later explains why an aggregate economy is not simply an aggregation of all of its component markets. To put it simply, even if a general equilibrium were possible with a given money supply, the money supply is changing all the time, and with those changes come price and demand changes, even if “pure” competition actually existed. 

Metaphorically, therefore, believing in a full-scale general macroeconomic equilibrium is like believing in the tooth fairy. In fact, it is almost exactly like that. It effectively implies that new money appears from out of nowhere and ends up under our collective pillow, leading us to ignore where new money really comes from. Thus, it prevents recognition of the rational policies needed to correct the current, or any other, economic decline.

I have learned much, as I have said, in my career in the trenches. In the early 1970s, a regulatory economist from Cornell, Alfred Kahn, became the chairman of the New York Public Service Commission (PSC). He later went on to head up the deregulation of the commercial airline industry for Jimmy Carter, and then become his chief inflation fighter in the late 1970s. When he came to the PSC, I was involved in determining the rates charged by New York Telephone Company (NYT), a predecessor of Verizon, for land-line telephone service. NYT was still a subsidiary of AT&T, the giant national monopoly provider of telephone services. Society had traditionally regulated the rates of giant telecom monopolies because they were the providers of essential infrastructure and services, and they could not be allowed to charge whatever they desired on whatever terms they desired.

At one point while I was conducting a NYT rate case, Fred Kahn called me to his office to discuss his intention to develop a record on incremental costs in my proceeding, and he wanted to be sure I understood what he had in mind. Ubiquitous land-line telephone service required much investment in switching and transmission plant, and consumer traffic tended to peak at certain times over certain routes. He planned to try to minimize investment costs by optimizing off-peak usage, and to do that he had ordered NYT to study its incremental investment costs and to develop time-of-day rates. I recall him explaining to me that marginal cost pricing would encourage usage to move toward a certain point, and I blurted out: “Equilibrium?” He looked up quickly, somewhat surprised, and responded: “Precisely!” But he looked away just as quickly. Off-peak incremental cost pricing was a great idea, but there obviously could be no overall “equilibrium” for NYT, which by law was entitled to rates allowing a reasonable opportunity to recover its average costs and a reasonable return on the capital invested in the enterprise. Its costs were constantly changing, and it filed for rate increases almost every year.

Only the wireless service alternative, which came into being long after Alfred Kahn left for Washington, after AT&T’s divestiture of its local telephone companies, and after the Telephone Act of 1996 established stringent nation-wide interconnection requirements, was successful in achieving anything even approaching competitive prices for telecommunications. And there has never been anything that could reasonably be called an “equilibrium” in any of the telecom or internet markets.   

Equilibrium is defined, in this context, as “a situation in which supply and demand are matched and prices stable” (here), and the definition of “stable” is “not likely to change or fail; firmly established” (here). Experience teaches that change is ubiquitous and continuous, that equilibrium states are theoretical only, and that stable equilibrium never exists.

Keynes decisively disposed of such neoclassical fantasies, but unfortunately he failed to shut the door permanently. Perhaps because there was no other term for the confluence of supply and demand, Keynes himself used the word “equilibrium” at least 80 times in his book. But, as Keynes remarked in concluding his introduction:

The composition of this book has been for the author a long struggle of escape, and so must the reading of it be for most readers if the author’s assault upon them is to be successful — a struggle of escape from habitual modes of thought and expression. The ideas which are here expressed so laboriously are extremely simple and should be obvious. The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.

Unfortunately, the old idea of “equilibrium” never died, but flourished anew, especially in the hands of Paul Samuelson, who moved “general equilibrium” (here) into another dimension of mathematical complexity, embellishing it with ideas of comparative statics, the “correspondence principle,” and the stability of equilibrium (here), feats of intellectual brilliance sufficient to earn him the Nobel Prize in economics.

The memory of Leon Walrus’s quest for the holy grail of a “general equilibrium” should have died with Keynes’s General Theory, but thanks to the neoclassical mission to obfuscate and ignore Keynes, and to Paul Samuelson’s abstruse, technical constructs, it is kept alive but never properly related to the big picture. Thinking along neoclassical lines ironically prevents us from learning the lessons of experience, and from understanding how the economy actually works. Perhaps this is the inevitable product of emotionally biased imaginations working without the benefit of sufficient real-world information. 

One of the most influential neoclassical economists and a staunch adversary of Keynes in the 1930s, the Austrian economist Friedrich Hayek, published a noteworthy article 70 years ago (“The Use of Knowledge in Society,” American Economic Review, Vol. 25, Issue 4, Sept., 1945) concerning the futility of central planning. Interestingly, he was tangentially critical of the growing application of scientific methods to economics. He opined that the fundamental problem of accumulation of knowledge “has, I am afraid, been rather more obscured than illuminated by many of the recent refinements of economic theory, particularly many of the uses made of mathematics.” He suggested that such approaches may have lost touch with the real nature of essentially social phenomena:

It seems to me that many of the current disputes with regard to both economic theory and economic policy have their common origin in a misconception about the nature of the economic problem of society. This misconception is in turn due to an erroneous transfer to social phenomena of the habits of thought we have developed in dealing with the phenomena of nature. (p. 520)

He concluded the article with a specific, cautionary reference to “equilibrium” theory:  

Any approach, such as that of much of mathematical economics with its simultaneous equations, which in effect starts from the assumption that people’s knowledge corresponds with the objective facts of the situation, systematically leaves out what it is our main task to explain. I am far from denying that in our system equilibrium analysis has a useful function to perform. But when it comes to the point where it misleads some of our leading thinkers into believing that the situation which it describes has direct relevance to the solution of practical problems, it is time that we remember that it does not deal with the social process at all and that it is no more than a useful preliminary to the study of the main problem.

Finding the notions of “stability” and “equilibrium” to be ideological constructs lacking real-world significance is one of the main reasons, back in the 1960s, I found economics to be more science-like than scientific. To find that same sense of things in the thinking of one of history’s chief neoclassical thinkers, despite his own ideological influences, powerfully re-enforces my perspective. But this also suggests how easily people can be led astray when insufficient data is available, and they are left almost entirely to their own devices. 

It seems clear to me that economics is subject to political influences dwarfing those that affect most of the physical sciences. This susceptibility to political influence, I have long believed, is why the economics discipline has been overrun by non-scientific, ideological thinking. Keynes expressly disagreed, in a confident passage appearing at the very end of his book:

[T]he ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age.

Whether economic falsehoods and misconceptions are propagated mainly by “the power of vested interests” or by “the gradual encroachment of ideas,” there remains an urgent need for a more objective, scientific approach to economics. Steven Strauss, an Adjunct Lecturer in Public Policy at Harvard Kennedy School, recently (12/8/13) posted his thoughts along these lines on the Huff Post Blog, “Is Economics a Religion?” (here), and he got right to point:

As a former policymaker and consumer of economic analysis, I suggest the priesthood of tax, regulatory and fiscal policy would benefit from: Replication studies (hint — what real scientists do); Indices/tracking metrics/awards to measure economic forecaster accuracy; The medical profession’s principle of “first, do no harm”; and Oversight of conflicts of interest.

I’m not alone in my concerns about economics. For example, Nassim Nicholas Taleb (here) commented: “You can disguise charlatanism under the weight of equations, and nobody can catch you since there is no such thing as a controlled experiment.” 

A return to unbiased, scientific economics is long overdue, and could not be more important, given our emerging understanding of the overwhelmingly destructive impacts of income and wealth redistribution.

Stiglitz v. Krugman on Inequality

Succumbing to ideological thinking has enormous consequences, and must be avoided at all costs. In the Keynesian tradition, Joseph Stiglitz’s views reveal a fact- and reality-based approach to economics that does not reflect ulterior motives. Thus, he is able to develop sound views.

Paul Krugman, too, claims to be a Keynesian, but his views conflict sharply with Stiglitz’s views, for reasons that remain unclear. I have been challenging Krugman’s perspectives on income and wealth distribution since he declared in his his latest book End This Depression Now! (May, 2012) that income inequality was merely a “political” problem, not a macroeconomic one.

In his most recent New York Times Op-ed, “Why Inequality Matters” (here), he remains true to form. The good news is that the inconsistencies in his thinking are becoming harder to overlook. Of the pundits who argue that “inequality isn’t that big a deal,” he says: “They’re wrong.” But then he says:

The best argument for putting inequality on the back burner is the depressed state of the economy. Isn’t it more important to restore economic growth than to worry about how the gains from growth are distributed?

Thus, his very first thought is to deny that distribution has anything to do with growth. That Krugman is still taking this posture is mystifying: It is well-established that the rate of income growth always declines with rising income inequality, as consistently demonstrated ever since WW II, both over the entire period of rising income inequality since 1979, and over the briefer periods of the Bush tax cuts and of the stagnation since the Crash of 2008. In fact, Krugman’s concerns about the “mutilated economy” discussed in my previous three posts stem from the continuing high rate of long term unemployment since 2008, and a reduced rate of employment growth, in and of itself, necessarily means slower income growth.

Krugman then suggests the possibility of macroeconomic impacts: “[I]nequality probably played an important role in creating our economic mess, and has played a crucial role in our failure to clean it up.” But he then perceives bottom 90 percent incomes and poor “economic performance” to be separate, apparently unrelated factors:

For the bottom 90 percent of families, this impoverishment reflects both a shrinking economic pie and a declining share of that pie. Which mattered more? The answer, amazingly, is that they’re more or less comparable — that is, inequality is rising so fast that over the past six years it has been as big a drag on ordinary American incomes as poor economic performance, even though those years include the worst economic slump since the 1930s.

And if you take a longer perspective, rising inequality becomes by far the most important single factor behind lagging middle-class incomes.

Again, no connection is seen between “performance” (aggregate income) and rising inequality (the bottom 99% share of income). Then he continues to waffle:

It’s now widely accepted that rising household debt helped set the stage for our economic crisis; this debt surge coincided with rising inequality, and the two are probably related (although the case isn’t ironclad). After the crisis struck, the continuing shift of income away from the middle class toward a small elite was a drag on consumer demand, so that inequality is linked to both the economic crisis and the weakness of the recovery that followed.

In my view, however, the really crucial role of inequality in economic calamity has been political.

This is the closest Krugman, a self-styled Keynesian, has come to actually reflecting the General Theory in his analysis of inequality. The Summers/Krugman belief in “secular stagnation” (discussed here), which requires more than a little faith in the ideological concept of stability, assigns all decline of the rate of GDP (income) growth in the 21st Century to the period following the Crash of 2008; but if the consumer debt surge is “probably” related to the rising inequality that proceeded the Crash, what would Krugman imagine the effects to be of all the income inequality growth that took place over the entire period between 1979 and 2007? And why has he not demanded an “ironclad” case for his outright dismissal of any macro-economic effects of inequality, or his continuing assertion that inequality is mainly a political problem?

Interestingly, BBC News, referring to the Emanuel Saez study showing that “the top 1% has captured 95% of the income gained since the financial crisis,” and “since 2009, the top 1% of incomes grew by 31.4% while the bottom 99% saw their incomes rise by only 0.4%,” recently asked both Krugman and Stiglitz whether rising inequality has anything to do with the retarded recovery from the Crash (November 21, 2013, watch video here).

Stiglitz has a clear position, demonstrably based in Keynesian theory, on the macroeconomic significance of inequality, and he answered accordingly that “those sorts of inequality figures are the main impediments to economic growth.” Krugman, on the other hand, merely said he was not convinced by the application of Keynesian consumption propensity analysis to the issue.

Krugman is waffling: Without any real basis or explanation, he has endorsed the supply-side ideological perspective on growth and decline. My wish for Paul Krugman for 2014, given his widespread credibility and fame, is that he swallow hard and choose between the supply-side doctrines he currently endorses and the demand-side theory he says, at least part of the time, he believes. He cannot have it both ways, and his current stance both badly hurts the interests of the middle class and the poor he champions and discourages the urgently needed renewal of scientific economics.

Conclusion

This is a fairly complete overview of my thoughts about the current state of the discipline of economics. I have not taken a conspiratorial stance with respect to the development and propagation of non-scientific ideology. The surreal approach to mythologizing “the invisible hand” of Adam Smith as a metaphor for market efficiency, however, suggests that there is at least a virtual if not actual conspiracy to conscript the classical philosopher/economists into the service of neoclassical ideology. I will soon, hopefully before the New Year breaks, post a summary of my extensive study of “The Cult of the Invisible Hand.” 

Best wishes for the holiday season.

JMH – 12/18/13

This entry was posted in - FEATURED POSTS -, - MOST RECENT POSTS -, Decline in America, Economics. Bookmark the permalink.

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