Home > Uncategorized > Paul Krugman — finally — admits he was wrong!

Paul Krugman — finally — admits he was wrong!

from Lars Syll

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.

  1. October 25, 2019 at 5:37 pm

    Lars all of modern economics is based upon a series of strawmen its a Public Choice theory Reality-based community. Soddy showed the way and people Like Martin Shubick will be sorely missed.

  2. John deChadenedes
    October 25, 2019 at 6:26 pm

    I would like to ask a very sincere question, if you don’t mind. I am not a professional economist, so I really don’t know the answer. Why don’t economists start by saying what the purpose of an economy (or “the economy”) is and then analyze what is happening in relation to that?

    • Craig
      October 25, 2019 at 9:09 pm

      I’ll answer that in the most basic and potentially insightful way, as basics/elementals are always insightful.

      The purpose of economic production is consumption.

      And a 50% Discount/Rebate monetary policy at the point of retail sale facilitates a free flowing economy by doubling everyone’s earned income purchasing power, doubling the actually available individual income/business revenue for any and all enterprises and just as a kicker not only completely eliminates any possibility of price and asset inflation, but by so integratively inverting the reality of chronic inflation to beneficial price deflation…fulfills one (and all) of the historically verifiable signatures of paradigm changes.

      Look at that. Don’t just gloss over it. Its effects are mathematical, empirical, temporal and almost un-gameable (and virtually so with philosophically aligned tax and economic regulations). And when everyone (immediately) realizes how nice it is that their income/revenue is mathematically doubled and economic stability is bulwarked, another of the signatures of paradigm changes will take effect. That is, everything adapts and moves on to the new paradigm….not the other way around….because its so obviously beneficial to every economic agent and to the system.

      The operations of paradigm changes are always basically simple and yet always transformational to the pattern it relates to.

      We should be focusing on the new paradigm, its problem resolving aspects and building a mass movement to herd the political apparatus toward its implementation, not endlessly affirming already agreed upon theories and policy parts of the paradigm change.


    • October 26, 2019 at 3:20 am

      John, here’s my version from Economy, Society, Nature (see right-hand column):

      “An economy is the set of activities through which a society provides for its material needs. An economy emerges from the exchanges of goods and services in which the society’s members engage. A society, in turn, emerges from the social interactions of a sufficiently large group of people.
      The purpose of an economy is to provide sufficient goods and services for the society and its members to survive and thrive indefinitely into the future. Thus not only should individuals be able to survive and thrive, but the society should also be able to continue in a form that is acceptable to its members.”

      It spends quite a bit of attention on how the present version does not meet people’s needs and how a better economy might.

      As to why mainstreamers don’t address this, long story but they got side-tracked by elegant mathematics over a century ago and never actually figured out how to do what you’re proposing.

      • Craig
        October 26, 2019 at 4:25 am


        What are the specific monetary policies in your book? I suspect you may have some of the ones other heterodox economists and myself have like a universal dividend and a debt jubilee of some proportion as well as increased government spending which I’m all for as well. What do you think of my 50% Discount/Rebate policy at retail sale?

      • October 26, 2019 at 11:28 pm

        Craig it’s more a text book than a policy document. It covers the nature of money, simple exchange systems, commercial banks creating money, central banks and MMT, the interaction of ‘loaned’ money with the financial markets to trigger booms and busts.

  3. Econoclast
    October 25, 2019 at 7:38 pm

    Regarding #5, I am no fan of unindicted war criminal Donald Rumsfeld, but he did have it right with his “unknown unknowns”.

    Regarding the purpose of an economy, let’s try this:
    At its essential core, stripped of ideology, an economy is a system, created or evolved by people to be run by people to serve people’s material needs. In this system resources derived from the solar/web of life systems are allocated to productive endeavors which create goods and services that subsequently are distributed throughout the cultural geography (tribe, region, nation, globe, whatever) that uses (consumes) them.

    From that basis, a particular economy is made specific by its culture and political ideology and action.

    • Rob
      October 25, 2019 at 11:28 pm

      That is a good definition Econoclast.

    • Craig
      October 26, 2019 at 12:22 am

      Change the article and add the word “monetary” in front of economy in your first statement.

      Your second paragraph begins to wander from the question asked and is therefore irrelevant

  4. John deChadenedes
    October 25, 2019 at 8:13 pm

    Thanks, Econoclast. If we take your purpose statement as a starting point, and I think it’s a pretty good one, economic analysis probably should begin by looking at how well and how efficiently an existing system actually serves people’s material needs, right? Why, then, don’t economists do that?

    • Craig
      October 26, 2019 at 4:20 pm

      That’s because they are largely off in some abstraction ONLY looking for the answer when they should be integrating both abstract and direct observation. And that’s the heterodox ones. The orthodox ones are simply way inured to their orthodoxy, concerned with career more than the search for truth, afraid to risk criticism and/or numerous other factors none of which is the wisdom of integrative thinking, and thinking on the paradigmatic level which is the quintessential integrative mental and temporal level of thought and observation as it is the integration of simple and complex, singular concept and pluralistic pattern effect.

  5. Helen Sakho
    October 26, 2019 at 12:23 am

    One must endorse the compliments paid to Econoclast. It is amazing though how illiterate war criminals can memorise “poetry” written for them by their advisers, but economists find it difficult to come clean. Blessed are those who repent before the event! Mainstream economists should be put on trial for having mislead millions of readers and students for decades. But, of course, plenty of revenue will flow their way from their new essays, books and so on…

  6. postkeynesian spain
    October 26, 2019 at 2:10 am

    Really Krugman is the most wrong economist…


    • October 29, 2019 at 2:44 pm

      Yes, postkeynesi- spain, Krugman went after Bill Greider’s 1997 book, “One World, Ready or Not: The Manic Logic of Global Capitalism” which worried, and warned about nations, leading economic powers, that traded in “making things” for various forms of “financialization.”

      The attacks were of the “how dare you” nature, a mere journalist without economic models, pronouncing on economic directions – and their effects on politics. The tone was as Lars portrays Krugman in this posting.

      In my essay on the rise of Trump, I cited Greider and John Gray’s “False Dawn.”

      My title says it: “Major miscalculations: globalization, economic pain, social dislocation and the rise of Trump.”

      Here at http://www.paecon.net/PAEReview/issue79/Neil79.pdf

      Specifically, pages 18-19.

      It is a shame that both Kevin Phillips and William Greider have now withdrawn from the American national stage, because both men saw the drift of bad things to come.

  7. Yoshinori Shiozawa
    October 26, 2019 at 4:50 am

    It is easy to denounce Krugman and all other economists who specialize in trade theory. If I borrow Krugman’s expression, international trade theory since Samuelson (Heckscher-Ohlin-Samuelson model) has been “spectacularly useless at best, and positively harmful at worst.”

    However, denouncing or accusing trade theory does not change the situation. We should know why and how trade theories after HOS (roughly speaking there are four generations) are all wrong and we should construct a theory (or theories) by which we can guide trade policy and policies about globalization. In my understanding, the minimal criterion for this is that a trade theory has a framework for analyzing unemployment. While it is not well known, such a theory already exists. See my papers:

    (1) A New Construction of Ricardian Trade Theory–A Many-country, Many-commodity Case with Intermediate Goods and Choice of Production Techniques
    A paper published in a journal but You can download the first draft at https://www.researchgate.net/publication/233943493_A_New_Construction_of_Ricardian_Trade_Theory–A_Many-country_Many-commodity_Case_with_Intermediate_Goods_and_Choice_of_Production_Techniques

    (2) The New Theory of International Values: An Overview (2017)
    This is already published as a chapter in a book. You can download the first draft at https://www.researchgate.net/publication/304717720_The_New_Theory_of_International_Values_An_Overview

    Both papers contain a section that analyzes gains and losses from trade and origins of trade conflicts.

    • Yoshinori Shiozawa
      October 28, 2019 at 1:56 pm

      Why do no one other than I talk about Krugman’s trade theory? Krugman is famous as a popularizer of New Keynesian economics and his polemiques in his New York Times columns but he is or at least was primarily a specialist in international trade theory.

      Lars Syll cited Michael Hirsh, but Syll argues totally different topic that is talked in Michael Hirsh’s article. Why does nobody other than I criticize Krugman at his most pertinent and strongest subject matter?

      • October 29, 2019 at 3:44 pm

        Because “Krugman is famous as a popularizer of New Keynesian Economics”, but the real Keynesian economics was not about trade but about curing unemployment. When we talk about Krugman we are likely to be talking about him misrepresenting Keynes.

  8. Robert Locke
    October 26, 2019 at 9:36 am

    According to my son (age 46), economics should be taught in Kindergarten, what the social science discuss, as on this blog, is rot.

    • Yoshinori Shiozawa
      October 26, 2019 at 2:04 pm

      If your son says so, more plausible dictum is: economics should not be taught before 40 years old.

  9. October 26, 2019 at 4:36 pm

    From Lars’ 1: “Self-critically [Hicks] 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.”

    Back in 1999 I saw that the Hicks formula described the same relationships as one of the earliest electrical circuits, known as a Wheatstone Bridge. Translating the economist’s monetarised jargon into real terms, the Investment is of real Resources, the liquidity (flow of power from the battery) represents consumption by labour needed to maintain Production, and the need for money is replaced by the need for Maintenance (as in recycling of Resources). The system is balanced (i.e. at equilibrium, with its meter reading zero) when the ratio of use of Resources to Maintenance is the same as that between Investment and Production, which can be maintained by varying the maintenance (as by recycling or of Keynesian infrastructure).

    So I found myself agreeing with Hicks’s mathematics, though not with his graphical monetary interpretation of reality. (In a credit system we could agree to use the word ‘money’ just for physical tokens of credit advances, retaining these for convenience in informal local markets and for teaching children the responsible use of credit). The model works for a particular circuit, but it can also be seen in a macro sense, not as what we have but as defining the aim of the system. What I’ve been saying here these last ten years is that it is indeed just “a classroom gadget, to be superseded, later on, by something better”, because the “something better” already exists in form of the PID control system, which uses the same circuit formation with dynamic corrective feedbacks. In the human form of this, in which people have different aims at different stages of their lives, the three subcircuits which do not represent their current aims represent their feedbacks. In this form it provides the macro foundation necessary for microeconomies, which the internet can prioritise, synchronise and keep independent, acting like the operating system in a multi-use and user computer.

    At 6. Lars claims: “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.”

    That all depends on how one interprets it. If he had taken the trouble to get his head round information theory, circuit theory and cybernetic (navigational) control he might have learned to see further than he did in his outdated school of economics and Santa Fe school of complexity. But how do you teach an old dog new tricks when it is either too deaf to hear you or too preoccupied with chewing its old bone to even notice you?

    Sorry, Lars, but this discussion needs to move on when we may have less than ten years to save the planet.

  10. gerald holtham
    October 26, 2019 at 6:33 pm

    A small suggestion: let’s ban the use of the word “economists” on this blog. When questioning or criticising some work or statement, give names. “Economists” include Karl Marx, Keynes, Kalecki, Minsky, Paul Krugman and Steve Keen – as well as Walras, Robert Lucas and Milton Friedman. Whatever it is you like or don’t like, someone on that list will agree with you. So lets be a bit more discriminating. The answer to John deChadened’s question is: some do, or at least try.

    • Robert Locke
      October 27, 2019 at 9:41 am

      “include Karl Marx, Keynes, Kalecki, Minsky, Paul Krugman and Steve Keen – as well as Walras, Robert Lucas and Milton Friedman.”

      All the usual cast of characters in Anglosaxonia, what if I gave the following names: Eugen Schmalenbach, Fritz Schmidt, Heinrich Nicklisch, Wilhelm Rieger, Erich Schneider, Hans Albach, and Erich Gutenberg. Who invariably would have heard of them and read their work or about them? In our group, myself, outside our group, German business economists and economists. I refer to these names constantly, when referring to question of firm governance, concepts of the firm, etc. Their names never come up here when discussing economists.

      • Robert Locke
        October 28, 2019 at 9:27 am

        Hans Muenstermann (1973) in his study of Schmalenbach related that an English colleague once expressed regret that there had been “…no Schmalenbach to set up the scientific discipline of business economics in Great Britain. ‘When kings build, the English economist told him, “‘carters (Kaerner) have something to do.” Our ignorance of economists in anglosaxonia, which we should be trying to correct here, is monumental.

  11. Paul Davidson
    October 26, 2019 at 9:13 pm

    As editor of the JPKE I accepted and published Hicks article where he abandoned the
    ISLM model as useful. Hicks wrote to me that my 1986-87 JPKE article on the Fallacy of Rational Expectations where I first published the use of nonergodic as the meaning of uncertainty in Keynes;s General Theory inspired him to abandon the ISLM model

  12. Gerald Holtham
    October 27, 2019 at 2:50 pm

    Marx was German, Kalecki was Polish and Walras was French. Anglosaxonia? If your point is that there are different traditions in economic analysis, you reinforce what I was saying.

    • Robert Locke
      October 28, 2019 at 9:41 am

      Gerald, you are not trying to understand what I am saying. Do me a favor, read the chapters in The End of the Practical Man, 1984, that describe the foundation and development of the discipline of business economics in Germany (1880-1940). In the book, I describe the new discipline’s theoretical and educational achievement, and its role in the institutionalization of management. That’s pp. 155-294 in the book. In your comment you are confusing economics with business economics. For central Europe that is a big mistake. Marx, Kalecki, and Walras are always included in discussions about economics in Anglosaxonia. The business economists in Germany, never included.

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