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The useful economist and economic research

from James Galbraith

The useful economist

The common characteristic of almost all of this work, excepting a few who preoccupied themselves with logical skirmishes with the neoclassical orthodoxy – e.g., the Cambridge-Cambridge controversies over the theory of capital (Robinson, 1956; Sraffa, 1960; Harcourt, 1972), or in microeconomics (Keen, 2011) – is that the protagonists were concerned, in the first place, with the practical questions of policy facing their governments or the international community of which they were a part. Whether reformist or revolutionary, their economics was (and still is) the elucidation of problems and the means of dealing with them. The purpose of economic reasoning is to inform and buttress political and social choices. It is not merely to create a simulation that kinda-sorta emulates some run of economic data.

The useful economist is one who engages in the quest for solutions. A truly useful economist does so in an open-minded, informed way, aware of underlying principles but not hypnotized by them, and independent of financial gain and personal ambitions, whether political or for status and celebrity among economists. The behavior of bankers and speculators, the emissions of factories and transport networks, the withdrawal of critical resources from a finite reserve in the crust of the earth, the level and distribution of wages, profits and rents, fair and effective taxation, how to achieve the willing cooperation of free citizens in pursuit of the common good – all these are part of what a useful economist may study. The person who stands outside and aloof from such questions, who purports merely to “model the system” is, for most purposes, an idler, not so much a scientist as a hobbyist.

Thus: Adam Smith’s objective was to promote the interests and welfare of the trading community of which he was part, by expounding the virtues of large markets and the division of labor. David Ricardo sought to shift the burden of taxation from profits to rent, and Henry George sought to shift them from wages to rent, in both cases so that taxes would fall on the idle and unproductive landholding classes. Karl Marx wrote Capital as a theoretical foundation for the expropriation of capitalists. John Maynard Keynes sought to save and reform Britain and the bourgeois democratic order by advancing a practical cure for mass unemployment. John Kenneth Galbraith (1958, 1967) turned the attention of his readers to the economic problems of abundance: public squalor, pollution, residual poverty, the cultural and aesthetic wasteland, and corporate power. Hyman Minsky described the phase transitions of financial instability – hedge, speculative, Ponzi – and the need for Big Government and a Big Central Bank as stabilizing devices. Milton Friedman, an engaged conservative, co-wrote a monetary history to support a case for monetary rules (Friedman and Schwartz, 1963). In brief, the notion that any significant economist of any century has stood aside from the policy questions of their time is purest pretense.

Economic research

Economic research as it should be, is therefore a matter of trying to understand how the particular complex system in which we happen to live functions – or malfunctions – at any particular time, and to what sort of forces, pressures and policies it responds. Here one illuminating example is P. Chen’s (2021) demonstration, from real data, that exchange-rate crises “can only be caused by financial oligarchs”. Another was Mandelbrot’s (1999) showing that the movement of capital asset prices is well-modeled by a multifractal generator, hence open to intrinsically unpredictable crashes. Such findings have the property that they are drawn from, or compared directly to, the phenomena of the real-existing economy in such a way as to motivate political and social choices. They do not consist in deriving policy from first principles, nor in exploring the properties of mathematical systems that – however interesting in themselves – map poorly or not at all to the complex economy in which we live. Again, examples of good work can be multiplied; the problem is not that research on the real world is lacking among economists and (especially) physical scientists turning their attention to economic questions. It is rather that such research lacks the standing it deserves, because it cannot be integrated into the dominant theory.

  1. Gerald+Holtham
    May 30, 2022 at 12:58 pm

    Quite right

  2. Meta Capitalism
    June 1, 2022 at 1:37 am

    Here one illuminating example is P. Chen’s (2021) demonstration, from real data, that exchange-rate crises “can only be caused by financial oligarchs”.

    I downloaded the linked paper (Foundations of complexity economics by W. Brian Arthur) but could not find the quotation above. Was the link correct? Could someone help me find the correct source where the quote (“can only be caused by financial oligarchs”) comes from?

  3. Meta Capitalism
    June 1, 2022 at 3:33 am

    Here one illuminating example is P. Chen’s (2021) demonstration, from real data, that exchange-rate crises “can only be caused by financial oligarchs”. (Fullbrook & Morgan 2021, 137)

    The closest I could find was:

    Box 1 | All systems will be gamed

    Standard economics has learned how to stabilize macroeconomic outcomes, avoid depressions, regulate currency systems, manage central banking and carry out antitrust policy. What it has not been able to do is prevent financial and economic crises (Arthur 2021, 140)

    Financial crises happen when small events trigger a cascade of further events that get out of control, or when a small group of players gains control of some part of the system140,141 to its own private advantage but to the detriment of the system as a whole. Thus, in Russia’s 1990s transition from communism to capitalism, a coterie of private players took control of the state’s newly freed assets for their own benefit and industrial production plummeted142,143. In California’s 2000 freeing of its energy market, a small number of suppliers manipulated the market to their own profit and the state’s finances suffered144. In the USA’s mortgage-backed securities market in 2008, financial institutions on Wall Street had obtained looser regulations and created exotic derivative products they greatly benefited from, which caused an unstable structure that spectacularly collapsed143,145. Each of these systems was manipulated or ‘gamed’, and all broke down. (Arthur 2021, 140)

    The consequences of economic collapse are serious. So why does equilibrium economics not warn us of these potential failures in advance? The reason is subtle: equilibrium economics is not primed to look for such possibilities. If we assume a system is in stasis or equilibrium, then, by definition, cascades of hazardous events and their consequences cannot happen, and, also by definition, players cannot find ways to manipulate the situation and improve their position. And so, a muted bias precludes the idea of collapse. Complexity, by contrast, sees the economy as a web of incentives open to further actions or to exploitation, so it disposes us to examine economic systems for where they might be open to manipulation or to systemic failure. (Arthur 2021, 140)

    Can we program computers to probe for weaknesses? I believe we can. We can model large policy systems and probe them, deliberately or automatically, to see where they might be exploited. We need to adopt such failure-mode practices from structural engineering, or aircraft design146, or encryption, and examine where economic systems have weak points and might be manipulated. Doing so would yield more reliable economic and social outcomes. (Arthur 2021, 140) (Arthur, W. Brian. Foundations of complexity economics. Nature Reviews | Physics. 2021 Feb; 3136-145.)

  4. Meta Capitalism
    June 17, 2022 at 11:35 pm

    Just What is “Useful Knowledge”?

    The real problem, which many great economists over the past hundred years have identified in their writing, is the lack of commitment within the profession toward honestly advancing useful knowledge. Many economists are confused here about the word “useful,” thinking that it must mean “having a direct application” as opposed to developing a better understanding of the world. This confusion then gets contorted, where an economist might think: I am more interested in understanding than direct application—therefore, why should I concern myself over what is “useful”? In turn, that alleged better understanding is confused with an interest in esoteric theory, which, more often than not, offers no better understanding. Rather, all that such esoteric theory really offers, in most cases, is a self-contained and self-serving exercise of mental self-gratification. This is where many theoretical economists are so impressed with the mathematics involved, and so proud of themselves for having the gray matter to handle that math, that they lose sight of the fact that their theory offers nothing valuable for anyone (beyond self-amusement), regardless of whether the work results in a technical journal article. (Payson, Steven. How Economics Professors Can Stop Failing Us (pp. 6-7). Lexington Books. Kindle Edition. https://a.co/5ihM0wQ)
    Most academic economists need to realize that it is not about any contrast between direct, practical application and higher understanding or theory. One’s “understanding” of phenomena, independent of direct practical application, can be useful or it cannot be useful. That is, by “useful” here I do not mean “applied” in contrast to “theoretical” knowledge—theoretical knowledge that is not applied can be extremely useful because anything that advances our true understanding of how the world actually works is inherently useful, even if the only immediate benefit is to grant us the satisfaction that we understand the universe better. In economics, knowledge that is not useful (if we go even as far as calling it “knowledge”) is typically literature that shows how certain published mathematical models, which usually have virtually no relevance to the real world, can be related to another newly created mathematical model which also has no relevance. Such useless “knowledge” is analogous to “knowledge” about what the next move should be in a particular chess game, after thirty moves have already been played, in a chess game that will never be repeated again by anyone in the world for the next hundred years. (Payson, Steven. How Economics Professors Can Stop Failing Us (p. 7). Lexington Books. Kindle Edition. https://a.co/ffR6uYj)

    At a minimum it seems that to honestly advancing useful knowledge one must be self-aware of any hidden ideological value judgements in one’s methodology.

  5. Meta Capitalism
    June 19, 2022 at 4:14 pm

    Economic research
    Economic research as it should be, is therefore a matter of trying to understand how the particular complex system in which we happen to live functions – or malfunctions – at any particular time, and to what sort of forces, pressures and policies it responds. Here one illuminating example is P. Chen’s (2021) demonstration, from real data, that exchange-rate crises “can only be caused by financial oligarchs”.

    My first instinct was to do a historical study of everything ever written about exchange-rate crises and oligarchs and see if the connection was ever made prior to P. Chen. It didn’t take long to find a potential example in Adam Tooze’s Crashed. Which came first (the chicken or the egg) is the question; the recognition of the relationship between oligarchs and financial crises or the mathematical modeling of what we already can see?

    China’s growth was spectacular. Huge profits were to be made for American investors. American manufacturers like GM would stake their future on China.17 After a brief storm over the Taiwan Strait in 1995–1996, diplomatic relations calmed. But China’s sheer size made it a contender. With the Tiananmen crackdown of 1989, the Communist Party had signaled its intent not to abandon its one-party leadership. Since then it had fashioned a popular ideology that was as much nationalist as Communist.18 If Washington was betting on international trade and globalization to “Westernize” China, the Chinese Communist Party took the other side of the bet.19 The party’s leaders wagered that supercharged growth would not weaken them but would consolidate their position as the successful helmsmen of their nation’s spectacular comeback. Beijing took advantage of trading opportunities. But it never subscribed to fully open markets. It decided who would invest and on what terms. It controlled movement of funds in and out. That, in turn, allowed the People’s Bank of China to fix its exchange rate, and since 1994 it had done so by pegging against the dollar. (Tooze, Adam. Crashed (pp. 31-32). Penguin Publishing Group. Kindle Edition.)

    In choosing a dollar peg, China was far from unique. Despite the reigning narrative of market liberalization, the financial world was not flat. The global monetary system was hierarchical with the key currency, the dollar, at the top of the pyramid.20 The twenty-first century began with a network of dollar-linked currencies accounting for c. 65 percent of the world economy (weighted by GDP).21 Those currencies that were not pegged to the dollar tended to be hooked to the euro. Often pegging was a sign of weakness. In many cases the exchange rate was set at an aspirational, overvalued rate. This created short-term advantages. It made imports cheap. Local oligarchs could snap up prestige foreign real estate at a discount. But it also harbored huge risk. The peg could break and frequently it would do so with a bang. The appearance of stability offered by a fixed exchange rate encouraged a large inflow of foreign funds, which helped to stoke up domestic economic activity, creating an unbalanced trade account funded from abroad. Banks that acted as the conduit for foreign funds boomed. This set up the crisis.22 When international investors lost confidence, the result was a devastating sudden stop. Then the central bank’s foreign exchange reserves would drain and it would have no option but to let the currency peg go. Stability would give way to a disastrous devaluation. Those who got their money out first would be saved. Those who had borrowed in foreign currency would face bankruptcy. (Tooze, Adam. Crashed (p. 32). Penguin Publishing Group. Kindle Edition.)

    This was the saga of the 1990s: 1994 in Mexico; 1997 in Malaysia, South Korea, Indonesia and Thailand; 1998 in Russia; 1999 in Brazil. It was containing these crises that earned US Federal Reserve chairman Alan Greenspan, Treasury secretary Robert Rubin, and Larry Summers, Rubin’s number two, the accolade of the “Committee to Save the World.”23 What happened when the American superheroes were not on hand was revealed in 2001. With the Bush administration fully distracted by the terror attack of 9/11, financial speculation built against Argentina. Despite a $22 billion loan from the IMF, without American backing the Argentinian position became untenable; 80 percent of Argentine private debt was in dollars, whereas only 25 percent of Argentina’s economy was export oriented.24 In December 2001, with dollars draining out of the country, the Argentine government suspended access to bank accounts. Amid rioting that claimed the lives of twenty-four people, the government collapsed. On December 24, 2001, Argentina announced the suspension of payments on $144 billion of public debt, including $93 billion owed to foreign creditors. The peso plunged in value from 1:1 to 3:1 against the dollar, bankrupting the dollar debtors. The economy reeled backward to levels not seen since the early 1980s. As the twenty-first century began, more than half of Argentina’s population fell below the poverty line.25 (Tooze, Adam. Crashed (pp. 32-33). Penguin Publishing Group. Kindle Edition.)

    China had no intention of becoming either the victim of a sudden stop or the needy recipient of US assistance.26 To reverse the balance of risk, when Beijing pegged its exchange rate it chose one that was not too high, but too low. This was what Japan and Germany had done in the 1950s and 1960s.27 It was a recipe for export-led growth, but it created tensions of its own. Undervaluing the currency made imports more expensive than they needed to be, which lowered the Chinese standard of living. When it ran a trade surplus with the United States and bought American government bonds, poor China was exporting capital to rich America, funding American consumers to buy the products of its huge new factories. Moreover, maintaining the artificially low peg was a battle in its own right. With China’s trade surplus with the United States surging from $83 billion in 2000 to $227 billion in 2009, to hold the value of the yuan down the Chinese central bank had to continually buy dollars and sell its own currency. To do so it printed yuan. In the normal course of things this would have unleashed domestic inflation, wiping out any competitive advantage and triggering social unrest. So, to “sterilize” the effects of its own intervention, the People’s Bank of China required all Chinese banks to hold large and growing precautionary reserves, effectively removing the currency from circulation. It was a profoundly unbalanced situation and one that could be sustained only because of the extremely tight relationship between the Chinese regime and the business elite, a relationship built on common affiliation to the Communist Party, coercion and mutual profit. Chinese businesses and their owners, the emerging oligarchs, profited spectacularly from a gigantic export-led development boom.28 Chinese peasants and workers chased the dream of urban prosperity. Meanwhile, Beijing’s giant foreign currency reserves were the best guarantee an uncertain global economy could offer that in case of a crisis, it would not be China’s sovereignty that was violated. Tooze, Adam. Crashed (pp. 33-34). Penguin Publishing Group. Kindle Edition. (Tooze, Adam. Crashed [How a Decade of Financial Crises Changed the World]. Kindle Edition ed. New York: Penguin Publishing Group; 2018; pp. 31-34.)

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