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Adam Smith’s bad history leads to bad economics

March 15, 2019 2 comments

from Asad Zaman

Guest Post by Donni Wang [author details at bottom of post]. Republished from The Economic Historian blog: “No Go from the Get Go: Adam Smith’s Bad History, Lessons from Ancient Greece, and the Need to Subsume Economics” – She is a historian, and argues here that a false history which portrays progression and progress actually seals off alternatives and choices which we could, and indeed need to, make today. Correcting Adam Smith’s views about history of mankind, using lessons from Ancient Greece, thus creates new possibilities for us today.

WORLDVIEWS THAT gain traction tend to be comprehensive in nature. They account for a wide range of phenomena that define the human condition, one of which being the changes that occur to society over time. This is true also for capitalism as an extensive body of thought. Although there is much emphasis placed on the modern epoch that features the rise of the industrial nation in the West, the weltanschauung of capitalism does supply a neat story of human development that extends back to earlier periods.

The obvious source for this narrative is to be found in the writing of Adam Smith.  Having been rightly credited as the father of capitalism, Smith has contributed much to the overall coherence of the market system by reinforcing it with a supportive philosophical foundation. In fact, his narrative of the past, which is still being circulated in contemporary textbooks and popular discourse, has not only rationalized the ascent of market forces in 18th century Europe, it also validated the major assumptions that undergird orthodox economic thinking today.

The historical account proffered by Smith, however, does not hold up even to the most basic test. read more

Islam’s gift: an economy of spiritual development

February 4, 2019 17 comments

from Asad Zaman

My article with the title above is due to be published in the next issue of the American Journal of Economics and Sociology (2019). This was written at the invitation of the editor Clifford Cobb, as an introduction to Islamic Economics for a secular audience. The Paper explains how modern economics is deeply flawed because it ignores the heart and soul of man, and assumes that the best behavior for humans is aligned with short-sighted greed. Islam provides a radically different view, showing how generosity, cooperation, and overcoming the pursuit of desires leads to spiritual progress. Islam seeks to create a society where individuals can make spiritual progress and develop the unique and extraordinary capabilities and potentials which every human being is born with. Pre-print – to appear in American Journal of Economics and Sociology, 2019 – is available for view/download at the bottom of this post.

As an excerpt, I am posting Section 2 of the paper, entitled

The Flawed Foundations of Modern Economics

The defeat of Christianity in a battle with science led to an extraordinary respect and reverence for scientific knowledge, sometimes called the “Deification of Science,” in Europe (Olson 1990; Zaman 2015a).   This had fatal consequences. Even though all scientific knowledge is inherently uncertain, a concerted effort was made to prove the opposite—that scientific knowledge is not only certain, but it is the only source of certain knowledge.  Because of distortions necessary to prove something which was not true, the methodology of science was dramatically misunderstood by the logical positivists. read more

Perils of exchange rate miss-alignment

January 26, 2019 5 comments

from Asad Zaman

As I have only recently come to realize, stabilizing the exchange rate at the wrong level can have massively harmful effects. One can trace major economic tragedies to such attempts. The British attempt to go back to the gold standard after post WW1 failed because they set the level too high (as Keynes pointed out). This attempt set of a sequence of events which had far reaching consequences. A similar story is told about Pakistan in “The Rupee is falling; let it crash”. Linked article shows that overvaluation of Pak Rupee de-linked the Pakistan and Indian Economies, which may the economic root of current political hostilities. Current problems of the European Union are a more advanced version of the same problem, where the rate of exchange between European countries cannot be re-aligned according to the gaps between their imports and exports. This is a subject worth exploring further, and if readers have more pointers/articles, I would appreciate learning more about it. The article below deals with the Dutch Disease in Pakistan.  read more

Fisher’s debt deflation theory of financial crises

January 18, 2019 Leave a comment

from Asad Zaman

This post is the third part of lecture 8 of Advanced Macro L08C: Fisher’s Debt-Deflation Theory of the Great Depression. In previous segments of this lecture L08A: Micro-Foundations for Keynesian Economics, and L08B: Keynesian Explanation for Great Depression: Seriously Incomplete, we examined the Keynesian explanation for the Great Depression, and found serious deficiencies in it. L08A explains that many different kinds of outcomes, with and without unemployment, are possible depending on how we specify details of the micro-structure that Keynes failed to specify. L08B explains that a simple deficiency in aggregate demand created by savings does not suffice to create unemployment because savings of current period is income/wealth of the next. It is necessary to look at abnormal savings, together with fixed prices, to create surplus production which signals shortfall in aggregate demand to the producers. Thus, many elements – micro-structure, role of debt, and different sectors of the economy – must be added to the Keynesian model to achieve the outcome of unemployment due to shortfall in aggregate demand that is at the center of Keynesian analysis.  read more

Romer’s trouble with macro

January 2, 2019 32 comments

from Asad Zaman

Let us start with Five Fundamental propositions, which would be startling to the general public, but familiar to my current audience of heterodox economists.

  1. Mainstream modern economic theory is complete garbage. This is true of Micro, Macro, Econometrics, Trade, Monetary, Industrial Organization — EVERYTHING.
  2. It is very EASY to prove this assertion. Fundamental principles on which the entire discipline is built are easily proven to be wrong. The axiomatic theory of human behavior encapsulated in homo economicus has no match to real human behavior. The theory of perfect competition devised to explain prices and markets has no relation to the realities of oligopolies, multinationals, excess production, and shaping of demand by advertisements and culture. The welfare theory implicit in maximization of lifetime utility is exceedingly harmful to our human welfare, which comes from social associations and character traits, rather than excess consumption. The optimization/equilibrium methodology is a complete failure. Humans do not and cannot optimize; they lack the information required to do so. Dynamic systems cannot be understood by looking at their equilibria. Standard econometrics techniques can be used to prove anything at all, given any data. In any place you look, the theory is flawed beyond belief. The young earth theory, as well as the flat earth theory are more defensible, in comparison.
  3. Many leading economists are aware of the astonishing conflicts between economics and simple facts of observation. See “Quotes Critical of Economics“ for a choice collection of quotes to prove this assertion.
  4. The Global Financial Crisis of 2007 created widespread public awareness of this catastrophic failure of Economics. The Queen of England went to London School of Economics to ask why no one saw this coming. The US Congress appointed a commission to study why economists not only did not foresee the crisis, they confidently predicted that such an event could not happen. read more

Class-conflict theory of inflation

December 27, 2018 4 comments

from Asad Zaman

Economists do not understand inflation. Daniel K. Tarullo. Former Governor, Federal Reserve Board should surely be in a position to know. I will list some key conclusions from his paper with the revealing title:  Monetary Policy Without a Working Theory of Inflation :

  1. We do not, at present, have a theory of inflation dynamics that works sufficiently well to be of use for the business of real-time monetary policy-making
  2. Many … good monetary policymakers … have an almost instinctual attachment to some of those problematic concepts and hard-to-estimate variables.
  3. (Nonetheless!) Going forward, monetary policy decisions will need to be made with as much, if not more, emphasis on the constellation of observable indicators with which the FOMC is confronted
  4. (Despite all this!) Macroeconomists (should) continue to play a decidedly leading role.

The italicized words are mine, not in Tarullo’s paper. If we pause to reflect, these are breathtaking conclusions. Tarullo says — quite clearly and explicitly — that current theories of inflation are NOT of use for real-time monetary policy. Furthermore, despite their evident failure, economists are blindly attached to these theories — they are “ unmoved by lack of correspondence between their theories and facts of observation “. But, regardless of these, for reasons that I could not fathom, Tarullo advocates going forward with using current constellation of observable indicators, and having the blind macro-economists continue to play a leading role in monetary policy decision making.

The real reason that economists do not understand inflation is because it is an outcome of the class struggle between laborers and capitalists. This topic is taboo in conventional economic theory — it has been ruled out of bounds of the subject, and to study it is to commit professional suicide.  read more

Demise of the Dollar?

December 11, 2018 Leave a comment

from Asad Zaman

SADLY, it is true that ‘money makes the world go round’. But, it is also true that very few people understand how. This article is an attempt at explaining the basics of our global trading system.

A good starting point is the Bretton-Woods conference which took place in 1944, while the Second World War was still raging. The two World Wars had drained the treasuries of the European states, making the gold standard impossible to maintain. An entirely new system had to be created to enable global trade for the post-War era. At the Bretton-Woods conference, the most sensible proposal for the global trading system was created and advocated by John Maynard Keynes. Unfortunately, the political power of the United States enabled it to quash this proposal. Instead, gold was replaced by the dollar standard, with the proviso that dollars could be exchanged for gold.

When the Vietnam War forced the US to print an excessive amount of dollars, president Richard Nixon declared in 1971 that dollars would no longer be backed by gold, creating a brave new world of currencies without any backing. Just like a fixed exchange rate is the natural consequence of pegging currencies to dollar or gold, so too a floating exchange rate system emerges naturally when there are no pegs for any currency

Today, the dollar is at the centre of the global trading system, and is as good as gold once was. Everyone needs dollars as reserves to back up their currencies. To acquire dollars, all countries other than the US, must strive to increase exports — this is how one earns dollars. The US can increase imports just by printing dollars, while the rest of world exports goods and services to earn dollars. Because dollars are the gold of the modern financial system, the US can print money without adverse consequences. For instance, the US printed trillions of dollars to finance the Iraq war, and other trillions to bail out the financial sector from the global financial crisis that was created by it. read more

We all use glasses to see the world.

November 27, 2018 2 comments

from Asad Zaman and the current issue of RWER

The outcome of all this discussion can be summarized metaphorically by saying that we all use glasses to see the world. The direct world out there is a jumble of sensations – a matrix of points – which makes no sense by itself, and must be interpreted using our own frameworks, represented by the glasses. This means that ALL observations are tinged with subjectivity, and interpreted within the frameworks created by our past experiences, successes and failures, in viewing the world.

A paradigm shift occurs if we remove the glasses we use to view the world, and instead put on a different pair of glasses. A famous experiment  conducted by Professor Theodor Erismann, of the University of Innsbruck put reversing glasses on his student and assistant Ivo Kohler. It caused extreme disorientation and discomfort at first, but after about a week of stumbling around, he adapted to this new way of seeing the world. His subjective interpretative equipment learned to interpret the reversed image by performing an additional reversal within the brain to arrive at a correct image of the world. Now, when the glasses were removed, the world appeared to be upside down to Ivo.  On a much larger scale, this is what happened in Europe due to the Great Transformation[1] which transformed traditional society to a market society, where everything is viewed a commodity for sale.  Later, these ways of thinking were spread throughout the world by colonization and Western education. We learned to value everything according to its market price, and forgot that the most precious things cannot be purchased. Then it became easy to kill a million children, and destroy entire nations, for corporate profits.  Read more…

Keynesian explanation of unemployment: seriously Incomplete

November 23, 2018 3 comments

from Asad Zaman

This post is Lecture 8B — from 17m to 37m of video lecture linked at bottom of post. It attempts to make sense of the Keynesian explanation of unemployment based on insufficient aggregate demand. It concludes that several elements missing from Keynes must be added to get to a satisfactory explanation.

 Friedman’s Methodology  leads to crazy models: In previous post (  Lecture 8A – Microfoundations for Keynesian Economics ), we showed that even small differences in the micro-foundations could lead to very large differences in the macro outcomes. Depending on how we choose micro-foundations, we can get almost any result we like at the macro level. So the question arises: HOW should we construct our micro-foundations? How can we choose among the wide variety of possible micro-structures. This leads to a very serious methodological issue of what models are and how they relate to reality. On this topic, see my detailed discussion in post on “Models and Reality“. Briefly, the standard POV adopted in neoclassical textbooks is that the only job of models is the provide a match to observations. The inner details of the models can be arbitrary.  However neoclassical economists insist that a good model must have optimizing behavior by all agents, and the equilibrium outcome of the model should match observations. There is no requirement for models to be realistic.   read more

Micro-foundations for Keynesian Economics

November 17, 2018 21 comments

from Asad Zaman

  Lecture 8A of Advanced Macroeconomics   — Outline below covers the first 17m of the lecture linked below at bottom of post.

1. EXCESS Savings reduce Effective Demand, Normal Savings Do Not

It seems clear that shortfalls in aggregate demand can lead to recessions, but only in presence of fixed prices. Furthermore, normal levels of savings cannot create such shortfalls – an abnormally high level of savings is required. This is because of factors discussed in “ The Subtleties of Effective Demand ”. Basically, if a normal level of savings is reduced from Aggregate Demand, this money is saved and goes on to period T+1. Similarly, the savings of last period T-1, is going to come into the present period T. This will exactly offset the shortfall in Aggregate Demand created by the savings. However, this will not happen if for some reason there is EXCESS savings, over and above normal levels. This excess S(T) > S*  will be not be compensated fully by S(T-1)=S*, where S* is the normal level of savings.

What could lead to abnormally high savings? It appears that debt can force people to earn money to pay off debt, reducing aggregate demand. Thus it appears that the Keynesian mechanism for creating unemployment as an equilibrium phenomenon relies on debt – without explicit mention. Once the role of debt is highlighted as the source of shortfall in aggregate demand, we examine in detail Fisher’s theory of Debt-Deflation, which never received the prominence that Keynes did. In the recent times, this theory has been resurrected, and is solidly backed by empirical evidence. See: Fisher-Minsky-Koo theory of debt-deflation.

2. Empirical Evidence favors Keynes Conjectures   read more

 

Modern Monetary Theory

November 4, 2018 5 comments

from Asad Zaman

In a rapidly changing world, ways of thinking which served us well in other eras, become obstacles to understanding, and reacting appropriately to change. Traditional economic theories, currently being taught all around the world,blinded economists to the possibility of the global financial crisis.The Queen of England went to London School of Economics to ask why “no one saw it coming?”.The US Congress appointed a committee to study why economic theories “dismissed the notion that a financial crisis was possible”. At the heart of this failure arewrong ideas about the role of money in the economy. All major schools of macroeconomics currently being taught around the globe teach that the quantity of money only affects the prices, and does not have any other effects on the real economy. Economists write that “money is a veil” – it hides the workings of the real economy, but does not play any role in it. Economists were blindsided by the crisis because models currently in use for policy making do not have a role for money, credit, banking, and debt, even though these were the factors responsible for the Global financial crisis.

The crisis made clear to all and sundry the vital role of money in the economy. Surprisingly, the mainstream economics profession has been extremely resistant to change. The same textbooks, theories and models which failed so drastically, continue to be used in teaching and policy making throughout the world. However, the space for unorthodoxy has expanded substantially, and a lot of new theories of money have emerged to challenge mainstream views.  read more

Models and Reality

September 30, 2018 1 comment

from Asad Zaman

The subtleties of effective demand

September 25, 2018 6 comments

from Asad Zaman

As I read more and more about effective demand, I got more and more confused — how can I explain this concept to my poor students, if I don’t understand it myself? There are a huge number of articles with different and conflicting views and interpretations of this concept, which Keynes describes as being central to his theory. Let me proceed to clarify the insights that have resulted from struggling with this material, and going through many iterations of revisions in terms of how to make sense of this theory.

Keynes and followers — both the Hicks-Hansen-Samuelson variety, as well as true blue post Keynesians — argue that it is deficiencies in the Aggregate Demand which lead to the unemployment equilibrium which is central to Keynesian economics. Stated in very simple terms, the argument can be phrased like this. The process of production generates factor incomes. These incomes are exactly the source of the demand for the product. If all the income generated is always spent on purchase of products, then the aggregate demand will exactly equal the aggregate supply — this is Say’s Law. In this case, there is no concept of shortfall in aggregate demand which could lead to unemployment.

However, Keynes and his followers deny the equality. They argue that some portion of the factor income could go into savings, thereby lowering the aggregate demand. Now the aggregate demand could be greater or lesser than the aggregate supply. An equilibrium would occur when the two are the same, but there is no guarantee that this equilibrium would occur at full employment. The standard diagram used to illustrate this idea is given below:  read more

Kant’s blunder

September 20, 2018 26 comments

from Asad Zaman

What is a model? How does it relate to reality? This question has been discussed thoroughly in previous post on  Models and Reality , and briefly in previous lectures. Western understanding of models was derailed by a complex set of historical accidents. This is a tangled tale with bewildering twists and turns, some aspects of which are discussed in “Deification of Science and Its Disastrous Consequence“, and some others in Logical Positivism and Islamic Economics . The reason we need to tell this story is because without understanding it, it is impossible to understand why Friedman could say, without being laughed out of court, that “Truly important and significant hypotheses will be found to have “assumptions” that are wildly inaccurate descriptive representations of reality, and, in general, the more significant the theory, the more unrealistic the assumptions.” Similarly, how could Lucas and Sargent make assumptions that are certifiably crazy, and receive Nobel Prizes and accolades? To understand why completely crazy understanding of models currently dominates the economics profession, it is necessary to understand some aspects of this story. Nonetheless, it is too long and difficult a task, so we will vastly oversimplify, and pin all the blame on poor stodgy German philosopher Kant — not that he does not deserve a lot of blame, but he also had a lot of accomplices, both before and after. A more nuanced account must be left for a much longer treatment by someone much more knowledgeable about Western philosophy and intellectual history. For students of economics, a brief explanation can be provided by looking at a key turning point, called a “Copernican Revolution” by Kant himself.  read more

Simple model explains complex Keynesian concepts

September 16, 2018 5 comments

from Asad Zaman

In the context of the radical Macroeconomics Course I am teaching, I was very unhappy with the material available which tries to explain what Keynes is saying. In attempting to explain it better, I constructed an extremely simple model of a primitive agricultural economy. This model has a lot of pedagogical value in that it can demonstrate many complex phenomenon in very simple terms. In particular, Keynesian, Marxists, Classical and Neo-Classical concepts can be illustrated and compared within our model. We will show the failure of all neoclassical concepts of labor, Supply and Demand, equality of marginal product, value theory —  the whole she-bang — in an intuitive and easy to understand plausible model of a simple economy.  read more

Summary of Stiglitz on monetary policy

September 7, 2018 1 comment

from Asad Zaman

After the Global Financial Crisis, there has been a lot of re-thinking about Monetary Policy, as one might expect. In fact, in light of the magnitude of the failure, re-thinking efforts have been much less than proportional. There are many, many, different strands of thought, and personally, I do not have clarity on what needs to be done. Furthermore, the situation is rapidly changing, so that a solution for today would not be a solution for tomorrow.  The fundamental problem is private sector creation of money, and nobody wants to discuss this elephant-in-the-room. But there may be a good reason for this unwillingness — with the financial sector is firmly in control of the US Government, and the Euro area, it does not seem politically feasible to think about radical alternatives. The goal of this post is just to summarize a paper of Stiglitz expressing his post-GFC thoughts on Monetary Policy — without much in the way of comments and discussion. The full paper itself is linked at the bottom of the post.

Summary of Joseph Stiglitz paper on monetary policy:  read more

Changing the Economics Curriculum

September 3, 2018 15 comments

from Asad Zaman

Introduction:

How does it happen that we have given our quiet assent to a situation where the richest 85 individuals have more money than the bottom 3.5 billion? Where vultures wait for starving children to die, while others eat luxurious meals on private resort islands? Where horrendous military and commercial crimes leading to deaths, misery, and deprivations of millions are routinely committed by highly educated men with multimillion dollar salaries in luxury corporate and government suites?

A core component of the answer to these critical questions is that we have been educated to believe that this is a normal state of affairs, which comes about through the operation of iron laws of economics. Economic theories currently being taught in universities all over the world are an essential pillar which sustains the economic system currently in operation.  These theories state that we (human beings) are cold, callous, and calculating. Microeconomic theory says rational individuals are concerned only with their own consumption. They are callous; completely indifferent to the needs of others. They maximize, calculating personal benefits to the last penny. They are cold – their decisions are not swayed by emotions of any kind. All this theorizing is not without power – it creates the world we live in, and the rules we live by.

We have even been taught that laissez-faire automatically brings about the best possible outcomes. We are told that the rich are efficient wealth producers and deserve their wealth, just as the poor deserve their poverty. To create a labor market to sustain capitalist production processes, we have been trained to believe that our lives are for sale to the highest bidder.  read more

Methodology of Modern Economics

August 6, 2018 12 comments

from Asad Zaman

My paper is a survey of the huge amount of solid empirical evidence against the utility maximization hypothesis that is at the core of all microeconomics currently being taught today in Economics textbooks at universities all over the world. It is obviously important, because if what it says is true, the entire field of microeconomics needs to be re-constructed from scratch. Nonetheless, it was summarily rejected by a large number of top journals, before being eventually published by Jack Reardon as: ” The Empirical Evidence Against Neoclassical Utility Theory: A Review of the Literature,”  in International Journal of Pluralism and Economics Education, Vol. 3, No. 4, 2012, pp. 366-414.   Speaking metaphorically, my paper documents the solid evidence that the earth is a round sphere in world where educational institutions teach the widely held belief that the earth is flat. Readers of RWER blog will recall that when challenged on the failure of macroeconomics after the Global Financial Crisis, economists retreated to the position that while macro theory may be in a bad shape, at least Microeconomics is solidly grounded. My paper blows this claim out of the water. As a result, nothing is left of Micro and Micro, and of economics as whole. This supports my earlier claim that a Radical Paradigm Shift is required to make progress — patching up existing theories cannot work.

None of the several leading journals that I sent the paper to made any comments about any mistakes in my arguments. There were two main reasons which were stated for rejections.  read more

Quotes critical of economics

July 28, 2018 Leave a comment

from Asad Zaman

This is an assorted collection of quotes I have found useful from time to time in different contexts. I am putting them all together for my own reference, as well as for the benefit of others who may find them similarly useful to make points.

JM Keynes Quotes (mostly from General Theory GT):

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. (GT)

It is an extraordinary example of how, starting with a mistake, a remorseless logician can end up in bedlam. (GT)

It is astonishing what foolish things one can temporarily believe if one thinks too long alone, particularly in economics (along with the other moral sciences), where it is often impossible to bring one’s ideas to a conclusive test either formal or experimental. (GT)

For if orthodox economics is at fault, the error is to be found not in the superstructure, which has been erected with great care for logical consistency, but in a lack of clearness and of generality in the premisses – (GT)

For professional economists, after Malthus, were apparently unmoved by the lack of correspondence between the results of their theory and the facts of observation;— a discrepancy which the ordinary man has not failed to observe, with the result of his growing unwillingness to accord to economists that measure of respect which he gives to other groups of scientists whose theoretical results are confirmed by observation when they are applied to the facts. (GT)  read more

The Invisible Hand

July 22, 2018 20 comments

from Asad Zaman

This post is a continuation of ET1%: Blindfolds Created by Economic Theory, We show how the Invisible Hand theory appears to be neutral but actually favors the top 1%.

As quoted and refuted in my earlier post on “Failures of the Invisible Hand“, Mankiw writes that: “The reason for excellent functioning of decentralized market economies is that all participants are motivated by self-interest. This self-interest works better than love and kindness in terms of promoting social welfare.”  

What a monstrous statement! How can any human being think such thoughts? This is what comes from cutting off human experience as a source of knowledge, removing hearts from bodies, and leaving only brains floating in vats as a the sole source of knowledge.

Our hearts — in their pure states –would revolt at the oxymoron of a society based on selfishness. However, contamination by the poisons of economic theory and positivism leads to the blindness to sources of human welfare displayed in the Mankiw quote. In earlier times, A Christmas Carol of Dickens was sufficient as a reminder the wealth is not a measure of welfare. However, modern times reflect modern mindsets, which convert greed and wealth to desirable virtues, as reflected in the Disney version of Uncle Scrooge. So it becomes necessary to argue on logical grounds, appealing to brains in vats, instead of appealing to the heart.   read more