Thomas Kuhn once famously described textbooks as the vehicle by which students learn how to do “normal science” in an academic discipline. Economic textbooks clearly fulfil this function, but the pity is that what passes for “normal” in economics barely deserves the appellation “science”.
Most introductory economics textbooks present a sanitised, uncritical rendition of conventional economic theory, and the courses in which these textbooks are used do little to counter this mendacious presentation. Students might learn, for example, that “externalities” reduce the efficiency of the market mechanism. However, they will not learn that the “proof” that markets are efficient is itself flawed.
Since this textbook rendition of economics is also profoundly boring, the majority of those exposed to introductory course in economics do no more than this, and instead go on to careers in accountancy, finance or management – in which, nonetheless, many continue to harbour the simplistic notions they were taught many years earlier. Read more…
from Lars Syll
Most work in econometrics and regression analysis is — still — made on the assumption that the researcher has a theoretical model that is ‘true.’ Based on this belief of having a correct specification for an econometric model or running a regression, one proceeds as if the only problem remaining to solve have to do with measurement and observation.
When things sound to good to be true, they usually aren’t. And that goes for econometric wet dreams too. The snag is, of course, that there is pretty little to support the perfect specification assumption. Looking around in social science and economics we don’t find a single regression or econometric model that lives up to the standards set by the ‘true’ theoretical model — and there is pretty little that gives us reason to believe things will be different in the future.
To think that we are being able to construct a model where all relevant variables are included and correctly specify the functional relationships that exist between them, is not only a belief without support, but a belief impossible to support.
The theories we work with when building our econometric regression models are insufficient. No matter what we study, there are always some variables missing, and we don’t know the correct way to functionally specify the relationships between the variables.
Every regression model constructed is misspecified. There are always an endless list of possible variables to include, and endless possible ways to specify the relationships between them. So every applied econometrician comes up with his own specification and ‘parameter’ estimates. The econometric Holy Grail of consistent and stable parameter-values is nothing but a dream. Read more…
from Lars Syll
As Paul Romer’s recent assault on ‘post-real’ macroeconomics showed, yours truly is not the only one that questions the validity and relevance of DSGE modeling. After having read one of my posts on the issue, eminent statistician Aris Spanos kindly sent me a working paper where he discusses the validity of DSGE models and shows that the calibrated structural models are often at odds with observed data, and that many of the ‘deep parameters’ used are not even identifiable.
Interesting reading. And confirming, once again, that DSGE models do not marry particularly well with real world data. This should come as no surprise — microfounded general equilibrium modeling with inter-temporally optimizing representative agents seldom do.
This paper brings out several weaknesses of the traditional DSGE modeling, including statistical misspecification, non-identification of deep parameters, substantive inadequacy, weak forecasting performance and potentially misleading policy analysis. It is argued that most of these weaknesses stem from failing to distinguish between statistical and substantive adequacy and secure the former before assessing the latter. The paper untangles the statistical from the substantive premises of inference with a view to delineate the above mentioned problems and suggest solutions. The critical appraisal is based on the Smets and Wouters (2007) DSGE model using US quarterly data. It is shown that this model is statistically misspecified …
from Maria Alejandra Madi
Since the late 1980s, the World Bank has been defending a policy agenda that reinforces the free market model of endogenous economic growth where human capital plays an outstanding role since the acquisition of abilities would increase the productivity levels, and as a result, the income levels. In the model of endogenous growth, the evolution of the level of product per worker depends on the increase of productivity. Regarding the human capital model, the long run growth in each country is analysed considering the particular features of infrastructure and human capital. The divergences verified in the levels of product per worker among different countries can be attributed to the abilities accumulated by labour and to the infrastructure of the economies. The emergence and diffusion of the model of endogenous growth reflected the intellectual victory of the ideas about the supremacy of the competitive economic order and the rejection of interventionism to promote economic growth and social justice. Considering the relevant economic outcomes of this intellectual victory, the main question that arises in the context of economics education is: What is at stake in the economic discourse that privileges the economic competitive order as the pillar of economic growth?
The competitive order, as a necessary one, is the pillar of Hayek’s theoretical construction. Hayek’s economic discourse turns out to “naturalize” the competitive market as a superior arrangement. However, the “naturalization” of the competitive market – by considering it a “natural” arrangement – is overwhelmed by political interests that play a crucial role in the economic and political decision procedures, and in the institutional management of such issues.
Taking into account a real-world approach to economic growth, it is relevant to highlight the ideas of Keynes, Minsky, Kalecki, Rifkin in order to re-think current economic growth challenges
1. Uncertainty read more
from Lars Syll
The Coin-tossing Problem
My friend Ben says that on the first day he got the following sequence of Heads and Tails when tossing a coin:
H H H H H H H H H H
And on the second day he says that he got the following sequence:
H T T H H T T H T H
Which day-report makes you suspicious?
Most people I ask this question says the first day-report looks suspicious.
But actually both days are equally probable! Every time you toss a (fair) coin there is the same probability (50 %) of getting H or T. Both days Ben makes equally many tosses and every sequnece are equally probable!
The Linda Problem
Linda is 40 years old, single, outspoken, and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations. Read more…
from Asad Zaman
One of the core and central properties of markets is that they lead to increasing concentration of wealth at the top. This is because market allocations of goods and services respond to money, automatically conferring great power to those with wealth. For instance, market incentives lead to the production of luxury handbags and briefcases for plutocrats priced at $40,000+. According to the World Health Organisation (WHO), the price of one such bag can save more than 300 lives.
The extremely ugly realities of market societies are hidden from view because markets generate myths to glorify achievements, project illusions and conceal defects. Indeed, the creation of market myths is a second core and central property of markets, which is not mentioned in any current economics textbook. Market myths are crucial to the survival of market societies since knowledge of realities would lead to a revolution of the bottom 99% who are exploited by the super-rich. In this essay, we analyse a few of the central myths of market societies, and contrast them with the realities. read more
from Lars Syll
Oliver Hart and Bengt Holmström won this year’s ‘Nobel Prize’ in economics for work on applying contract theory to questions ranging from how best to reward executives to whether we should have privately owned schools and prisons or not.
Their work has according to the prize committee been “incredibly important, not just for economics, but also for other social sciences.”
Asked at a news conference about the high levels of executive pay, Holmstrom said,
It is somehow demand and supply working its magic.
Wooh! Who would have thought anything like that.
What we see happen in the US, the UK, Sweden, and elsewhere, is deeply disturbing. The rising inequality is outrageous – not the least since it has to a large extent to do with income and wealth increasingly being concentrated in the hands of a very small and privileged elite.
Societies where we allow the inequality of incomes and wealth to increase without bounds, sooner or later implode. The cement that keeps us together erodes and in the end we are only left with people dipped in the ice cold water of egoism and greed.
And all this ‘Nobel prize’ laureate manages to come up with is demand and supply ‘magic.’
Impressive indeed …
from Lars Syll
Many economists have over time tried to diagnose what’s the problem behind the ‘intellectual poverty’ that characterizes modern mainstream economics. Rationality postulates, rational expectations, market fundamentalism, general equilibrium, atomism, over-mathematisation are some of the things one have been pointing at. But although these assumptions/axioms/practices are deeply problematic, they are mainly reflections of a deeper and more fundamental problem.
The main problem with mainstream economics is its methodology.
The fixation on constructing models showing the certainty of logical entailment has been detrimental to the development of a relevant and realist economics. Insisting on formalistic (mathematical) modeling forces the economist to give upon on realism and substitute axiomatics for real world relevance. The price for rigour and precision is far too high for anyone who is ultimately interested in using economics to pose and (hopefully) answer real world questions and problems.
This deductivist orientation is the main reason behind the difficulty that mainstream economics has in terms of understanding, explaining and predicting what takes place in our societies. But it has also given mainstream economics much of its discursive power – at least as long as no one starts asking tough questions on the veracity of – and justification for – the assumptions on which the deductivist foundation is erected. Asking these questions is an important ingredient in a sustained critical effort at showing how nonsensical is the embellishing of a smorgasbord of models founded on wanting (often hidden) methodological foundations. Read more…
from Asad Zaman
If any group of concerned citizens would gather to discuss economic problems, it would seem natural to begin with the problem of feeding the hungry. Strangely enough, one would not encounter this problem within a standard course of study of economic theory at any of the leading universities throughout the world. This is due to two major mistakes made in the formulation of conventional economic theories currently being taught and practised throughout the globe. The first mistake is the idea that the goal of an economic system is the production of wealth, broadly defined. For example, Adam Smith takes the fundamental economic problem to be the production of wealth. The maximisation of GNP per capita currently forms the core of economic growth theory. The value of human life can be evaluated in terms of how much wealth the human can produce. This also accounts for the use of the degrading term ‘human resource’, which basically puts humans on a par with other resources, like factories and machines, as inputs to the production process.
A revolution in economic theory would result if we replace this completely mistaken idea with its opposite: the goal of an economic system is to increase human welfare. Wealth is important only to the extent that it can bring about increases in human welfare. In conjunction with wealth, many other types of invisible inputs, such as social capital, cultural norms and institutional structures also play an important role in determining human welfare, broadly understood in terms of all dimensions of life which contribute to our collective well-being. Wealth, industry and production of goods and services are resources to be used to help improve human lives. A central goal of economics should be the relation between resources, and their relative efficiency at contributing to human welfare. In particular, providing food to the hungry is clearly the single most important and universal invariant in production of human welfare. The fundamental economic problem is to study how to use a given amount of wealth to produce the maximum amount of welfare. read more
From today’s Guardian
The Nobel prize in economics takes too little account of social democracy
The Nobel prize in economics will be announced today. For economists, it is the pinnacle of reputation. When the word Nobel becomes attached to a winner’s name, his word acquires newsworthy authority (only one woman, Elinor Ostrom, has won the prize so far). The prize matters to everyone else too, because of market liberalism, which advocates marketisation, deregulation, union-busting, financialisation, inequality, outsourcing of healthcare, pensions and education, low taxes for the rich, and globalisation. In the 1990s, this rightwing platform was endorsed by New Labour, Clinton Democrats, and their equivalents elsewhere.
The faith in markets comes from economics. Confidence in economics is underpinned by the Nobel prize, which gives it scientific authority. Nobel economist Paul Samuelson quoted the poet William Blake: “Truth can never be told so as to be understood, and not to be believed.” There is also a Nobel prize for literature. Is the truth of economics more like physics or literature? How good a warrant does economics provide for the primacy of markets?
Like market liberalism, economics regards buying and selling in markets as the template for human relations and claims that market choices scale up to the social good. But the doctrines of economics are not well founded: premises are unrealistic, models inconsistent, predictions often wrong. The halo of the prize has lent credibility to policies that harm society, to inequality and financial disorder. Read more…
New paperback from WEA Books
A Philosophical Framework for Rethinking Theoretical Economics
and Philosophy of Economics
by Gustavo Marques
is now available from the Amazon pages listed below
This book argues that mainstream theoretical economics has been a basically misdirected effort at creating and exploring imaginary worlds with little practical use, rather than focusing on developing instruments to understand and explain real-world economic phenomena, Gustavo Marques’ new book shows how economic theory could be redirected so as to help find solutions to real-world problems.
Exposing the ungrounded pretensions of the mainstream philosophy of economics, Marques’ carefully argued book is a major contribution to the ongoing debate on contemporary mainstream economics and its methodological and philosophical underpinnings. Even those who disagree with his conclusions will benefit from his thorough and deep critique of the modeling strategies used in modern economics.
Lars Pålsson Syll, Malmö University, Sweden
Is ‘mainstream philosophy of economics’ only about models and imaginary worlds created to represent economic theories? Marqués questions this epistemic focus and calls for the ontological examination of real world economic processes. This book is a serious challenge to standard thinking and an alternative program for a pluralist philosophy of economics.
John Davis, Marquette University, USA and University of Amsterdam
In recent decades economists have focused heavily on the development and use of models. In this scholarly but accessible book Marques clearly describes the limitations of this approach and suggests alternative directions. It is a valuable addition to the armoury of anyone concerned about the nature of mainstream economics.
Stuart Birks, Massey University, New Zealand
In this book Gustavo Marqués, one of our discipline’s most dexterous and acute minds, calmly investigates in depth economics’ most persistent methodological enigmas. Chapter Three alone is sufficient reason for owning this book.
Edward Fullbrook, University of the West of England
Other reasonably priced WEA Paperbacks
Finance as Warfare by Michael Hudson
Developing an economics for the post-crisis world by Steve Keen
On the use and misuse of theories and models in mainstream economics by Lars Palsson Syll
Green Capitalism. the God That Failed by Richard Smith
40 Critical Pointers for Students of Economics by Stuart Birks
The European Crisis editors: Victor Beker and Beniamino Moro
Piketty’s Capital in the Twenty-First Century editors: Edward Fullbrook and Jamie Morgan
The Economics Curriculum: Towards a Radical Reformulation, editors: M. Alejandra and J. Reardon
from Lars Syll
Balliol Croft, Cambridge
27. ii. 06
My dear Bowley …
I know I had a growing feeling in the later years of my work at the subject that a good mathematical theorem dealing with economic hypotheses was very unlikely to be good economics: and I went more and more on the rules — (1) Use mathematics as a short-hand language, rather than as an engine of inquiry. (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important in real life. (5) Burn the mathematics. (6) If you can’t succeed in 4, burn 3. This last I did often …
There ought to be an enormous amount of burning going on at economics departments today. The market for smoke detectors must be peaking …
from Lars Syll
Lynn Parramore: It seems obvious that both fundamentals and psychology matter. Why haven’t economists developed an approach to modeling stock-price movements that incorporates both?
Roman Frydman: It took a while to realize that the reason is relatively straightforward. Economists have relied on models that assume away unforeseeable change. As different as they are, rational expectations and behavioral-finance models represent the market with what mathematicians call a probability distribution – a rule that specifies in advance the chances of absolutely everything that will ever happen.
In a world in which nothing unforeseen ever happened, rational individuals could compute precisely whatever they had to know about the future to make profit-maximizing decisions. Presuming that they do not fully rely on such computations and resort to psychology would mean that they forego profit opportunities.
LP: So this is why I often hear that supporters of the Rational Expectations Hypothesis imagine people as autonomous agents that mechanically make decisions in order to maximize profits?
Yes! What has been misunderstood is that this purely computational notion of economic rationality is an artifact of assuming away unforeseeable change.
Imagine that I have a probabilistic model for stock prices and dividends, and I hypothesize that my model shows how prices and dividends actually unfold. Now I have to suppose that rational people will have exactly the same interpretation as I do — after all, I’m right and I have accounted for all possibilities … This is essentially the idea underpinning the Rational Expectations Hypothesis …
LP: So the only truth is the non-existence of the one true model?
RF: It’s the genuine openness that makes our ideas – and education – more exciting. Students can think about things in an open, yet structured way. We don’t lose the structure; we just renounce the pretense of exact knowledge …
Economists may fear that acknowledging this limit would make economic analysis unscientific. But that fear is rooted in a misconception of what the social scientific enterprise should be. Scientific knowledge generates empirically relevant regularities that are likely to be durable. In economics, that knowledge can only be qualitative, and grasping this insight is essential to its scientific status. Until now, we have been wasting time looking for a model that would tell us exactly how the market works.
LP: Chasing the Holy Grail?
RF: Yes. It’s an illusion. We’ve trained generation after generation in this fruitless task, and it leads to extreme thinking.
from Thomas Palley
I received an e-mail from an undergraduate economics student who was curious about economic policy in Washington, DC. His question says a lot about the current state of affairs. Here it is with my reply.
From: Xxxxxxx Xxxxxxx [mailto:firstname.lastname@example.org]
Sent: Saturday, October 1, 2016 10:56 AM
Subject: Question from an undergraduate
Dear Dr. Palley,
I am a first-year undergraduate in economics and political theory, and a longtime admirer of your work.
What are your thoughts on how Keynesian/Post-Keynesian ideas are treated in current political discourse?
I was in Washington D.C. recently and I had conversation with a Brookings fellow who told me that he thought Joseph Stiglitz was an “extremist who isn’t taken seriously by anyone who knows their way around the Beltway.”
Does it worry you that ideas which used to be considered “mainstream” (like social democracy) are now increasingly considered “extreme”?
Deeply grateful for your time and attention
From: Thomas Palley [mailto:email@example.com]
Sent: Saturday, October 1, 2016 3:59 PM
To: ‘Xxxxxxx Xxxxxxx’
Subject: RE: Question from an undergraduate
Dear Xxxxxxx, Read more…
The potential future costs of financial fragility and asset price bubbles raise the prospect of policy whiplash effects due to contradictions between current and future policy actions.
The economy currently suffers from shortage of AD owing to systemic failings related to income inequality and trade deficit leakages. That demand shortage was papered over by a thirty-year credit bubble plus successive asset price bubbles, which eventually burst with the financial crisis of 2008. Now, central banks are seeking to revive AD via negative interest rates that will reflate the credit and asset price bubbles.
This policy is based on a contradiction. If it is successful, it will necessitate raising interest rates in future. That risks triggering another financial crisis as the new bubbles burst and the effects of accumulated financial fragility magnify the ensuing fallout. When asset prices are inflated, subsequent very small upward moves in the interest rate can produce large capital losses. In effect, policy measures to revive the economy now via NIRP can generate even greater imbalances that produce whiplash effects later.
This whiplash dynamic has been building over the past thirty years. Disinflation allowed successive lowering of interest rates from their double digit levels of 1980, thereby producing successively larger boom – bust cycles. That process appeared to be ended by the financial crisis of 2008 which pushed the economy to the ZLB. However, central banks are now seeking to circumvent the ZLB circuit-breaker via NIRP. If NIRP is pursued for an extended period of time, without remedying the deep causes of AD shortage, the prospect is a future more intractable economic crisis.
Negative interest rates or 100% reserves:
alchemy vs chemistry
Herman Daly [University of Maryland, USA]
The close connection of fractional reserve banking with alchemy was recently emphasized by Mervyn King, former head of the Bank of England, in the very title of his recent book, The End of Alchemy: Money, Banking, and the Failure of the Global Economy. He refers to the more thorough development of this connection by Swiss ecological economist H. C. Binswanger in his brilliant study, Money and Magic. Given this connection to alchemy, it is more than a coincidence that the earliest and most thorough critique of fractional reserve banking came not from an alchemist but from a real chemist, Nobel Laureate Frederick Soddy (See H. Daly, “The Economic Thought of Frederick Soddy”, History of Political Economy, 1980, 12:4). Soddy’s advocacy of full reserve banking was later picked up by Irving Fisher, and by Frank Knight and others of the Chicago School. Mervyn King stops short of advocating full reserve banking, but clearly is unhappy with the fractional reserve system.
For a group that has helped change the way economics is taught at universities up and down Britain, the Post-Crash Economics Society had a less than momentous start. It was November 2012 when seven undergraduates met in a cramped room on the top floor of Manchester university’s student union. Chairs drawn into a semi-circle, they listened as the two founding members went through a brief PowerPoint presentation explaining what they thought was wrong with the economics curriculum. A polite discussion followed before everyone shuffled off for the Christmas holidays. It wasn’t exactly Paris 1968.
The students had gathered in response to an email with the subject line: “CALL OUT TO ALL THE ECONOSCEPTICS OUT THERE”. “In the middle of the biggest global recession for 80 years,” the email read, “students across the world are questioning the very foundations of our discipline.”
It asked whether the economics they were learning, dominated by mathematical formula and abstract models, was relevant to the real world. “How far can economics be called a real science?” it prodded, an allusion to academic economists’ tendency to present their equations and mathematical identities as iron laws rather than imperfect attempts to model unpredictable human interactions. Isn’t economics, they suggested, really more like politics than physics?
The Post-Crash Economics Society was not alone in feeling this way. Ha-Joon Chang, a developmental economist who teaches at Cambridge, remembers “students banging on my door, saying, ‘There’s the biggest financial crisis since 1929 going on around us and our professors teach as if nothing has happened.’ ”
In 2011, students at the university set up the Cambridge Society for Economic Pluralism, galvanised by attending a corporate-sponsored, casino-themed ball run by the Marshall Society, the official Cambridge economics society, at which attendees sipped champagne and talked about jobs in the City. It was, says PhD student and co-founder Rafe Martyn, aimed at those “who learn economics to make the world a better place rather than just improve their private-sector employability”. Similar societies began to take root on other campuses.
It is hardly surprising that after the sharpest economic crisis since the Wall Street crash and an even more prolonged sense of malaise, which has provoked political upheavals across Europe and the US, the economics profession is under profound pressure.
The economic “experts” who told us we had solved once and for all the problems of boom and bust and who ignored — even celebrated — widening inequality in most advanced countries have proved wantonly lacking in their powers of prediction and remedy. What is perhaps more striking is the determination of many in the economic establishment to defend their turf. Chang laments that economics, like other disciplines defended by tenured academics, progresses one funeral at a time.
from Lars Syll
The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, usually — incorrectly — referred to as the Nobel Prize in Economics, is an award for outstanding contributions to the field of economics. The Prize in Economics was established and endowed by Sweden’s central bank Sveriges Riksbank in 1968 on the occasion of the bank’s 300th anniversary. The first award was given in 1969. The award this year is presented in Stockholm at a ceremony on Monday 10 October.
Avner Offer’s and Gabriel Söderberg’s new book — The Nobel factor: the prize in economics, social democracy, and the market turn (Princeton University Press 2016) — tells the story of how the prize emerged from a conflict between the Swedish central bank — Sveriges Riksbank — and social democracy. It is no pure coincidence that the ascendancy of market liberalism, Reagan and Thatcher, to a large part coincides with the creation and establishment of the prize. Especially during the despotic Assar Lindbeck’s long chairmanship — 1980-1994 — the prize was thought to take advantage of the connection with the true Nobel prizes and spearhead a market-oriented neoliberal reshaping of the world. Although not all economists who have got the prize have enlisted in the market-liberal crusade, it is still an undeniable fact that neoliberal and conservative leaning male economists are highly over-represented among the laureates. Their often ideologically biased doctrines have to a large extent motivated the neoliberal turn in economic policies for more than forty years. Read more…
Negative interest rates or 100% reserves: alchemy vs chemistry 2
Herman Daly download pdf
Why negative interest rate policy is ineffective and dangerous 5
Thomas I. Palley download pdf
Japan’s liquidity trap 15
Tanweer Akram download pdf
Paul Romer’s assault on ‘post-real’ macroeconomics 43
Lars Pålsson Syll download pdf
Another reason why a steady-state economy will not be a capitalist economy 55
Ted Trainer download pdf
Using regression analysis to predict countries’ economic growth: 65
illusion and fact in education policy
Nelly P. Stromquist download pdf
Can a country really go broke? Deconstructing Saudi Arabia’s macroeconomic crisis 75
Sashi Sivramkrishna download pdf
Reconsideration of the Prebisch-Singer Hypothesis 95
Ewa Anna Witkowska download pdf
Industrial policy in the 21st century: merits, demerits and how can we make it work 109
Mohammad Muaz Jalil download pdf
Review of James Galbraith, Welcome to the Poisoned Chalice 124
Michael Hudson download pdf
A travesty of financial history – which bank lobbyists will applaud 129
Michael Hudson download pdf
Capitalism, corporations and ecological crisis: a dialogue concerning Green Capitalism 136
Richard Smith, William Neil and Ken Zimmerman download pdf
Board of Editors, past contributors, submissions and etc. 146