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Cherry picking economic models

July 23, 2016 3 comments

from Lars Syll

Chameleons arise and are often nurtured by the following dynamic. First a bookshelf model is constructed that involves terms and elements that seem to have some relation to the real world and assumptions that are not so unrealistic that they would be dismissed out of hand. The intention of the author, let’s call him or her “Q,” in developing the model may to say something about the real world or the goal may simply be to explore the implications of making a certain set of assumptions. Once Q’s model and results become known, references are made to it, with statements such as “Q shows that X.” This should be taken as short-hand way of saying “Q shows that under a certain set of assumptions it follows (deductively) that X,” but some people start taking X as a plausible statement about the real world. If someone skeptical about X challenges the assumptions made by Q, some will say that a model shouldn’t be judged by the realism of its assumptions, since all models have assumptions that are unrealistic. Another rejoinder made by those supporting X as something plausibly applying to the real world might be that the truth or falsity of X is an empirical matter and until the appropriate empirical tests or analyses have been conducted and have rejected X, X must be taken seriously. In other words, X is innocent until proven guilty. Now these statements may not be made in quite the stark manner that I have made them here, but the underlying notion still prevails that because there is a model for X, because questioning the assumptions behind X is not appropriate, and because the testable implications of the model supporting X have not been empirically rejected, we must take X seriously. Q’s model (with X as a result) becomes a chameleon that avoids the real world filters.   Read more…

“How Individualist Economics Are Causing Planetary Eco-Collapse”

July 22, 2016 5 comments

A selection from the cover of Green Capitalism: The God That Failed. (Image: WEA Books)A selection from the cover of Green Capitalism: The God That Failed. (Image: WEA Books)

For some in the environmental movement, it has been tempting to believe that “innovation” and free market solutions could address the challenge of climate disruption. In his provocative and robustly argued book Green Capitalism: The God That Failed, Richard Smith shows why that idea is a myth. Click here to order this important book today with a donation to Truthout!

Click here for an abridged excerpt from the essay “How did the common good become a bad idea? The eco-suicidal economics of Adam Smith,” in Green Capitalism: The God That Failed.

 

The top ten economics books of the last 100 years

July 22, 2016 Comments off

RWER Poll 2016

The top ten economics books of the last 100 years

Subscribers to this journal were asked:

“What are the top ten economics books of the past 100 years?

The poll was open for two weeks in May and over 3,000 economists voted.  They could vote for up to ten of the books on the short list of 50 which had been compiled from the nominations submitted by Real-World Economics Review readers.  People on average voted for five books.  Here are the results. Read more…

The other half of macroeconomics – Richard Koo

July 21, 2016 3 comments

Four possible states of borrowers and lenders

The discussion above suggests an economy is always in one of four possible states depending on the presence or absence of lenders (savers) and borrowers (investors). They are as follows: (1) both lenders and borrowers are present in sufficient numbers, (2) there are borrowers but not enough lenders even at high interest rates, (3) there are lenders but not enough borrowers even at low interest rates, and (4) both lenders and borrowers are absent. These four states are illustrated in Exhibit 2.

Of the four, only Cases 1 and 2 are discussed in traditional economics, which implicitly assumes there are always borrowers as long as real interest rates can be brought low enough. And of these two, only Case 1 requires a minimum of policy intervention – such as slight adjustments to interest rates – to keep the economy going.

The causes of Case 2 (insufficient lenders) may be found in both financial and non-financial factors. Non-financial factors might include a culture that does not encourage saving or a country that is simply too poor and underdeveloped to save. A restrictive monetary policy may also qualify as a non-financial factor that weighs on savers’ ability to lend. (If the paradox of thrift leaves a country too poor to save, this would be classified as Case 3 or 4 because it is actually due to a lack of borrowers.)  Read more…

The World Bank on the way back to the Washington Consensus – with Chicago Boy Paul Romer

July 20, 2016 2 comments

from Norbert Häring

On Monday the World Bank made it official that Paul Romer will be the new chief economist. This nomination can be seen as a big step back toward the infamous Washington Consensus, which World Bank and IMF seemed to have left behind. This is true, even though Paul Romer has learned quite well to hide the market fundamentalist and anti-democratic nature of his pet idea – charter cities – behind a veil of compassionate wording.

Romer won significant academic merits with his theory of endogenous growth. He modelled the production of new knowledge within his model rather than letting it drip from sky in convenient increments, as growth theory had done before. At first sight, this sounds like a good qualification for the task at hand. However, Romer has admitted in an interview that it is of rather little use for development economics, because it fails to discriminate between the production of new knowledge at the knowledge frontier, i.e. in highly developed industrial countries, and the adaption of knowledge, which is of particular importance for catch-up processes in poor countries. Still is honors him, that he knows and talks about the limits of his theory.   Read more…

Why economists can’t reason

July 20, 2016 4 comments

from Lars Syll

reasoning-9780070558823

Reasoning is the process whereby we get from old truths to new truths, from the known to the unknown, from the accepted to the debatable … If the reasoning starts on firm ground, and if it is itself sound, then it will lead to a conclusion which we must accept, though previously, perhaps, we had not thought we should. And those are the conditions that a good argument must meet; true premises and a good inference. If either of those conditions is not met, you can’t say whether you’ve got a true conclusion or not.

Neoclassical economic theory today is in the story-telling business whereby economic theorists create make-believe analogue models of the target system – usually conceived as the real economic system. This modeling activity is considered useful and essential. Since fully-fledged experiments on a societal scale as a rule are prohibitively expensive, ethically indefensible or unmanageable, economic theorists have to substitute experimenting with something else. To understand and explain relations between different entities in the real economy the predominant strategy is to build models and make things happen in these “analogue-economy models” rather than engineering things happening in real economies.

Read more…

Making firm governance part of the economists’ dialogue

July 20, 2016 19 comments

from Robert Locke

In a recent article,”The Milton Friedman Doctrine is Wrong.  Here’s How to Rethink the Corporation,” Susan Holmberg and Mark Schmitt intoned: “We won’t fix the problem until we address the nature of the corporation.” at http://economics.com/milton-friedman-doctrine-wrong-heres-rethink-corporation/. Egmont Kakarot-Handtke asserts that sciences of society make no contribution to economics because they are scientifically invalid — to which I replied that his assertion is not true because the neoclassical economists who took over economics in the 20th century excluded history and social studies from the discipline’s purview. History and social studies could make no contribution since they have been ignored. The neoclassical economists’ failure to incorporate firm governance into the economists’ dialogue is a prime example of what I mean.    Read more…

Four possible states of borrowers and lenders – Richard Koo

July 19, 2016 1 comment

. . . an economy is always in one of four possible states depending on the presence or absence of lenders (savers) and borrowers (investors). They are as follows: (1) both lenders and borrowers are present in sufficient numbers, (2) there are borrowers but not enough lenders even at high interest rates, (3) there are lenders but not enough borrowers even at low interest rates, and (4) both lenders and borrowers are absent. These four states are illustrated in Exhibit 2.

Of the four, only Cases 1 and 2 are discussed in traditional economics, which implicitly assumes there are always borrowers as long as real interest rates can be brought low enough. And of these two, only Case 1 requires a minimum of policy intervention – such as slight adjustments to interest rates – to keep the economy going.

The causes of Case 2 (insufficient lenders) may be found in both financial and non-financial factors. Non-financial factors might include a culture that does not encourage saving or a country that is simply too poor and underdeveloped to save. A restrictive monetary policy may also qualify as a non-financial factor that weighs on savers’ ability to lend. (If the paradox of thrift leaves a country too poor to save, this would be classified as Case 3 or 4 because it is actually due to a lack of borrowers.)

Financial factors weighing on lenders might include an excess of many non-performing loans (NPLs), which depresses banks’ capital ratios and prevents them from lending. This is what is typically called a credit crunch.  Read more…

Critical inspiration

July 18, 2016 5 comments

from Lars Syll

Almost a century and a half after Léon Walras founded neoclassical general equilibrium theory, economists still have not been able to show that markets move economies to equilibria. What we do know is that — under very restrictive assumptions — unique Pareto-efficient equilibria do exist.

But what good does that do? As long as we cannot show, except under exceedingly unrealistic assumptions, that there are convincing reasons to suppose there are forces which lead economies to equilibria – the value of general equilibrium theory is nil. As long as we cannot really demonstrate that there are forces operating — under reasonable, relevant and at least mildly realistic conditions — at moving markets to equilibria, there cannot really be any sustainable reason for anyone to pay any interest or attention to this theory. A stability that can only be proved by assuming “Santa Claus” conditions is of no avail. Most people do not believe in Santa Claus anymore. And for good reasons. Santa Claus is for kids.

Continuing to model a world full of agents behaving as economists — “often wrong, but never uncertain” — and still not being able to show that the system under reasonable assumptions converges to equilibrium (or simply assume the problem away), is a gross misallocation of intellectual resources and time.

In case you think this verdict is only a heterodox idiosyncrasy, here’s what one of the world’s greatest microeconomists — Alan Kirman — writes in his thought provoking paper The intrinsic limits of modern economic theoryRead more…

“The continuing tension between Neoliberal economics and democracy” – William R. Neil

July 18, 2016 8 comments

Today’s Neoliberalism had nearly silenced serious left dissent by the late 1990s, or successfully isolated it in remote academic corners.  Bill Clinton’s two terms in the 1990s are proof of that. And there is the continuing tension between Neoliberal economics and democracy: notice the desperate, barely concealed attempt by the Republican Right to shrink the franchise, using as one of its main levers the racial stigmas from “The Great Incarceration” and the yet to be proven accusations of voter fraud.

This political “shunning” of the left happens even in the supposedly liberal Ivy League. The late political theorist Sheldon Wolin (1922-2015), shortly before his death, in an interview with Chris Hedges, spoke of the silent treatment he was given by the faculty at Princeton University when he placed a copy of his new magazine “Democracy” on the faculty lounge coffee table. He was shunned. Perhaps they did not like where he was going with his last book, or could see it coming much earlier: Democracy Inc.: Managed Democracy and the Specter of Inverted Totalitarianism (2008). Here is that interview, Segment Seven from a nine part series at the RealNewsNetwork.

Modern economic thought, and practice, since the 1970s, has witnessed a growing crescendo of Market Utopianism – the “purer the better” – is still the rallying cry of the Republican Right, even in the wake of the sobering events of 2008-2009 and despite some professional economists making substantial dents in the pretentions.   And if you had any doubts about that, then you haven’t been watching the Republican Presidential Primary debates of 2015-2016, or the sheer destructive obstructionism of its behavior towards President Obama as shamefully displayed in Congress. In its deliberate jamming of the democratic process itself, the Republican Right echoes the behavior if not the ideas of the Fascist parties in the Parliaments of Italy and Germany in the 1920s and early 1930s, before they became outright dictatorships.  Read more…

Economic Theory as Ideology

July 17, 2016 4 comments

from Asad Zaman

Ideology and Science are diametrically opposed to each other. An ideology is a set of beliefs that is maintained even in face of strong empirical evidence to the contrary. Science is primarily concerned with explaining the empirical evidence. Theories which conflict with observations are rejected.  This does not mean that ideology is necessarily wrong or bad – we must maintain our belief in justice, morality, honesty, trust, integrity without any empirical evidence; indeed, even when strong empirical evidence suggests that these beliefs will not bring us popularity or personal benefits. However, ideological beliefs in wrong ideas can blind us to the facts and prevent learning which is essential to progress. Nobel Laureate Joseph Stiglitz remarked that modern Economics represents the triumph of ideology over science. This essay explains the reasons for his remarks.

Modern economic theory is founded on axioms for rational behavior, which is equated with selfish behavior by economists. No empirical evidence is presented for this axiom; rather it is taken to be self-evident. In the 1980’s some psychologists, perplexed by the economic theories of human behavior, decided to test these theories via some experiments. Amazingly, nearly all experiments conducted showed human behavior to be strongly in conflict with the economic axioms. A widely replicated experiment is called “The Prisoner’s Dilemma”. This game is similar to many real life situations, where an individual can benefit by betraying a social agreement, as long as other parties stick to the agreement. However, if all people betray the agreement, then everybody loses. Economic theory predicts that selfish individuals will betray agreements, and social conventions of cooperation will break down. However, real life experiments show that cooperation and maintenance of social conventions, even with complete strangers, is quite common.  Generally, economic theory assumes that selfish motives dominate all others. However, real life behavior in experiments displays a large variety of motivations, based on reciprocity, trust, generosity, charity, morality, and other motives which are assumed absent in economic theories.  read more

The U.S. supremacy in the age of high finance: expansion and crisis

July 16, 2016 1 comment

from Maria Alejandra Madi

In the post-war boom era of 1945 to 1971, the U.S. surplus was at the center of the global economic order. Throughout the Bretton Woods period, the United States recycled part of its surplus via foreign direct investment – mainly in Western Europe and also in Japan. Within the system of international economic flows, the U.S. exported goods to the rest of the world and also finance these purchases.  Besides, the United States created demand for the exports of  foreign countries, primarily Germany and Japan.

After the 1970s, this system of international economic flows changed.  From 1971 to 2008, there is the expansion of the age of high finance where the U.S. deficits have been at the center of the global economic order. Considering this background, What Yanis Varoufakis (2013) calls the “Global Minotaur” is the system of international economic flows built after the 1970s. According to this system, the whole world surpluses aimed to finance the unsustainable expansion of a double deficit on which the US built its political and economic hegemony.  The American trade surplus turned into a large and increasing deficit that joined the government deficit to form the twin deficits. These twin deficits characterize the “Global Minotaur era”.  read more

“The two necessary words to describe the dominant economic “regime” of the past 35 years” – William R. Neil

July 15, 2016 4 comments

It’s hard not to notice, during the American Presidential election drama, that despite all the debates and speeches, and multiple candidates, the terms “Neoliberalism” and “austerity” have yet to be employed, much less explained, these being the two necessary words to describe the dominant economic “regime” of the past 35 years. And this despite the fact that most observers recognize that a “populist revolt” driven by economic unhappiness is underway via the campaigns of Donald Trump and Bernie Sanders. With Trump, of course, we are getting much more, the uglier side of American populism: racism, xenophobia and misogyny, at least; the culture wars at a higher pitch.

Yet when Trump commented on the violence which canceled his Chicago rally on the evening of March 11th, he stated that the underlying driver of his supporters’ anger is economic distress, not the ugly cultural prejudices. The diagnoses for the root cause of this anger thus lie at the heart of the proposed solutions. For students of the Great Depression, this will sound very familiar. That is because, despite many diversions and sub-currents, we are really arguing about a renewed New Deal versus an ever more purified laissez-faire, the nineteenth century term for keeping government out of markets – once those markets had been constructed. “Interventions”, however, as we will see, are still required, because no one, left or right, can live with the brutalities of the workings of “free markets” except as they exist in the fantasyland of the American Right. Read more…

A Travesty of Financial History – which bank lobbyists will applaud

July 15, 2016 7 comments

from Michael Hudson

Review of William Goetzmann, Money Changes Everything:
How Finance Made Civilization Possible (Princeton University Press, 2016)

Debt mounts up faster than the means to pay. Yet there is widespread lack of awareness regarding what this debt dynamic implies. From Mesopotamia in the third millennium BC to the modern world, the way in which society has dealt with the buildup of debt has been the main force transforming political relations.

Financial textbook writers tell happy-face fables that depict loans only as being productive and helping debtors, not as threatening social stability. Government intervention to promote economic growth and solvency by writing down debts and protecting debtors at creditors’ expense is accused of causing an economic crisis (defined as bankers and bondholders not making as much money as they thought they would). Creditor lobbyists are not eager to save indebted consumers, businesses and governments from bankruptcy and foreclosure. The result is a biased body of analysis, which some extremists project back throughout history.

The most recent such travesty is William Goetzmann’s Money Changes Everything, widely praised in the financial press for its celebration of finance through the ages. A Professor of Finance and Management at the Yale School of Management, he credits “monetization of the Athenian economy” – the takeoff of debt – as playing “a central role in the transition to … democracy” (p. 17), and assures his readers that finance is inherently democratic, not oligarchic: “The golden age of Athens owes as much to financial litigation as it does to Socrates” (p. 1). That litigation consisted mainly of creditors foreclosing on the property of debtors.  Read more…

Financing vs. spending unions: How to remedy the Euro Zone’s original sin

July 14, 2016 3 comments

from Thomas Palley

In economic policy, timing isn’t everything, it’s the only thing. The euro zone crisis has been
evolving for over seven years, making it difficult to time policy proposals. Now, the shock of
Brexit has created a definitive political opportunity for reforming rather than patching the euro.
With that in mind, I would like to revive an earlier mistimed proposal for a euro zone “financing
union” (English version, German version). The proposal contrasts with others that emphasize
“spending unions”. But first some preliminaries.

The euro zone’s original sin

The original sin within the euro zone is the separation of money from the state via the creation of
the European Central Bank (ECB) which displaced national central banks. Under the euro,
countries no longer have their own currency for which they can set their own exchange rate and
interest rate, and nor can they call on a national central bank to buy government bonds and
finance government spending.  Read more…

“Paradox of thrift was the norm before industrial revolution” Richard Koo

July 13, 2016 11 comments

Exhibit 1. Economic growth became norm only after industrial revolution

Koo 1

Looking further back in history, however, we can see that economic stagnation due to a lack of borrowers was much closer to the norm for thousands of years before the industrial revolution in the 1760s. As shown in Exhibit 1, economic growth had been negligible for centuries before that. There were probably many who tried to save during this period of essentially zero growth, because human beings have always been worried about an uncertain future. Preparing for old age and the proverbial rainy day is an ingrained aspect of human nature. But if it is only human to save, the centuries-long economic stagnation prior to the industrial revolution must have been due to a lack of borrowers.

For the private sector to be borrowing money, it must have a clean balance sheet and promising investment opportunities. After all, private-sector businesses will not borrow unless they are sure they can pay back the debt with interest. But with little or no technological innovation before the industrial revolution, which was essentially a technological revolution, there were few investment projects capable of paying for themselves. Businesses also tend to minimize debt when they see no investment opportunities because the probability of facing bankruptcy is reduced drastically if the firm carries no debt. Given the dearth of investment opportunities prior to the industrial revolution, it is easy to understand why there were so few willing borrowers.  Read more…

Paul Krugman — nothing but a die-hard neoclassical economist

July 13, 2016 4 comments

from Lars Syll

In his review of Mervyn King’s The End of Alchemy: Money, Banking, and the Future of the Global Economy Krugman writes:

Is this argument right, analytically? I’d like to see King lay out a specific model for his claims, because I suspect that this is exactly the kind of situation in which words alone can create an illusion of logical coherence that dissipates when you try to do the math. Also, it’s unclear what this has to do with radical uncertainty. But this is a topic that really should be hashed out in technical working papers.

This passage really says it all.

Despite all his radical rhetoric, Krugman is — where it really counts — nothing but a die-hard neoclassical economist. Just as people like Milton Friedman, Robert Lucas or Greg Mankiw.

The only economic analysis that Krugman and other mainstream economists accept is the one that takes place within the analytic-formalistic modeling strategy that makes up the core of mainstream economics. All models and theories that do not live up to the precepts of the mainstream methodological canon are pruned. You’re free to take your models — not using (mathematical) models at all is, as made clear by Krugman’s comment on King, totally unthinkable —  and apply them to whatever you want – as long as you do it within the mainstream approach and its modeling strategy. If you do not follow this particular mathematical-deductive analytical formalism you’re not even considered doing economics. ‘If it isn’t modeled, it isn’t economics.’   Read more…

Betrayed again: TPP’s unconvincing economic and national security arguments

July 11, 2016 2 comments

from Thomas Palley

Voters of all stripes have recognized the Trans-Pacific Partnership (TPP) as another betrayal of working people, and they have resoundingly rejected it. Despite that, President Obama continues to push it, to the extent of possibly seeking passage in a “lame duck” session of Congress.

President Obama’s pushing of the TPP is recklessly irresponsible politics that benefits Donald Trump who is the outsider candidate. Hillary Clinton is the insider who has touted her links to President Obama, and she still lacks credibility regarding her TPP opposition because of her past endorsement.

In the current dangerous political climate there is no room for error. Yet, that is what we have. Clinton has refused to condemn the TPP in the Democratic Party platform, setting herself up for Trump. Not only does she risk handing the issue to Trump, giving him the economic high-ground, she also sets herself up as “crooked Hillary”. She was for the TPP, then she was against it, and now she is for it again? That plays into voters’ worst assessment of her character.

As for President Obama, he must be made to realize that every time he pushes the TPP, he might as well be campaigning for Donald Trump.  Read more…

On the central importance of a meta-theory for economics

July 11, 2016 5 comments

from Asad Zaman

This post was meant to provide a framework for further elaboration of the idea of ET1% — the Economic Theory of the top 1% — as one ingredient of a Meta-Theory of Economics. However, covering necessary preliminary background already took up more than a thousand words, so this project has been deferred for a later post. The goal of this post is to explain why we need to focus on Meta-Theoretical aspects of social science, rather than whether or not economic theories are true or false. The perspective emerges from my understanding of the Methodology of Polanyi’s “The Great Transformation” [which was recently ranked as the 2nd most important book of the 20th Century in a Poll of RWER Blog Readers]

As the name indicates a Meta-Theory for Economics is a theory about economic theories. As we are all aware, economic theories evolve, change and mutate. Multiple rival conflicting and contradictory theories co-exist within the mainstream. Outside the mainstream, there are people (like myself) who claim that all of mainstream theories are fundamentally and deeply flawed.

A meta-theory studies the process by which new theories emerge. Some of the central questions for a meta-theory would be:  Read more…

Paul Krugman vs. Mervyn King on Keynes

July 10, 2016 2 comments

from Lars Syll

Most self-described Keynesians are Part 1ers. They don’t necessarily believe that workers and consumers are perfectly rational, or deny that sudden shifts in behavior can happen, but irrationality and volatility are at the fringes of their worldview.

King argues, however, that this is all wrong; he is, basically, a Chapter 12er, asserting that economic decisions always take place under conditions of “radical uncertainty”—ignorance about the future that can’t be quantified by probabilities, so that there is no such thing as optimizing behavior. People cope with this uncertainty by settling on “narratives” that are conventionally accepted at any given moment, but can suddenly change. And he urges economists to turn away from supply-and-demand-type analysis, which he calls the economics of “stuff”—as in markets for prosaic physical goods—in favor of the economics of “stuff happens.”

That’s not an unheard-of position, but it’s a remarkable one for an ex–central banker to take, let alone one who, in a former life, was a card-carrying mainstream economist. Why does he go there?   Read more…

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