Category Archives: Economic theory and policy

Economic Council of Tribal Elders

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This is a self-explanatory letter I have written to Professor Richard Lipsey. It was a Saturday afternoon, my most whimsical moment of the week. I have re-read it now on Monday morning, my least whimsical moment, and it still works for me. While my proposal for encouraging change was not intended to be taken literally, something really does need to be done.

Dear Professor Lipsey

I hope you won’t mind my invading your email account but following your posting on the SHOE website, I wanted to continue that conversation because I think this is an issue of no small importance. I have posted the correspondence up on my blog so you can look at my more considered thoughts here.

About myself, I will mention only four things: (1) Canadian born and educated though living in Australia for the past forty years, I have learned and taught from your Positive Economics; (2) I have been trying in my own way to save the history of economic thought from oblivion an outcome it seems destined to achieve [see my Defending the History of Economic Thought (Elgar 2013)]; (3) I am in the smallest of all current heterodox groups – the John Stuart Mill Classical School of Economic Theory for which I have written the textbook: Free Market Economics: an Introduction for the General Reader (Elgar 2nd ed 2014); and (4) virtually all of my career was spent in politics as the Chief Economist for Australia’s national organisation of employers which has warped my approach to issues, both economic and academic (see below).

I think there is a crisis in economics at the moment that no one is facing up to. The Queen supposedly put her finger on it by asking why no one had forecast the GFC. I think the crisis comes from no one being able to guide us out of the recession. You will have seen that I think that is because of the Keynesian models we have embedded, on which I may be right or wrong. But what troubles me is that no one has made a serious effort to revisit economic theory and worry over where the problem is. If I were to be classified using any of the modern schools, I would probably find myself, like you, within the Evolutionary Economics camp (my close associate at RMIT is Jason Potts who I understand is well known in this area). But whatever fuss has been made seems very muted, so muted I have been unable to detect anything at all.

In fact, until I read your post, I had no idea that you had these views. There may be many others who hold views similar to your own, who are, like yourself, individuals with genuine stature who are concerned about the way things are going. The minute I saw your post, I knew whatever thoughts others may have had to take potshots at me – and there may well have been none – they would be instantly suppressed. I am also very conscious of how narrow economic theory is, but as presently designed, it is both seductive and empty. The MC=MR diagram drives me crazy, and I won’t teach it, and in fact, instruct anyone who has ever come across it, to do all they can to forget it. Yet everyone who has learned it, cannot be lured away from its seductive grasp. I make the notion of equilibrium something that should be shunned and a concept devoid of serious economic content but on it goes even though economies are absolutely open ended and with so many cross-currents, the very notion is pointless. I think the stimulus was as deranged as anything I have ever seen inflicted on a peacetime population in my life but seriously, aside from myself, no one seems to be taking up arms against the underlying theory that has led to these policy outcomes. But my point is that although everyone can understand what is in my text, their careers would be cut dead if any of them ventured into this kind of territory, enemy territory to the mainstream (although a couple of them have, brave souls).

The nature of what we teach and the way we restrict what is in and what is not in, so far as a mainstream department goes, is astonishing. For whatever reason, the latitude given is near zero. You could drop your first edition into any course today and it would hardly make a difference compared with the latest, most up-to-date text just off the press. I came back to teaching after 35 years away and I didn’t have to learn a single new thing.

I don’t know whether there is something that can be done. But an Economic Council of Tribal Elders made up of people like yourself seems to me to be the only answer. A student uprising, as at Manchester and discussed by Hugh Goodacre, can only go so far but must stop. No one will pay attention, and I’m afraid, no one should either. But persons such as yourself in league with others of a similar stature, people who are no longer worried about contract renewals and finding their next job, can make the difference that I think needs to be made.

You must know others like yourself who are dissatisfied with the mainstream plod. Perhaps it is too hard, but perhaps it is also not too late.

With kindest best wishes.

The moribund state of economic theory

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I wrote about Hugh Goodacre’s post on the History of Economics discussion thread under the heading, How many economists can dance on the head of a pin?. This is what he said in his post:

Sir, The moribund orthodoxy that currently exercises such an inflexible grip on university economics departments will, as Wolfgang Münchau comments, inevitably face a challenge, and this “will come from outside the discipline and will be brutal” (“Macroeconomists need new tools to challenge consensus”, April 13). The orthodoxy has brought this dismal prospect on itself through the brutality with which it has purged those departments of any other school of thought than its own.

Indeed, in its extreme version, the orthodoxy’s doctrine holds quite simply that there are “no schools of thought in economics”, a totalitarian assertion all too true in most economics departments today, so ruthless has been the purge of alternatives. As a result, the different approaches to economic issues of Adam Smith, Bentham, Ricardo, Marshall, Keynes, Friedman and so on are all relegated to the fringe subject of the “history of economic thought”.

This is indeed a 1984 situation, in which the very idea that debate could exist on how to approach economic issues is regarded as a mere historical memory, and consequently of purely antiquarian interest.However, economics students are increasingly demanding a pluralistic curriculum, as discussed by Martin Wolf in “Aim for enlightenment, technicalities can wait” (April 11). Similarly, the “fossilised habits of thought” entrenched in much of the economics professions are facing increasing criticism from within the academic world (see, for example, “The world no longer listens to the deaf prophets of the west”, Mark Mazower, April 14). Let us hope that all this pressure from students, from the worlds of journalism and of interdisciplinary debate, will combine to bring university economics departments back into the world of liberal academic life from which they have for so long isolated themselves.

I left a very substantial space in time for others to say their piece, but after almost a week, I felt I had waited long enough. This is what I wrote:

I have let six days go by to see if anyone else was interested in Hugh Goodacre’s message on the moribund state of economic theory. The more time goes by, the more I am convinced there is this subject taught at universities called “economics”, and there is this aspect of the world that is called “the economy”, but the first has only a remote relationship to the second. And I could not agree more about the following in the letter Hugh quoted, with two minor qualifications which I will come to:

‘In its extreme version, the orthodoxy’s doctrine holds quite simply that there are “no schools of thought in economics”, a totalitarian assertion all too true in most economics departments today, so ruthless has been the purge of alternatives. As a result, the different approaches to economic issues of Adam Smith, Bentham, Ricardo, Marshall, Keynes, Friedman and so on are all relegated to the fringe subject of the “history of economic thought”.’

My first qualification is the exclusion of John Stuart Mill and second is the inclusion of John Maynard Keynes. Mill is excluded because he has become so far off the beaten track that virtually no one even thinks of his contribution to economic theory, which was massive and arguably a good deal greater than Ricardo or Bentham. Ricardo could no longer be read to gain insights into the operation of an economy, while with Mill you certainly can.

But the inclusion of Keynes is a mystery. Virtually all macro is Keynesian. Who nowadays writes contra-Keynes? Is there any economist in the world writing today – other than myself – who is associated with a strident anti-Keynesian perspective? I can think of hardly a one, and there are not many more than a dozen. Following the dismal failures of fiscal and monetary policies to restore growth – both of which I consider Keynesian to their roots – I cannot understand why there has been so little interest in a post mortem of some kind and the investigation of alternatives.

I can only wish Hugh and his associates the best of luck in their quest to broaden the spectrum of opinion that are considered worth consideration within schools of economics. It is long overdue.

If I knew how to write these things without antagonising the others, I would. But years in the midst of a political environment, and then all this blogging, has left me with a style of writing not necessarily perfectly equipped for the academic world. But following my post was this one from one of the great economists of the world, Professor Richard Lipsey, from whose world class introductory text I had previously learned and taught. And this is what he said:

I agree completely with the others who say that many modern economics departments (but not, I think, mine) admit of no conflicts among, or even the existences of, various modern approaches. It is a mystery how anyone can hold to this view in the light of institutionalists who emphasise the importance of institutions, ‘Newtonians’ of various sorts who use maximising equilibrium models and evolutionists who emphasis evolving systems without static equilibria. And this only mentions a few of the competing visions of how best to study the economy.

I do not suppose this is the place to dwell on the contentious additional point raised by Steve Kates but I would observe that there is a world of difference between traditional Keynesian, New-Keynesian, and post-Keynesians. The econometric models of my country’s Department of Finance and its Central Bank use updated and expanded Keynesian income-flow models. So, like it or not, updated traditional Keynesian concepts, insights and measurement categories are still useful in the work of applied economists.

Since as a text book writer, I am often accused of accepting the modern no-differences view, I mention below three of my recent publications that put forward alternative visions to the prevailing one. This is not only to set the record straight but in the belief that they might be of some interest to those who agree that creative criticisms of the prevailing view are needed.

I would also say that in going ahead, we should not throw the maximising baby out with the bath water of its overuse. Partial equilibrium, maximising models of some markets, such as foreign exchange and wheat, are useful.

Recent non-orthodox recent publications by Lipsey

“Does History Matter: Empirical Analysis of Evolutionary versus New Classical Economics” (with Kenneth I Carlaw), Journal of Evolutionary Economics, 2012.

“Some Contentious Issues in Theory and Policy in Memory of Mark Blaug,” in Mark Blaug: Rebel with Many Causes, M. Boumans and M. Klaes (eds.), (Cheltenham: Edward Elgar), 2013

“The Phillips Curve and the Tyranny of an Assumed Unique Macro Equilibrium” Simon Fraser University Discussion Paper, 2014

He may not agree with my anti-Keynesian views, but sees it properly as a legitimate perspective. More importantly, if Richard Lipsey sees the moribund nature of economic theory as a genuine issue to be considered, there are some very influential people who have seen the problem and are willing to add their names to the list of those who are dissatisfied with standard economic teaching and practice. I don’t know how much dynamite it will take to break up the logjam, but this is certainly a very much needed assist.

The best test of a sound economist

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A friend and colleague has written a fascinating paper on the various interactions amongst later classical economists from the late middle of the nineteenth century through to the end. Part of his paper dealt with Mill’s Fourth Proposition on Capital – “demand for commodities is not demand for labour” – on which I have just published a paper explaining its meaning which no one else has been able to do since Leslie Stephen at the end of that century. Most intriguingly for everyone since, in 1876 he described it as “the best test of a sound economist” which no one, until me this year, has been able to make sense of. Here is my reply to his note to me. I also have put this up since I think it is a perfect example of why the study of the history of economic thought makes someone a better economist. Where is the standard issue economist who would even begin to know what any of this is about?

As always, it was a fascinating paper from which I learned a great deal, even some things I didn’t want to know, such as Cairnes form of rheumatism which sounds like a kind of torture you would wish on no one. But being almost entirely like Leslie Stephen in the issues you discuss, I can stand in as a proxy to see things from his point of view.

On your three points:

(1) It is perfectly clear to everyone that Mill’s Fourth Proposition (MFP) is a restatement of Say’s Law. The problem is that they don’t understand Say’s Law which I have translated thus: demand deficiency does not cause recessions and a demand stimulus will lead neither to recovery nor higher employment. That is the point, and the words support my view. Economists since 1936 have been trapped in the belief that classical economists always assumed full employment, on the assumption, I guess, that they were idiots. Once you see that they never thought any such thing, you are able to take the first steps in understanding Mill and MFP.

(2) You say that the issue came up again in the 1870s because of a rekindling of interest in the wages fund doctrine. This may well be, but whatever may have rekindled the issue, the arguments in support of the Fourth Proposition have nothing to do with the wages fund doctrine. I don’t teach the wages fund, but I do teach all four propositions. But you have to understand Mill, which no one, absolutely no one in my view, does.

(3) You say that Stephen’s statement that it was the best test of a sound economist was not an offhand comment as I do. I thought of it as offhand given the nature of the book he was writing. It was far from being a book on economic theory and while it is in context, it is not essential to the point he was making over all.

On your paper, let me make a few points related to these matters.

(i) You quote the proposition incorrectly, but it is this error that is part of the problem. The proposition is “demand for commodities is not demand for labour”. You wrote, “a demand for commodities is not a demand for labour” (p 9 and 13). This is fundamental and was the same problem that Simon Newcomb had. It is not micro. It is classical macro. Mill is looking across the entire economy and pointing out that lifting the level of aggregate demand does not lower the unemployment rate. I can see that, but no one else can see that. Aside from myself, no one, so far as I know, opposed the stimulus because it would not create jobs. To me, because I understand Mill, and therefore believe because of that that I understand how an economy operates, the failure of the stimulus was an absolute certainty. I listen to Krugman-style blather about how the stimulus was not large enough or that we are beset by secular stagnation and it is all ridiculous. Mill makes it clear, but to understand Mill you must absolutely give up on modern macro (and on Real Business Cycle theory as well). Stephen says it precisely right as you quote him (14-15) where he points out that expenditure by the rich will not lower unemployment. Substitute the government for the rich and you will see what he is getting at. I say the same and have more than enough evidence given the past six years. What evidence does a Keynesian have that they know the first thing about any of it?

(ii) The notion that MFP has been “exploded” is news to me. Marshall and Hayek tried to show that it was true, if you just made these wee adjustments. Of course, they made it completely incomprehensible and leached out of it any reason to see it as a “fundamental” proposition. They just couldn’t understand it for reasons I explain in my paper. That is why, I also think it is the “best test of a sound economist” which is why I think there are so few sound economists left. No Keynesian is a sound economist since each and every one would fail this test.

(iii) You seem to think that Stephen and Ruskin couldn’t agree on economic issues because of their different philosophies, and that Ruskin was shoveled out because he was not amongst the professional economic elite. I went back to read Ruskin’s Munera Pulveris after watching Mr Turner and even with the best will in the world, which I then had, could not bear it. Ruskin is a rotten economist. He asks the wrong questions and comes up with stupid answers. Mill, and I presume Stephen, were concerned about the poor and wished to raise living standards and see them employed (as I wish to do myself). It’s not even that I disagree with him but that Ruskin had literally nothing to contribute to any serious debate about how economies work. It wasn’t that they disagreed but that Ruskin’s views were irrelevant since he wasn’t looking at serious questions.

But these differences aside, your paper was very stimulating reading. Could you send me in the direction of this additional debate over MFP that followed from the debate over the wages fund. There may be something there that I should follow up on.

I am very pleased to find myself cited by you in this excellent paper.

Kind regards

How many economists can dance on the head of a pin?

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This is a letter by Hugh Goodacre to the editor at the Financial Times on 16 April which came with the heading, Bringing economics back into liberal academic life. As you read the letter, you need to appreciate that the deeper reality is that the effort to marginalise alternative ways of looking at the economy goes beyond just putting such heterodox ideas into the history of economic thought. The further aim is to fully remove the history of economic thought as even being a component of the study of economics. I wrote a book on this very subject – Defending the History of Economic Thought – but these movements have a grinding relentlessness that will not be turned back unless there is the will to do so. I can see that for an academic, it may not much matter what is taught as long as doing whatever it is can get your paper published. That the university economics we actually apply to the real world have little value in curing any of the problems that exist, seems of only minor importance. I will also note that the one economist that was left out of the list is the one I think is the most important, being John Stuart Mill. I am also curious why Keynes is on the list since “Keynesian theory” is the very core of what we do teach. Pretty well every economist I know thinks they are teaching Keynesian models of one sort or another. Here is the letter that has been posted on the history of economics website with, so far, not a single comment from any one of the more than one thousand subscribers from around the world.

Sir, The moribund orthodoxy that currently exercises such an inflexible grip on university economics departments will, as Wolfgang Münchau comments, inevitably face a challenge, and this “will come from outside the discipline and will be brutal” (“Macroeconomists need new tools to challenge consensus”, April 13). The orthodoxy has brought this dismal prospect on itself through the brutality with which it has purged those departments of any other school of thought than its own.

Indeed, in its extreme version, the orthodoxy’s doctrine holds quite simply that there are “no schools of thought in economics”, a totalitarian assertion all too true in most economics departments today, so ruthless has been the purge of alternatives. As a result, the different approaches to economic issues of Adam Smith, Bentham, Ricardo, Marshall, Keynes, Friedman and so on are all relegated to the fringe subject of the “history of economic thought”. This is indeed a 1984 situation, in which the very idea that debate could exist on how to approach economic issues is regarded as a mere historical memory, and consequently of purely antiquarian interest.

However, economics students are increasingly demanding a pluralistic curriculum, as discussed by Martin Wolf in “Aim for enlightenment, technicalities can wait” (April 11). Similarly, the “fossilised habits of thought” entrenched in much of the economics professions are facing increasing criticism from within the academic world (see, for example, “The world no longer listens to the deaf prophets of the west”, Mark Mazower, April 14). Let us hope that all this pressure from students, from the worlds of journalism and of interdisciplinary debate, will combine to bring university economics departments back into the world of liberal academic life from which they have for so long isolated themselves.

Crony socialism

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Here’s the nature of the problem. The Treasurer goes to the public service – the very people whose entire livelihoods are financed by public spending – and says to them that the government has a massive deficit that has to be dealt with. And he adds, in the short term, there are only two solutions:

  • cut spending and live within your means
  • raise taxes and finance as much of current spending as you can

    What do you think these self-interested custodians of the public good are going to answer?

    Every regulation has a thousand regulators who want to keep their jobs. Every program has ten thousand programmers who like the steady income and their cushy jobs. Much of it is a ponzi scheme in which they even get to set their own level of wages.

    There is, of course, the one additional problem. Every regulation has a fan club. Every program has its clients. It is the regulations they have to endure they are really interested in removing. It is programs that don’t benefit themselves they think need to be ended. But there is a kind of everyone defends regulation since no one trusts the market, and removing any public programs threatens all of them so there is a reluctance to see any of them wound back.

    Finally there’s the media, especially the publicly-funded ABC, who can be counted on the bag and slag any serious effort at public saving if it is done by a more conservative government.

    In sum: where’s the constituency for cuts to spending?

    It really shouldn’t be so hard

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    Here’s the strategy:

    Arthur Laffer has a simple theory of politics. It’s about as simple as his theory of economics. . . . The economic theory says that the lowest, simplest tax code will produce the most growth. The political theory goes like this: Politicians crave love from voters. So if you want to get a politician to do what you think is right, give him a plan he can easily sell, and make sure that plan will deliver a lot of crowd-pleasing economic growth.

    George Bush Snr sat in the Reagan White House for eight years and didn’t learn a thing. Nor did the voters who elected Obama. Even here, we had a government that brought us lower taxes and ongoing prosperity, so we rewarded them by bringing in the other side. There is, of course, more to the theory than we see at the final upper stage. And it is even possible he is right about what might happen in the US next, assuming someone can be induced to actually take those crucial first steps.

    His economic calculations have led him to believe that the U.S. economy is primed, after a decade of slow growth and middle-class income stagnation, to grow rapidly – it just needs a big tax reform bill that would lower rates and eliminate most deductions. . . .

    This is Laffer’s unshakeable belief: that once voters elect a supply-side acolyte to the White House, massive growth will follow. That growth will please voters. Voters will reward the president’s party. And Republicans, he predicts, will go on to enjoy a generation-long lock on Washington – until, he says, voters forget the power of supply-side economics, and the cycle begins again.

    Here, alas, we are still trying to unwind from the old cycle never mind starting a new one.

    MORE ALONG THE SAME LINES BUT FROM AUSTRALIA: Peter Costello’s taxing truths. Here is what you need to know but do read the rest:

    The government has been hurt by the former treasurer’s claim that it is leaning too heavily on tax increases and not enough on spending cuts to repair the budget.

    Raising taxes is bad economics and will repel votes. Other than that, it’s a great idea.

    Academic publishing and policy

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    Someone wrote of nice review of my Defending the History of Economic Thought. So I wrote him back:

    I am sorry that it has taken me so much time to write to you about your review of my book. But it was so excellent and added so much to what I had written myself, that I didn’t wish to just dash something off but preferred till I had time to sit down and write a more complete response. And till now, time has been in short supply. Yesterday, I read the review through for the third time and found it even more remarkable than when I read it the first time.

    I naturally am very happy to find a positive review, which is rare enough at any time. But what completely stopped me was not only that we were absolutely on the same side on these issues, but that you had added much more to what I had originally written. I did indeed learn a great deal from reading what you wrote.

    The most important part was your explanation of why there has been such a comprehensive turn from HET. As soon as I read what you wrote about the nature of the academic world today, and how the aim is publication of worthless articles in even more worthless journals, I could see exactly what you meant. It, of course, surrounds me here as well, since the pressure is put on all of us to publish. The result then is that the focus is not on whether we are furthering some policy debate, but whether we have made a point sufficiently different from someone else that will convince two referees and an editor that the points made are worth going into print. Whether any of it has relevance as a means to understand how an economy works, or whether there are any valid policy implications, is typically so far from anyone’s mind that it may not matter at all. I have had a policy background for most of my career and it has struck me far too often when I go through the journals that pass my way that there seems few if any useful conclusions to draw from most of the articles published. Having read your review, I can now see more clearly what is going on, and also can see more clearly what an obstacle keeping HET within economics must be to those who think of HET as an opportunity to write about some vacuous issue distantly related to some economist of the past.

    The role of positivism is one that I had not considered before and will take some time to look into. You put “organised ignorance” in quotation marks so I wasn’t sure whether you were just distancing yourself from the sentiment, or whether it is a well-known quote that I had not come across before. But whichever it was, I was more than comfortable with the point. I now think of economic theory as an actual menace to good economic policy. I don’t know how much you know of my other work, but mostly I find myself lamenting the disastrous sets of policies that flow from our macroeconomic theories, and what I think of as even worse, the almost complete absence of any serious re-thinking about how to conceptualise the world, or how to fashion policies that will actually cause an economy to grow and employ.

    But really, the changing nature of academic economics as a means to publish something is so bizarre that if this is really the way it is, we have become the Mediaeval Schoolmen we still laugh at. There is almost nothing we cannot gather data on and run a regression through the numbers. Whether human knowledge is thereby advanced is another story. I have to say that what you have described is a singularly depressing set of circumstances, but I cannot truly see in what way you are obviously wrong. I must merely hope that in amongst all of these publications that flow into the world each year, there is still good economics going on, and that somehow the best will rise to the top and be noticed.

    It’s good politics AND it’s good economics

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    Here’s the strategy:

    Arthur Laffer has a simple theory of politics. It’s about as simple as his theory of economics. . . . The economic theory says that the lowest, simplest tax code will produce the most growth. The political theory goes like this: Politicians crave love from voters. So if you want to get a politician to do what you think is right, give him a plan he can easily sell, and make sure that plan will deliver a lot of crowd-pleasing economic growth.

    George Bush Snr sat in the White House for eight years and didn’t learn a thing. Nor did the voters. Even here, we had a government that brought us lower taxes and ongoing prosperity so we rewarded them by bringing in the other side. There is, of course, more to the theory than we see at the final upper stage. And it is even possible he is right about what might happen next, assuming someone can be induced to actually take those crucial first steps.

    His economic calculations have led him to believe that the U.S. economy is primed, after a decade of slow growth and middle-class income stagnation, to grow rapidly – it just needs a big tax reform bill that would lower rates and eliminate most deductions. . . .

    This is Laffer’s unshakeable belief: that once voters elect a supply-side acolyte to the White House, massive growth will follow. That growth will please voters. Voters will reward the president’s party. And Republicans, he predicts, will go on to enjoy a generation-long lock on Washington – until, he says, voters forget the power of supply-side economics, and the cycle begins again.

    I need hardly point out that the Reagan Revolution was based on Laffer’s complete appreciation of Say’s Law.

    Comic relief at the AFR

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    I turned from reading Chris Berg and Sinclair’s serious and excellent article on our real tax problem in the Financial Review to its next door neighbour by Brian Toohey dealing with super which must have been provided for comic relief. What is one to make of its opening two sentences?

    Australia has a savings glut. So does much of the globe.

    One of those mistakes no classical economist would make but every Keynesian does. Could a modern economist even begin to understand why a classical economist might have thought differently? Probably not, which is why we will raise taxes, maintain public spending and lower interest rates and never know what we are doing wrong.