Keynes and Keynesian Economics in Light of the Financial Crisis

The economic societies of the United States meet over the first few days of the year, with the meeting this year in Boston. This is the full conference program which is gigantic. My interest is what is being said about the sad state of economic theory and its inability to provide guidance on how to find our way out of the present low state of our economies. This was the part of the conference I was most interested in myself:

Keynes and Keynesian Economics in Light of the Financial Crisis

So in its own way, you might say that these issues were on the agenda. However, not only was this the sole manifestation across the hundreds of papers given during the conference, but this was also not in any way part of the mainstream program, only tucked away as part of the program devoted to the history of economic thought. Clearly, none of this is of any genuine interest to virtually the entire profession. Nevertheless, all credit to Robert Dimand for putting the session together, and for treating this as the serious contemporary issue it is. These were the papers found in this session.

Keynes and Financial Crises
ROBERT DIMAND (Brock University)

The global economic and financial crisis that began in 2007 has renewed interest in Keynes’s analysis of whether the economic system is self-adjusting and of his proposals for ending depression. This analysis is complemented by Keynes’s more specific accounts of financial crisis, notably in his incisive “The Consequences to the Banks of the Collapse in Money Values” (in his Essays in Persuasion, 1931) and his Harris Foundation Lectures, a body of work that is much less well-known.

Keynes, Wages and Employment in Light of the Great Depression
HARALD HAGEMANN (Universität Hohenheim)

The wage-employment relationship is one of the central and most controversial issues in the General Theory. . . . and etc for another 200 or so words.

James Meade and Keynesian Economics
SUE HOWSON (University of Toronto)

James Meade (1907-1995), although Oxford-educated, was one of the very first Keynesians, a member of the Cambridge “circus” which met to analyze and criticize Keynes’s just published Treatise on Money in the early months of 1931. Not only did he use Keynesian ideas in his writings throughout his long career; he was a major player in the implementation of Keynesian policies in Britain during and immediately after World War II. My paper will discuss his encounters with Keynes and his use and development of Keynesian economics in his own academic and policy work.

Not that you should think that Keynesian economics was mentioned nowhere else. It showed up one more time, under “Heterodox Macroeconomics”, a session put on by the Union for Radical Political Economics. But I do love his first line, which is something the rest of the profession would prefer to forget. I’ve put it in bold just because, and left the rest in just to see how tedious this stuff can be.

Keynes is Dead — Long Live Marx

Many liberal/progressive economists envisioned a new dawn of Keynesianism in the 2008 financial meltdown. More than five years later, it is clear that the much-hoped-for Keynesian prescriptions are completely ignored. Why? Keynesian economists’ answer: “neoliberal ideology,” which they trace back to President Reagan. Using a Marxian method of inquiry, this study argues, by contrast, that the rise/dominance of neoliberalism has much deeper roots than pure ideology, that the transition from Keynesian to neoliberal economics started long before Reagan was elected President and that the Keynesian reliance on the ability of the government to re-regulate and revive the economy through policies of demand management rests on an optimistic perception that the state can control capitalism. Contrary to such hopeful perceptions, public policies are more than simply administrative or technical matters of choice. More importantly, they are class policies—hence, continuation/escalation of neoliberal policies under the Obama administration, and frustration of Keynesian/liberal economists. The study further argues that the Marxian theory of unemployment, based on his theory of the reserve army of labor, provides a much robust explanation of the protracted high levels of unemployment than the Keynesian view, which attributes the plague of unemployment to the “misguided policies of neoliberalism.” Likewise, the Marxian theory of subsistence or near-poverty wages provides a more cogent account of how or why such poverty levels of wages, as well as a generalized predominance of misery, can go hand-in-hand with high levels of profits and concentrated wealth than the Keynesian perceptions, which view high levels of employment and wages as necessary conditions for an expansionary economic cycle.

The largest single problem with economic theory today is that economists do not even know they have a problem. But the second most important problem is that what ought to have been the most important part of the entire program was relegated to students of the history of economic thought, which is the one area of economic theory economists are trying to rid themselves of. It’s as if these are issues so completely settled that no one any longer has to waste their time thinking about any of it at all.

AND LET ME JUST ADD THIS: From the Wall Street Journal, The Depression That Was Fixed by Doing Nothing. Before Keynes, there was no such thing as a Keynesian stimulus, but recessions got fixed anyway:

Beginning in January 1920, something much worse than a recession blighted the world. The U.S. suffered the steepest plunge in wholesale prices in its history (not even eclipsed by the Great Depression), as well as a 31.6% drop in industrial production and a 46.6% fall in the Dow Jones Industrial Average. Unemployment spiked, and corporate profits plunged.

What to do? “Nothing” was the substantive response of the successive administrations of Woodrow Wilson and Warren G. Harding. Well, not quite nothing. Rather, they did what few 21st-century policy makers would have dared: They balanced the federal budget and—via the still wet-behind-the-ears Federal Reserve—raised interest rates rather than lowering them. Curiously, the depression ran its course. Eighteen months elapsed from business-cycle peak to business-cycle trough—following which the 1920s roared.

That was what they did, but with the low state of economic knowledge today, there is little likelihood anyone will understand why it worked.

Dealing with the inflexible grip of an intolerant orthodoxy

This was a note posted to the Societies for the History of Economics three days ago.

The Guardian, Tuesday 21 October 2014

Ha-Joon Chang powerfully argues the case that it was “an economic fairytale” which “led Britain to stagnation” (Opinion, 20 October). It may be added that our universities bear a heavy responsibility for this situation. Certainly, it cannot be denied that the fairytale paradigm (“supply-and-demand”, competition in the market, and all the rest of it) can be applied to any economic issue. The point, however, is that the currently dominant adherents of this approach deny that any other approach can even claim to be economics at all; indeed, adherents of other schools of thought have very largely been purged from our university economics departments.

Proponents of the fairytale justify this stranglehold by claiming that all former insights into the economy that have stood the test of time have now been incorporated into their own – narrowly quantitative – “modelling” framework: thus, Keynes’s discussions of uncertainty are reduced to “models” of expectations, Hayek’s alternative to neoclassicism into models of “price messages”, Marx’s heritage into models of inequality, Ricardo’s into “rent-seeking”, and so on. Consequently, so the argument goes, there is no longer any basis for the claim that there are different schools of thought in economics. There is only one.

It is the inflexible grip of this intolerant orthodoxy on university economics departments which has so signally distanced academic economics from engagement in discussion and debate outside the academic arena, much of which is directed towards questioning its fairytales. It is, by the same token, very encouraging that students who reject their approach have in the past year or more been reintroducing into university economics departments the kind of vibrant debate which ought to lie at the heart of academic life.

Dr Hugh Goodacre

Member of the academic board, University College London

I could not have agreed more so this was the reply I posted today:

I left Hugh Goodacre’s interesting post alone for the last few days to see if anyone else were interested. Apparently not, but I am. He made two points. First that the monopoly position of the economic mainstream, which he described as “this intolerant orthodoxy”, needs to be confronted so that other approaches to thinking about economic theory are brought into the curriculum. And then second, he notes that there has been the start of a kind of uprising amongst economic students who believe they have been deprived of the kind of broader education they would prefer but do not know how university departments can be encouraged to teach it.

I am in complete agreement with the need to bring these various other traditions into mainstream debate and am also working with the student movement, the so-called “Post-Crash Economics Society”, which coincidentally just last week had its first meeting in Australia.

There are many more ways to approach economic questions than those found in the confines of the mainstream. There has also been such a failure of the economic theory to provide much guidance in getting our economies out of the problems we are now in, that I find it a scandal how little effort has been made to have a post mortem on what went wrong. And when I think of what it is that went wrong, I am not referring to the frequently raised question about why was no one able to foresee the GFC, but the more significant question, which is, why are the policies that have been introduced to restore our economies to health not working?

The Post-Crash Economics approach is one way of going about it. But given my first experience here I have doubts about whether this is much of an answer even though the right questions were being asked.

The main speaker had come all the way from Manchester to discuss what they had in mind. And while there were various moments when his own underlying agenda was all-too-obvious to me as a long-ago member of the left, his final slide had the words “It’s time to challenge the orthodoxy” and showed a woman with a “power to the people” fist in the air.

I therefore asked the first of the questions from the floor, which was more of a comment than a question. And what I said was something like this

“If you would like to set up a group that widens the study of economics and introduces the full range of the various schools of thought to the education of economics students, then I am with you. But if you are going to just use this grouping as another version of the ratbag left, then you will do nothing other than create one more meaningless structure which someone such as myself will have nothing to do with. Your presentation was not neutral. You are a person of the left, which is all right since many people are. But you will only succeed if what you do really is neutral between all of the various groups that find neo-classical economics wrong in important respects. Economics, however, is not an easy subject that someone without formal training can choose amongst theoretical perspectives without serious study. If this is just one more self-indulgent anti-capitalist rant, then this will go nowhere. You cannot ‘democratise’ the study of economics as you described your ambition as if economics can be some kind of all-in enterprise where everyone’s opinion counts for one and no one’s counts for more than one. If you are genuinely interested in broadening the perspectives students receive, then, but only then, will you have the support of those of us from a more market-oriented perspective, or indeed, from anyone with an interest in the fullest development of economic theory.”

To be quite blunt about it, economic students are in no position to suggest how economic theory ought to be taught or what the content of their courses ought to be. And even while I agree with them that there is a large problem with mainstream economic theory, and I am pleased to find they are curious about other approaches, I cannot see how they can have much to say about which economic theories are the most appropriate. It is an issue to be decided within departments of economics and amongst economists themselves. They are absolutely right to seek a wider set of perspectives but I am not sure they are going about it in the right sort of way.

My own version of what these students have sought was proposed in my Defending the History of Economic Thought (Elgar 2013). In my view, the ideal place for debates among the various economic traditions is within the study of the history of economic thought. This is where it should be. Such discussions should be found on our websites, in our journals and as an important part of our conferences. Every one of these heterodox traditions has a history of its own that is an essential element in understanding these theories. Whether Austrian or Marxist or anything else between, each focuses on its own historical development as a way of understanding its own core concepts. It is, sadly, only the mainstream that ignores its history, which is why HET has almost disappeared from within most schools of economics.

I not only think this is part of the means to save the history of economic thought from extinction, but it would also be a valuable addition to the education of economists. The most important ability an historian of economic thought must have may be an ability to make sense of the views of others. It is why HET should be a forum for discussing the widest range of perspectives so that we can all learn new things from each other.

Free Market Economics and Say’s Law

This post is the second of a series I am writing on the second edition of my Free Market Economics that has been published in association with the Institute of Economic Affairs in London. This post focuses on the single most important principle in economics which now goes under the name Say’s Law. But it is a principle that was deliberately eliminated from within mainstream economic theory by Keynes in his General Theory and has disappeared from virtually all economic discourse since that time.

The book was itself written because there is literally no economics text of any kind anywhere that discusses Say’s Law. Yet it was this principle that made it perfectly obvious that the stimulus being applied across the world from the end of 2008 would lead to an economic stagnation that would last years on end. That is why I immediately began to write the book then and there, but it is also why I had published in February 2009, just as the stimulus was getting under way, an article with the title, “The Dangerous Return to Keynesian Economics”. The article specifically discussed the crucial disappearance of Say’s Law and included this forecast:

“Just as the causes of this downturn cannot be charted through a Keynesian demand-deficiency model, neither can the solution. The world’s economies are not suffering from a lack of demand, and the right policy response is not a demand stimulus. Increased public sector spending will only add to the market confusions that already exist.

“What is potentially catastrophic would be to try to spend our way to recovery. The recession that will follow will be deep, prolonged and potentially take years to overcome.”

While virtually the whole of the economics profession remains flummoxed by what has happened since the stimulus, neither my students nor myself have been in any doubt. It has been as obvious as the noonday sun, but invisible to anyone brought up on modern macroeconomics which has embedded the theory of aggregate demand, Keynes’s disastrous contribution to economic theory.

Say’s Law specifically stated that demand deficiency, that is, a deficiency of aggregate demand, could never be the cause of a recession (or in the archaic language of the classics, “there is no such thing as a general glut”). It then specifically told governments that while some additional public expenditure during recessions might do some small good, such a stimulus would never restore an economy to robust health but would, instead, do serious damage, and the larger the stimulus the more damage it would do.

The book explains the nature of Keynesian economics but also explains why a stimulus could not possibly have returned our economies to rapid rates of growth and low unemployment. The experience of the past six years ought to have made all this supremely evident in practice. But without an understanding of Say’s Law, there is not a chance in the world anyone will understand why the stimulus has been the colossal failure it has been.

Although named Say’s Law after the early nineteenth century French economist J.-B. Say, it was a principle that was part of the bedrock foundation of economic theory right up until 1936. But what will never be told to you by any Keynesian economist (in large part because they don’t even know themselves) is that the term Say’s Law was invented in the twentieth century by an American economist who thought it was absolutely essential for clear thinking in economics and brought into active use only in the 1920s.

If for no other reason, I commend my book to you because it is the only place where one can have Say’s Law explained in a way that makes you understand what economic theory has lost. It will also explain why the stimulus did not work and what must be done instead, reasons enough to buy the book I would hope. But there are also others which I will come back to in later posts.

Saving and investment as understood in 1886

This is from a note I have just written discussing the 2nd ed of my Free Market Economics. What is most interesting perhaps is the question that was found at the back of a chapter in an economics text published in 1886. Note the assumption that higher saving leads to higher growth, and more mysteriously, that money placed in a bank is not what savings really consist of. All very routine in 1886, now near incomprehensible.

The book being so far from the standard, even people who are potentially sympathetic to what it is trying to explain will be puzzled because of the way in which economic theory is currently taught. I have had the experience now for the past ten semesters in seeing students who don’t get it at the start, specially if they have done economics before, suddenly catching on. What now establishes the course material is that everyone is perfectly aware that neither the stimulus nor the low interest rate regime have brought recovery with it but cannot understand why. So I point out that if you were a classical economist, the economics you would have been taught would have explained all that already, and then I explain what every good classical economist would have known. The question below is one of my favourite questions for this part of the course.

What did Simon Newcomb mean when he asked this question in his 1886 Principles of Political Economy text:

“Trace the economic effect of the frugal New England population putting their money into savings banks. What do such savings really consist of?”

a) for a community the amount of money in banks is not what is meant by saving
b) the economic effect is that a larger proportion of its resources are made available for investment
c) high saving would mean high unemployment
d) money facilitates exchange but resources are what matters
e) the New England economy would be expected to grow only very slowly

It’s useful to me since I try to emphasise that I didn’t make this up but that there is a long pedigree to what I teach. It’s only that since 1936 there has been such a discontinuity in economics that the kind of question found at the end of an introductory text in 1886 would be virtually unanswerable using modern theory. “What do such savings really consist of?” is near on incomprehensible to anyone who has only learned modern macro.

John Stuart Mill and the logic of economics

I have just been confronted by two articles I have refereed, both on the economics of John Stuart Mill, that I rejected because they have no idea what Mill is trying to explain or the logic of what he is getting at. Both, however, are likely to be published no matter what I might think. Here was Mill, the man with the nineteenth century’s highest IQ, the author of the book on logic that was used for two generations across the English speaking world, a book still eminenty worth reading to this day, yet both of these papers criticise Mill for contradicting himself and faulty logic.

Mill’s Principles of Political Economy is far and away the best book on economic theory ever written. My own book on Free Market Economics (now in its second edition) is Mill brought up to date with a few modern gadgets. Also brought into the text and heavily criticised are the various additions to economic theory that have made economics far worse as a tool of analysis and a basis for policy, most notably MC=MR and Keynes.

All I can say is how exasperating it is to read these critics of Mill who cannot even begin to understand the problems with their interpretations. But what is the peculiar bit is that in being possibly the only economist in the world who thinks of Mill as the best economist who has ever lived, there is not a soul alive who I can turn to for support. I am not the smartest person on the world today, but I do come closer to understanding Mill than anyone else writing on economics. The massacre of our economies by the modern doctors of economic theory is as obvious to me as it is invisible to them. So on it will go but the certainty is that if we keep up in the way we have, we will never ever generate a recovery worth having and living standards will continue to fall.

The great discontinuity in Keynes’s economic thought

This is an extract from a note I have written to an economist in the United States whose work I have only just come upon. I am beginning to become aware of the various attempts by a number of economic schools to abandon modern neo-classical theory which, in my view anyway, mostly means trying to rediscover what the classical economists already knew. Perhaps there is more to it but so far I cannot see what. The interest in this letter, however, is in the nature of the Keynesian Revolution. I have no in-depth knowledge of Keynes’s Treatise on Money although am reasonably familiar with it. But it was published in 1930 while my interest begins in 1932 with Keynes’s discovery of demand deficiency as the explanation of recession and involuntary unemployment.

The paper I am commenting on treats Keynes’s ideas as if there had not been the great disruption at the end of 1932 when Keynes came upon Malthus’s 1820 letters to Ricardo. It was these that instantly converted him into a Keynesian theorist which he had not previously been, even though he had always sought to increase public spending to reduce unemployment during recessions. That virtually all of his contemporaries understood how thin Keynes’s arguments are is now just of historical interest and of interest to hardly anyone at all. Only by going back to those moments of transition, and by understanding what economic theory was like before 1936, is there any hope for again turning economic theory into something useful for analysing economic events. This then is what I wrote:

I would have written back straight away but Tuesdays is my heavy duty teaching day and I also didn’t want to clutter your inbox until I had read your brilliant article on Keynes. You cannot imagine how similarly we see the world and what a treat it is for me to read something like what you wrote. I will, of course, include this paper in my Anti-Keynesian Reader, but I must also beg your indulgence if I explain to you the 1932-1933 shift in Keynes’s thinking which is my speciality. I have also ordered your macroeconomics text which I am looking forward to since it came after your paper and must therefore incorporate the same ideas.

You have also made me even more aware than I was before that I have not been keeping up with the literature as well as I should. I found the scholarship of your article exhilarating and finished it at one go. I just sat down and read it and was only sorry that after thirty pages it turned out to be so short. My own excuse for not being aware of the most recent literature is that I spent the years from 1980-2004 as the Economist for the Australian Chamber of Commerce and Industry. I therefore think that my economic interests were driven by an eclectic interest in arguments that could be used to explain economic issues from the perspective on an entrepreneur. It is why the classical economists so appealed to me since that was their aim. From the marginal revolution on, I find almost nothing of much value in framing issues, specially since post the marginal revolution economics went micro and into equilibrium analysis, both of which are utterly contrary to what I could see right before my eyes being the need to make sense of an economy in which every business decision is fraught with the uncertainty of spending tonnes of money before the outcome of each of those decisions could be known. And while I may have been feeding on the classics, nothing I ever wrote looked archaic to those to whom our submissions went. Classical economics makes perfect sense and is much more logical and insightful than the kinds of economic theory we find today.

But what started me on the trajectory I travelled was a minor issue in the National Wage Case of 1980. I was brought on to write the economic submission to our industrial relations court on behalf of employers. It was explained to me that every argument in a court of law must be controverted so I had to go through the union submission, identify each argument they had made and then explain why it was wrong. Believe me, this was the easiest task I have ever been given, but one of them was easiest of all. This was the argument that wages had to be raised as a means to stimulate demand. So I just pointed out that you could not stimulate an economy by making employers pay an extra $100 a week so that employees could then spend that extra $100 in their shops. And then, in 1982, I was reading John Stuart Mill’s Principles, for no other reason than because I was interested in what he might have to say, and came across his Four Propositions on Capital which literally, on the spot, ended my days as a Keynesian. (And now, 32 years later, I am about to finally have an article published on these four propositions.) From there, I continued reading more of Mill and found a passage in which he pointed out how ridiculous it was that people thought an economy could be driven forward by demand. And the example he gave of how ridiculous this argument is was of someone who might steal from the till of the business they are working in, go out the back door and come back in the front and spend the money, and that the more this was done, the faster the business would grow. This was so exactly my own argument that it completely dumbfounded me. And yet, it was probably not until another couple of years later that I worked out that the notions that Mill was discussing are the actual meaning of “Say’s Law”. It has been coming to terms with Say’s Law and what it meant and all of its implications that has been the pole star for all of my economic writing ever since. And so, my Free Market Economics, which is me trying to do in my own fashion right now what Mill had done in 1848.

I have tried to explain over and again that Say’s Law is the Rosetta Stone for understanding The General Theory, and is also the foundational principle for understanding how an economy works. For the second, you can read my text when it gets to you. But the first is what you have written your article about which has been in so many ways a revelation to me. My speciality is the Keynesian Revolution and know less than perhaps I ought to about The Treatise and Keynes’s original monetary theories. You have perfectly situated Keynes’s arguments for me and his original conception which fits into everything I already know and understand. It is a tour de force, and I have tried to read everything I can on the critics of Keynes. But this is what I can add to what you have written. I have, of course, published things on this but to say that it has been ignored is something of an understatement. It so badly fits the narrative others wish to promote, and truly undermines Keynes as an original thinker and an honest purveyor of ideas, that it just cannot be allowed into the canon. Perhaps, however, you will see my point.

Keynes was doing exactly what you write all the way up to the end of 1932. He was going to write a book about the Monetary Theory of Production, almost certainly along the lines you set out. Unfortunately, it was just then that he came across Malthus’s long-lost letters to Ricardo which had just been discovered by his best friend, Piero Sraffa. In updating his “Essay on Malthus” for inclusion in his Essays in Biography, he read through those letters and discovered demand deficiency, the issue of the general glut debate of the 1820s. He therefore stopped writing about the monetary theory of production and began to write about Say’s Law. And rather than requiring a form of disequilibrium analysis, he is forced by what he wishes to argue, to adopt the most rigid form of equilibrium analysis. This may seem a conundrum to others who work forward from Keynes’s previous writings, but working backwards from The General Theory as I do, it seems perfectly clear to me what he had done.

Free Market Economics 2nd ed

fme2 cover_Page_1

When I wrote the first edition of my Free Market Economics in 2009, I thought of it even then as the best introduction to economic theory anywhere. It combined five features that were unique to this book: an uncompromising anti-Keynesian core, a microeconomics that rejected the notion of an equilibrium, a focus on the role of the entrepreneur, a discussion of the classical theory of the cycle and the installation of uncertainty as the crucial element in any serious discussion of how an economy runs.

I also had no idea how much more I wanted to say until I came to write the second edition which to my eyes has transcended the first, having been fashioned out of what I learned by teaching the first edition for five years while watching how economic events unfolded following the stimulus. You may only have the author’s word for it here, but there is no book like it. If you want to understand how an economy works based on the English tradition in economic theorising that goes from Adam Smith to John Stuart Mill, there is literally only a single place you can go. The book reverses two “revolutions” in economics, not just the Keynesian of the 1930s, but the marginalist revolution of the 1870s as well. It is a companion volume to David Simpson’s wonderful The Rediscovery of Classical Economics, also co-published by the IEA. Reading the two will provide you with an understanding of just what is wrong with economic theory today. That traditional policy based on standard economic theory is ruining our economies is beyond any doubt, but the reason why that is so will nevertheless remain incomprehensible to anyone who continues to believe that aggregate demand is a valid concept in trying to make sense of economic events or that equilibrium has much if anything to do with how an economy works.

My Free Market text was written in a kind of white heat over twelve weeks as the text for the course I was giving during the first months of the worldwide introduction of stimulus packages pretty well everywhere. The absolute dead certainty I had was that public sector spending whose only aim was to create jobs would end in disaster, as it most assuredly has. Our economies are sinking under the weight of massive levels of unproductive public spending and debt levels that continuously subvert every attempt to wind them back. Yet you cannot go to any standard economics text even for an inkling of why that is.

To understand any of this you must first understand Say’s Law. Say’s Law was the bedrock principle of economic theory from the earliest years of the nineteenth century until swept away in a fit of distraction by the publication of Keynes’s General Theory in 1936. It is founded on recognising that only value adding production can create economic growth and add to the number of jobs. The most central chapter in the book is the chapter on Value Added, a chapter found in no other text that I know of. Yet without understanding value added, understanding that every form of production not just creates more goods and services but also at the same time uses up existing goods and services during the production process, it is impossible to think about public spending and economic policy correctly. Only if what is produced has greater value than the resources used up can an economy grow. Government spending seldom creates value. The stimulus was therefore doomed to fail as is so much of the policy matrix found today.

The strangest part about the book, however, was for me to discover my own beliefs on the nature of economic theory. There is not a chapter in it that would fit into a standard economics text. All of it takes you back to an earlier time and a different theoretical matrix. Space is too short to tell you much more but let me draw you to the cover which shows a water mill on a plaque made of clay. This is because the two most important influences on my own way of thinking have been two of the greatest economists England has ever produced, John Stuart Mill and Henry Clay.

I can do no more than encourage you to read this book. It is a defence of the market economy published at a time when there may never been a greater need for such a defence.

HETSA symposium on the future of the history of economic thought

We’ve just had a symposium on my book, Defending the History of Economic Thought, at the History of Economic Thought Society of Australia meeting here in Auckland. I’m no fan of economics in the form of running a line through a set of dots, although I’m not an enemy either. But the astonishing transformation of economic theory from a philosophical study to social physics may be all right for the academic world – may be – but it’s not so all right for those who need to understand what’s going on if they’re trying to make policy.

Economics has a vast store house of approaches that are different from the mainstream, some bundled into different schools, such as Austrian economics, and some just part of an array of models that had been part of the mainstream in the past but have been sidelined for one reason or another. No natural science, for example, has ever had some concept from the past return in the way that Malthus’s early nineteenth century theory of over-saving and demand deficiency was resurrected as Keynesian economics and remains embedded in Y=C+I+G. The challenge to today’s mainstream provided by discarded theories and different schools has seen an effort made to push HET out of the economics classification and, as was attempted in Australia in 2007, to blend it into a category that was to be called, History, Archaeology, Religion and Philosophy, as far as possible from economics itself. My book is about that attempt, and a similar one in Europe in 2011. And the interesting part for me, during this symposium, was to find how many even here in Australia, want to make that transformation.

Why that is, I still cannot fully understand. There’s plenty of sociology in HET even as it stands, but there is also a good deal of rethinking old ideas as well. In the present structure you can do both. If HET became history and philosophy of science, the traditional form of HET would disappear, even as it is already shrinking in North America.

The contrast between our meeting in Auckland and the American HET meeting in Montreal at the end of last month was incredible. You would think that with economic theory at such a low ebb, that there would be many papers looking at the pre-Keynesian theory of the cycle, as just one example. As it happens, there was not a single paper in Montreal on either Keynes (or Marx for that matter), and very few that dealt with economic theory as in what did economist A say about issue B. There instead remains a systematic effort to reward sociology of knowledge. Here in Auckland, however, there have been just the kinds of papers that interest me, on both sides of these debates, and there are knowledgable people who can offer truly in-depth analyses and critiques.

It is, in fact, my wish that HET become in part what it never quite has been able to be, become a proving ground for older ideas that are tested in a pit of criticisms by people who are interested in these issues and know an immense amount about these ancient theories. It now happens in a haphazard way, but I think it should become institutionalised. There is, in fact, a new on-line journal that has opened called “History of Economics and Policy” which in my view is the direction things should go.

At the symposium, there were many things said from the floor that I found very useful and interesting, but amongst them was that MIT is about to make a history of economic thought course compulsory for its PhD candidates. If that is actually true, HET will be back within a decade.

Fixing economics

There is an article by Tim Thornton in today’s Age with the title I might have written myself, The problem with the way we educate economists. He thinks the problem is neo-classical economics which is the standard mainstream taught to everyone who seeks to become an economist. In saying he doesn’t like the way we teach economics, he is really saying he doesn’t like the standard theory found today or more particularly, the quality of the economics profession itself. These are the three problems with the way we teach he lists which are problems with the people who make economic policy:

Firstly, there is generally no required study of economic history or the history of economic thought. This produces graduates with dangerous levels of historical amnesia in regard to the world and to the discipline they assume they understand.

Secondly, contemporary economics students will rarely encounter any of the schools that compete with the neoclassical school: institutional, post-Keynesian, behavioural, Marxian, Austrian, feminist or ecological. These economics schools, which come from all points of the intellectual and ideological compass, make crucial contributions to building up our understanding of a complex and ever-changing economic and social world.

Thirdly, the curriculum fails to incorporate crucial insights offered by other disciplines such as politics, philosophy, history, sociology and psychology.

With any discipline what you teach depends on the question you want to answer. If you are interested in knowing how goods and services end up produced, incomes earned and output distributed, neo-classical theory is pretty reasonable. I say this even having major differences with the mainstream. The course I teach and the book I wrote cover all three of issues raised. I embed my course in history and the history of economic thought. I contrast modern theory with its classical alternative so no one comes away thinking there is only one answer to any question. I introduce politics, philosophy and history, although I must admit seeing little value in either sociology or psychology in answering any of the questions economists have traditionally asked.

Typically, those who would like to root out our modern neo-classical inheritance do so for some quasi-Marxist reason. They are seeking answers to different questions. Their interest is in explaining the distribution of power within a society. This is, of course, politics or sociology but it is not economics since even if you knew the answers to any of the questions a political scientist or sociologist might ask, you still wouldn’t understand how goods ended up being produced, what economic structures would give you the greatest output, how the community’s command over goods and services could be increased, what to do in recessions, or even what causes recessions in the first place. Instead what would be taught is some variant on the unfairness of the system and how it needs to change to ensure those who have the least wealth, which typically means those who have contributed the least to our communal flow of goods and services, can get a larger share of the pie.

Economics emerged as a separate study over two hundred years ago when our societies were extremely poor as they had been since the beginning of time. Now we, who live in economies where markets predominate, are astonishingly wealthy by any and every standard that an economist two hundred years ago might have listed as an aim and ambition. And because of the innovation machine that has been set in place by these same economic structures, we have a reasonable expectation that our wealth will continue to grow.

If someone has a better answer to the questions economists wish to answer, then they must convince other economists first. To take your ball and bat and go off somewhere else may make it easier to find someone to agree with what you say, but then you are talking into an echo chamber of your own construction. There is lots wrong with economics – lots – but to ask for a separate discipline, or encourage a schism within economic theory because you have a different view, is not the way these issues will ever be resolved.

But where I can overwhelming agree is that the economics establishment has built an edifice as strong and formidable as the one built by mediaeval theologians. The answers it gives to many questions seem wrong to me and many others. I hate to show disrespect to Her Majesty, but when she asked after the GFC why no one had forecast the recession, she was asking a question for which there will never be a solution. Recessions happen and it is precisely because they are unexpected that they turn out so badly.

What economists can, however, do is explain why that is, and try to provide answers on how to recession-proof our economies as best we can and hasten recovery when they turn down. Neo-classical theory, being drenched in Keynesian structures, will unfortunately never be able to find the answer to either question which is why a genuine review of economic theory and policy is so urgently required. But because a bunch of twenty year olds are dissatisfied with the answers that modern economic theory has devised is the worst possible reason for looking out for new answers to old questions, which in their case really turns out to be looking for old answers to different questions.

Post-Crash Economics

The secret is getting out. And what secret might that be? That modern economic theory is next to useless, or at least useless if your interest is either to understand what’s going on or to manage the economy in a productive way with high employment and low inflation. This is from the introduction to The Report which has been issued by the Post-Crash Economics Society in the UK, organised round a group of students at Manchester University:

Economics education is monopolised by a single school of thought commonly referred to as neoclassical economics. Crucially, very few economists working within this mainstream predicted the Financial Crisis. Afterwards many concluded that the best predictions came from those economists that had been marginalised by the mainstream. Despite this alternative perspectives are still close to non-existent in undergraduate programmes. We demonstrate this through a detailed analysis of Manchester’s syllabus, which itself is representative of economics syllabuses around the UK. This lack of competing thought stifles innovation, damages creativity and suppresses the constructive criticisms that are so vital for economic understanding and advancement. There is also a distinct lack of real-world application of economic ideas, with the focus being on abstract modelling that often seems devoid from reality. Finally, the study of ethics, politics and history are almost completely absent from the syllabus. We propose that economics cannot be properly understood with all these aspects excluded.

I have just the book for them, the second edition to be co-published in July by the Institute of Economic Affairs in London. In fact I have two books since The Report makes a point of stressing how important studying the history of economic thought is to understanding economics.

There is a write up of all this in an article, Bank of Englands’s Haldane Backs Broader Economics, found in the Wall Street Journal. Economics must change and I am extraordinarily pleased to see the revolution is finally about to begin.

UPDATE: Some further comment of my own based on the thread at Catallaxy:

For me there are a few issues of comfort in spite of some sense of pessimism.
First, I am just happy to see the logjam of modern neoclassical economics finally broken. This is the first step in a much needed process even to have a declaration of disquiet about the way economics is taught. I cannot think it could get any worse than it is. They may not call themselves socialists but economic theory as currently taught is for all practical purposes a form of centralised economic management, with the level of G the most important driver.
Second, that the coming Chief Economist of the Bank of England and Steve Davies of the Institute of Economic Affairs are willing to buy in on this gives me some sense that this is not some Marxist thought based around expropriating the expropriators. But whatever the basis of the theory, the issue is to force the mainstream to defend their theory and its practical value.
Third, and very oddly, Post-Keynesian economic theory, so far as the business cycle is concerned, is almost identical to the classical theory of the cycle. Very odd to me to find this but I have even begun to write a paper on this very issue. I’m not sure they even are aware of the difference it makes, but in much that is written, they substitute effective demand for aggregate demand which means they are actually restoring Say’s Law since Say’s Law was the core of the explanation behind what made demand effective. It is no longer just a total but in this way becomes a theory of economic activity.
Fourth, bringing back the history of economics and economic history can only be positive. The attempts to shut these out are attempts to shut down various forms of debate.
Fifth, we shall see.