One of the perils of growing old is that you get that jaded “seen-it-all-before” feeling. Which is the reaction I have to so-called heterodox economics. What you youngsters call ”heterodox economics” is what I call “stuff I remember learning in the 1980s”.
Which is not to denigrate it. Quite the opposite. It is the rediscovery of old truths which were forgotten after the late 80s.
Here are some examples of what I mean.
First, Lance Taylor and Nelson Henrique Barbosa Filho complain that standard inflation theory “leaves out social conflict”. But the account of inflation I learned in the 80s put class conflict centre stage. “Conflict over the distribution of income affects the general level of prices in advanced capitalist economies” wrote Bob Rowthorn in his 1977 paper Conflict, Inflation and Money which as good as introduced the Nairu. And in the Layard-Nickell model, the Nairu is the unemployment rate necessary to bring peace in “the battle of the mark-ups.”
One implication of this is that controlling inflation needs more than technocratic monetary policy tightenings, which only cut inflation by raising unemployment. It also requires changes in property rights to overcome class conflict. James Meade and Martin Weitzman, for example, proposed capital-labour partnerships which would give workers significant shares of profits and so mitigate wage militancy. This was hinted at by William Beveridge in 1944:
If…it should be shown by experience or by argument that abolition of private property in the means of production was necessary for full employment, this abolition would have to be undertaken. (Full Employment in a Free Society, p23)
It’s no accident that this view was totally forgotten when capitalists triumphed in the battle of the mark-ups.
Beveridge’s Full Employment in a Free Society saw something else that was subsequently forgotten and is only now being rediscovered – that the purpose of fiscal policy was not to balance the books but to ensure full employment:
It must be a function of the State in future to ensure adequate total outlay and by consequence to protect its citizens against mass unemployment.
Which illustrates Randall Wray’s point (pdf):
The main principles of functional finance were relatively widely held in the immediate postwar period. However, with the rise of the Phillips curve, the return of the Quantity Theory, the development of the notion of a government budget constraint, and accelerating inflation at the end of the 1960s, functional finance fell out of favour.
MMT is largely a rediscovery and repackaging of functional finance.
These are not the only examples of the Great Forgetting. Back in the 80s, macroeconomic modelling was about building structural models based upon econometric estimation of relations between macro variables. This was supplanted by dynamic stochastic general equilibrium models based upon microfoundations - usually, where the foundations were mythical rational representative agents rather than anybody you’d meet in the real world.
But these models have failed – either to predict the economy or to explain it, as Servaas Storm points out in a brilliant essay. Sure, later generations of such models have added real-world features, but Joe Stiglitz says these are like adjustments to Ptolemaic epicycles – attempts to fix a faulty theory with increasingly awkward patches.
Which means there is a place for structural models we had in the 80s. Yes, these have wonky microfoundations and it’s not obvious that they have a great predictive record. But as Simon says, they can do a better job of highlighting important relationships and mechanisms. Perhaps this is an example of something Robyn Dawes said – that improper (pdf), rough and ready models can do a decent job. Maybe they are like old cars – prone to breakdown, but easier for a reasonably skilled person to fix.
I’ve another example of the Great Forgetting – the Cambridge capital controversies. These showed that there were grave problems with the ideas of an aggregate production function and a marginal product of capital. One problem is that you can only aggregate different capital goods by adding up their prices, but these prices are a function of how much they could produce, so we have circular reasoning*. A second problem was noted by Sraffa – that a marginal product can only be discovered if things change, which doesn’t happen in equilibrium:
The marginal approach requires attention to be focused on change, for without change either in the scale of an industry or in the ‘proportions of the factors of production’ there can be neither marginal product nor marginal cost. In a system in which, day after day, production continued unchanged in those respects, the marginal product of a factor (or alternatively the marginal cost of a product) would not merely be hard to find - it just would not be there to be found. (Production of Commodities by Means of Commodities, pv)
Herbert Scarf noted a further problem – that marginal products require there to be constant returns to scale, but:
If production really does obey constant returns to scale, there is nothing to be gained by organizing economic activity in large, durable and complex units; in short, there is no economic justification for the existence of firms.
All of which means that, as John McCombie and Marta Spreafico say (pdf):
the marginal productivity theory is deeply flawed empirically and cannot, as a matter of logic, be substantiated theoretically.
Casual empiricism tells us that wages don’t equal marginal product for individuals simply because they differ in their bargaining power. And given these problems with aggregate production functions, it’s hard to see that marginal product theory applies (pdf) to aggregates of people either.
All this however was largely forgotten after the 80s. As Geoff Harcourt has written:
When theories of endogenous growth and real business cycles took off in the 1980s using aggregate production functions, contributors usually wrote as if the [Cambridge capital] controversies had never occurred and the Cambridge, England contributors had never existed.
In the same vein, Greg Mankiw tried to defend (pdf) the high incomes of the 1% by invoking marginal product theory, oblivious to these issues.
Which is all the weirder because, as Robert Solow replied (pdf) to him: “economic rents are pervasive…it is too nonchalant to presume that all market incomes reflect true productivity.” Indeed, one development of recent years has exactly been growing interest in the importance of rent extraction – highlighted by the work of researchers such as Lindsey and Teles, Thomas Philippon, Brett Christophers, or Jan De Loecker (pdf) and Jan Eeckhout (pdf). Which returns us to a theme of Joan Robinson – that the economy is dominated by imperfect competition and must be analysed (pdf) as such.
Of course, my account here is a little stylized. I don’t like talking about “mainstream” economics because it is often a straw man. But I think I’ve outlined a tendency for there to have been a Great Forgetting after the 80s, which a younger generation is reversing. But should this generation call themselves “heterodox”? On Twitter, Peter Doyle has suggested not. I agree. Perhaps we should regard the Great Forgetting as the aberration in economics, and the rediscovery of an economics as an empirical-based intellectual tradition as a restoration of normality.
* When Ian Steedman taught international trade theory at Manchester in the 80s, he refused to use the word “capital” in two-factor models, because he thought the notion of aggregate capital absurd.
yeah, I am not convinced by some of this. Possibly mainstream econ sailed on unperturbed by the CCC for reasons other than mainstream econs being duffers.
The idea that interest rates have something to do with what returns it is possible to get by borrowing for productive investment, and that marginal returns broadly speaking diminish as more capital is accumulation, is not negated by the observation that there is a good deal of heterogeneity in the returns you can get from productive investment, nor by the possibility of reswitching. And there are many other considerations and complications if you want to move away from incredibly simply abstractions towards messy reality.
And of course aggregate production functions don't exist - it is beyond me what anyone even means by "existence" in that context. It's simplifications, all the way down. Of course there is no neat way of adding apples and oranges - the fact that the prices of capital goods might partially reflect the returns one can make with them is just one of many problems with using prices to construct aggregates, but again is not enough to throw the whole enterprise out - anyone using aggregates of anything ought to have no illusions about what they are - anyone trying to pretend we can do without aggregates is kidding themselves.
To my eyes, a lot of these points are not nearly as clever as they appear (that one not observing marginal costs or products because in some theoretical setting nobody ever does anything is moronic) and there is a tendency to think you've put one in the back of the net for your team and wheel away waving your shirt around your head, rather than doing the more intelligent thing and asking, OK then, how would be interest rates be determined in the presence of heterogeneity and possible reswitching. for example.
Posted by: Patrick Carter | June 19, 2021 at 04:17 PM
oh and once more for those at the back of the room THE IDEA THAT WAGES ARE SET BY BARGAINING IS NOT HETERODOX
and bargaining does not mean "has nothing to do with individual productivity"
(although the approach to bargaining in labour econ is pretty crude from what I know of it - I don't know why the idea of wages as Shapely values didn't catch on more https://www.jstor.org/stable/2297888?seq=1#metadata_info_tab_contents )
Posted by: Patrick Carter | June 19, 2021 at 04:21 PM
I think the problems are much deeper than this.
It relates to the fetish of formalism and quantification. This goes back to at least Samuelson. It is the insistence of trying to explain the world in terms of rational choice models, and that predates New Classical Economics. Any partial attempt to move away from this by Keynes, and I stress partial - although later in life he basically said classical economics was "nonsense" - was undone by Samuelson and Hicks who reestablished classical frameworks (although latter at least expressed some regret for this). This objective of trying to fit everything into a rational choice framework with fundamental assumptions about constrained optimisation to get a model seems to trump any intellectual curiosity about what really happens.
Ontology and epistemology - questions of when where economic theory arose and how it took form it did and therefore why economics is done the way it is are not raised. For example, there should be obvious questions connected to the fact that its development was connected to periods of British Imperial and then American political hegemony.
For historians or people outside the economics profession it is a bizarre discipline.
Posted by: Nanikore | June 19, 2021 at 06:19 PM
"I don’t like talking about “mainstream” economics because it is often a straw man."
Why? We know what we are talking about; it is something that has the unquestioned starting point that people have unlimited wants and there are limited resources which sets you up for demand and supply curves, indifference curves, budget constraints etc. It uses models and econometrics. Its understanding of a societies is that it is a summation of individual utilities.
All of these things can explain why it is an inadequate manner of inquiry to understand the world's new (and possible old) problems.
Posted by: Nanikore | June 19, 2021 at 06:56 PM
Shouldn't you be remembering Fischer Black's 1986 essay "Noise"?
"the price level and rate of inflation are literally indeterminate. They are whatever people think they will be. They are determined by expectations, but expectations follow no rational rules. If people believe that certain changes in the money stock will cause changes in the rate of inflation, that may well happen, because their expectations will be built into their long term contracts."
Why can't central banks set inflation expectations by buying and selling inflation swaps, as part of open market operations?
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Posted by: Annillwood | June 20, 2021 at 11:43 AM
Makes you wonder why the so called "professional" economists who did the "forgetting" still have their jobs. I suggest the reason is that economics is a respectable middle class profession where no one gets called out for incompetence, thus we have see grotesque incompetents like Kenneth Rogoff and Carmen rise to the top of the profession (at Harvard of all places).
Adam Smith pointed to this sort of thing long ago when he said "People of the same trade seldom meet together even for merriment and diversion, but the conversation ends in a conspiracy against the public..."
Posted by: Ralph Musgrave | June 20, 2021 at 05:01 PM
Oooops . . . I should have said "Carmen Reinhart" above, not "Carmen".
Posted by: Ralph Musgrave | June 20, 2021 at 05:04 PM
The argument that our blogger is making seems to me:
* There are different "schools" of political economy.
* So-called "mainstream Economics" as championed by Mankiw, Lucas, Hubbard, Rogoff, Feldstein, is a largely american school that has ignored pre-Reagan/Thatcher political economy approaches, and has been given huge prominence by mainstream media and policy makers.
* There have been other schools of political economy, mostly in Europe, but also in some isolated corners of american academia, that have continued work using pre-Reagan/Thatcher approaches, and have been largely ignored be the mainstream media and policy makers.
* Some (not many) americans are rediscovering those pre-Reagan/Thatcher approaches that in Europe did not reach near-extinction as much as in the american context, and are thinking they are "heterodox" and new and exciting.
My comment: amusing, but what is given prominence by mainstream media and policy makers is "policy based evidence", so I am a bit cynical.
Posted by: Blissex | June 20, 2021 at 10:10 PM
Perhaps we will one day rediscover Erik Dahmén's idea that it does matter WHAT one produces and that two businesses are NOT the same just because they employ the same "labour" and "capital". And perhaps, perhaps we will one day rediscover the postwar truth that governments can actually improve businesses as good as capitalists can.
Posted by: Jan Wiklund | June 21, 2021 at 12:34 PM
Or it could all be much more simple that economic theory mostly seeks to describe how the fundamental energy flows into the system can be apportioned.
The economic theory of the 80's that abandoned the class consciousness of the 70's was enabled by the North slope, the North Sea and the Gulf of Mexico coming online to produce the final boom years of the nineties.
The step back now to 'forgotten' ideas could be because we are quickly sliding down the curve of lower energy inputs and the division that that will bring in society as the pie shrinks and once again explodes the class war.
The tiny bump of US shale will do nothing overall to solve that inexorable predicament, and all of the economic theory in the world will do nothing to solve that hard limit.
As Priests and Philosophers have sought to rationalise the reality of human suffering over the history of human civilization, suffering continues to exist in abundance regardless.
Posted by: Adrian Bailey | June 23, 2021 at 10:40 AM
Adrian: if you replace "energy" with money, don't you get a better description of the out-the-window world?
Posted by: rsm | June 25, 2021 at 09:17 AM