Economics

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Revolutionary Changes in Economics

In this series, I tried to learn what Thomas Kuhn’s The Structure of Scientific Revolutions meant for economics. In this post, I suggested a possible paradigm for neoliberal economic theory. It uses the Ten Principles of Economics preached by N. Gregory Mankiw in his best-selling economics textbook, the general principle of maximization of economic efficiency, and a method suggested by David Andolfatto of the St. Louis Fed. Let’s assume the goals of neoliberalism fit the parameters described by Philip Mirowski in this article. I think my proposed paradigm can be used to generate the economic theory those parameters require, and I think that suits the goals of the people who fund academic neoliberalism just fine.

As Kuhn describes them, scientific revolutions take the form of a wholly new way to look at things, like an optical illusion. Where once our eyes told us that the sun revolves around the earth, now we know that it’s just the opposite. Not just is the earth not the center of the universe, we are on a small planet on the outskirts of a small galaxy, whirling around in a monstrously large physical space until entropy ends it. Since publication of Kuhn’s essay in 1962, there has been some discussion of such paradigm changes in economics, but as the series shows, I think old ideas do not die, but come back to haunt us, just as John Maynard Keynes said:

… the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest. But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil. Chap. 24 Sect. 5, The General Theory of Employment, Interest and Money.

I don’t know where Keynes got the optimism in the second half of that quote, any more than his seeming optimism about the end of laissez-faire theories. The ideas of Hayek and Friedman and their laissez-faire government-hating chest-beating right wing capitalism-worshipping true believers are still dominant nearly a century later. It just goes to show that if you capture the minds of the young, especially the young elites with textbooks like Mankiw’s, it’s mostly impossible to change their minds with mere facts and natural experiments from the real world.

Still, I think it’s quite possible to change some minds, or I wouldn’t bother with this. And there are new ideas, ideas just as revolutionary as any that Kuhn describes. One example is taxation. For centuries, people believed that the function of taxes was to provide the revenues to run the government. That may have been true in an age of gold. But in an age of fiat money, it’s just not true. Here’s a 1946 discussion by Beardsley Ruml, head of the New York Fed, explicitly stating this truth, and then offering justifications for taxation:

1. As an instrument of fiscal policy to help stabilize the purchasing power of the dollar;
2. To express public policy in the distribution of wealth and of income, as in the case of the progressive income and estate taxes;
3. To express public policy in subsidizing or in penalizing various industries and economic groups;
4. To isolate and assess directly the costs of certain national benefits, such as highways and social security.

This, of course, is the basis of Modern Money Theory. Here’s a quote from a readable and cogent explanation from L. Randall Wray:

But in the case of a government that issues its own sovereign currency without a promise to convert at a fixed value to gold or foreign currency (that is, the government “floats” its currency), we need to think about the role of taxes in an entirely different way. Taxes are not needed to “pay for” government spending. Further, the logic is reversed: government must spend (or lend) the currency into the economy before taxpayers can pay taxes in the form of the currency. Spend first, tax later is the logical sequence.

In the same way, most of us were taught that banks and other savings institutions were intermediaries between savers/depositors, and borrowers/investors. The role of the banks was to direct the accumulated assets of a society into their most profitable uses. No. Banks don’t need deposits to make loans. That idea, which I remember learning in Econ 101 at Notre Dame a very long time ago, is false. The bank merely makes book entries, one set to loans receivable, and one to deposits. This model is called finance and money creation in this 2014 paper by Zoltan jakab and Michael Kuhof of the IMF. Here’s the abstract:

In the loanable funds model of banking, banks accept deposits of resources from savers and then lend them to borrowers. In the real world, banks provide financing, that is they create deposits of new money through lending, and in doing so are mainly constrained by expectations of profitability and solvency. This paper presents and contrasts simple loanable funds and financing models of banking. Compared to otherwise identical loanable funds models, and following identical shocks, financing models predict changes in bank lending that are far larger, happen much faster, and have much larger effects on the real economy.

I remember learning about bank multiplier effects and the importance of reserves in determining the amount of money in circulation. It was one of those bizarre things that seemed logical until you realized that there was no particular reason to think any bank could or would actually lend all that money sensibly. Yet, as Jakob and Kuhof say, that is the theory incorporated into standard models of the economy. They create a new model using the financing theory, and get completely different predictions. These graphs are from the paper. The dotted lines are the predictions under the loanable funds model, and the solid lines are from the financing and money creation model.

graphs for post

At one level, this is just another reason to distrust economic models, because their basic assumptions are simply wrong. At another, it demonstrates that the standard paradigm is useless, because it treats the finance sector are irrelevant. And at another level, the new model demolishes the idea that the role of the bank is to intermediate savings. Savings are irrelevant to the main role of the bank, which is not to insure that savings are rewarded, but to make sure banks are rewarded.

Of course, such revolutionary changes won’t affect anyone not exposed to them and to their basis. And the wrong ideas will stay in textbooks for decades, insuring that generations will have them imprinted. No wonder nothing changes.

The proposed paradigm is set out here. In future posts in this series, I’ll attempt to show how each element contributes to the neoliberal economic theory that dominates the national discourse, and see whether I can find an optical illusion in each, leading to a better although not revolutionary understanding.

Kuhn and Economics: A Summary

In a series of posts which you can find here, I have been trying to formulate an answer to the question why has neoliberal economics not been tossed out in the wake of its total failure as demonstrated by the Great Crash. I’ve used as a lens Thomas Kuhn’s seminal essay: The Structure of Scientific Revolutions. I am totally dissatisfied with the usual progressive explanations of bad faith, whether in the form of the ubiquitous quote from Upton Sinclair: “It is difficult to get a man to understand something, when his salary depends on his not understanding it;” or direct or indirect accusations of intellectual dishonesty or corruption. The world is more complex, and we need to think more deeply, especially if we want to change things. Here is a list of the most important things I think I learned from the exercise.

1. Kuhn argues that science cannot proceed without a paradigm. That seems true in the hard sciences, but it seems inadequate as a description of the social sciences. Even so, there it remains an important insight. This series offered insights because I used the paradigm paradigm to examine a specific problem.

2. Following Mark Blyth, it seems that there are a number of schools of economics. These include neoliberals, post-Keynesians, Austrians, rational expectations theorists, and real business cycle theorists; to which we can add Modern Money Theorists, Marxians, and perhaps Piketty and his colleagues. Each of these has a paradigm through which it tries to organize the vast amount of data and theory we have accumulated over the centuries. Each has its own incommensurate ideas about what counts as data and about how to interpret the data. In other words, they each have a definition of truth, and their truth claims cannot be settled inside their paradigms, as Kuhn tells us is true about the hard sciences.

That means that the decisions about which, if any, of these schools dominates at any point in time has nothing to do with some transcendent truth, but rather with a struggle over politics.

3. This view was reinforced by a reading of Keynes’ delightful essay The Death of Laissez-Faire, which actually didn’t die despite Keynes best efforts, but lives on in the grifter stylings of Grover Norquist and the rest of the zombie right wing. If Keynes caouldn’t kill it, it is permanent.

4. It is further reinforced by Bronfenbrenner’s suggestion that paradigms in the social sciences are not replaced outright as Kuhn argues, but are met by an antithesis, and eventually fall into a new synthesis. I suggest that Paul Samuelson follows this approach in his textbook, based on the back inside cover. In a Hegelian or Marxian world, this is supposed to represent progress, but I’ve always thought of it a just something different that might or might not be useful in a specific social situation.

5. I laid out the seeds of a paradigm for neoliberal economics in this post. In passing I pointed out that Mankiw’s principles are couched in bland language, but they can easily be interpreted to carry out the neoliberal program. See 8. below. Again in passing, I note that tweaking them, and setting up a slightly different paradigm can produce a better solution to the problems our economy faces. That is an exercise for another day.

6. One crucial problem that arises from the existence of many schools of economics is that each can claim that there are no tests that disprove it. As Kuhn and others point out, that’s because the meaning of facts and truth is determined by the paradigm, and neither facts nor truths are commensurate across paradigms. That’s why the likes of Gary Becker and N. Gregory Mankiw can claim that the Great Crash was not a problem for neoliberal economics. What looks like a failure to a person who got hammered looks like the normal course of events to an ideologue married to a paradigm.

7. The neoliberals recognized the importance of politics in economics long before the liberals. They wrote their views into textbooks, which have a thin veneer of science and a thick veneer of authority, and used them to indoctrinate generations of college grads who only took one or two economics classes. They also arranged to have the basic tenets taught in high school classes mandated in many states on the wonders of capitalism. As Kuhn explains, the textbook is the authoritative teaching tool for creating new scientists and presumably new followers of the dominant school of economics. The tenets of neoliberal economics are taught as if they were the only way to understand capitalism, and any other set of ideas are communist or socialist, by which we are to understand they are evil.

8. One factor Blyth doesn’t discuss is why neoliberal economics has such a hold on the populace. Certainly a big part of that is the domination of authoritative discourse through the textbook process in point 7. Another crucial point is that without quite saying so, Mankiw’s principles of economics play directly to the prejudices of the a large segment of the voting public. Take the first one as an example: People face trade-offs. Some people face the trade-off between summering in the Hamptons or on Martha’s Vineyard. Others face trade-offs between rent and food. These are the same thing to neoliberals, who sneak in a bunch of outmoded Benthamite utility. And these are also the same for a huge number of conservatives. Suck it up and pick. It’s your fault for not being rich.

The rich people who dominate elections and the public discourse in general can rely on those principles in anodyne form to pacify the liberals while dog-whistling to their base of conservatives.

9. As a result, the voices of authority on economic matters don’t have to listen to anyone who disagrees with them. They have a base of voters who think it’s great to screw the poor and don’t even necessarily want to accept anything that comes from the government.

10. We need to focus attention on the political nature of economic paradigms. Neoliberal economics failed. We need to hammer home the failure, to undermine the authority of neoliberals on economic matters.

UPDATE
Here are links to the posts in this series with a note about each.

1. The Two Prongs of the Neoliberal Project. This is a justification of the inclusion of economics at this blog. It is also a general introduction to neoliberal economic theory.

2. Paradigms in Economics. This is an introduction to Kuhn’s theory of scientific revolutions and an introduction to a theory of paradigms in economics.

4. Paradigm Change in Science and Economics. This is a discussion of Kuhn’s explanation for paradigm change in science, and begins the discussion of the comparable problem in economics.

5. A Possible Paradigm for Neoliberal Economics. N. Gregory Mankiw’s textbook lists 10 principles of economics. This post takes those and a simple methodology as a possible paradigm for neoliberal economics. In passing, I discuss an actual paradigm change that seems to meet the requirements of Kuhn’s analysis.

6. Pragmatic Aspects of Paradigm Change According to Kuhn. This addresses Kuhn’s argument that even in the hard sciences, paradigm change requires persuasion, because the superiority of an alternative paradigm cannot be tested inside a different paradigm. This idea is applied to economics, and specifically to textbooks.

7. Keynes on Paradigm Change. John Maynard Keynes calls for the death of laissez-faire, especially in its virulent form of demanding that government do nothing. Economic ideas don’t die.

8. Paradigm Change Through Authority and Arguments about Truth. This is a discussion of a more sophisticated approach to changes in economics paradigms through a paper by Mark Blyth. Blyth offers a grounded approach to the problem of change as a result of authority and persuasion.

Paradigm Change Through Authority and Arguments about Truth

So far in this series, we have encountered a number of answers to my central questions: why hasn’t neoliberal economic theory been thrown out as a result of its horrifying failure? Why hasn’t the paradigm change theory of Thomas Kuhn’s The Structure of Scientific Revolution worked? If Kuhn were right, then the utter failure of the neoliberals would lead to its rejection and replacement by a new paradigm.

Most of the people who followed Kuhn pointed to differences between the natural sciences and the social sciences as part of the reason. That led to explanations like the dialectic, in which an idea is met with an antithesis and eventually a synthesis emerges which solves the tension, but it then attracts its own antithesis, and so on. Another possibility is that bad ideas don’t ever die. We saw that with Keynes’ discussion of the end of the silly ideas of laissez-faire; he points to a number of reasons for its long life.

We might next look at the pendulum idea of intellectual history. There’s an excellent example of this in a paper by Ravi Kanbur of Cornell, The End Of Laissez-Faire, The End Of History, And The Structure Of Scientific Revolutions I’m going to skip that one, though, because I don’t think much of pendulum theories. They don’t help us see the forces that drive the swings. Instead, I’ll look at this paper by Mark Blyth, Paradigms and Paradox: The Politics of Economic Ideas in Two Moments of Crisis. Unfortunately, this excellent paper was published by Wiley, which is trying to screw money out of people, so perhaps you could find it through your library. Here’s the abstract.

This article argues that there is a paradox at the heart of Hall’s “Policy Paradigms” framework stemming from the desire to see both state and society as generative of social learning while employing two different logics to explain how such learning takes place: what I term the “Bayesian” and “constructivist” versions of the policy paradigms causal story. This creates a paradox as both logics cannot be simultaneously true. However, it is a generative paradox insofar as the power of the policy paradigms framework emerges, in part, from this attempt to straddle these distinct positions, producing an argument that is greater than the sum of its parts. In the second part of the article, I discuss the recent global financial crisis, an area where we should see third-order change, but we do no not. That we do not strengthens the case for the constructivist causal story.

This article starts as a discussion of a paper by Peter Hall on the shift of ecocnomic paradigm by the Thatcher government from Keynesian to neoliberal. The “Bayesian” story mentioned in the abstract is the standard version of Kuhn’s theory. It says that the normal process of change in institutional governance is cumulative: “an additive function of policy errors that begin with settings, moves to instruments, and then leads to goals as a function of environmental pressures.” Suppose a policy and a paradigm are accepted by the institutions of government and the private sector as controlling in a certain area. As things change and evolve, the institutions first change the settings, hiking or lowering interest rates or taxes, for example. Then they add or delete the instruments through which the policy is put into practice, perhaps adding a new tax or a new deduction. Only if these fail do questions about the paradigm itself come to the fore. These are the three orders of change in this discussion. Paradigm change only comes in the third order.

The alternative is the “constructivist” view. Blyth isn’t as direct in the definition of this idea, but here’s the general idea. The Bayesian view is that there are “transcendent, objective, and empirical standards through which observations of events and other ‘facts’ can be judged.” In the constructivist view, “Truth is a series of intersubjectively held conventions regarding “the way the world works” among a given community at a given moment.” The Bayesian view is probably eventually true in the natural sciences, even if new data or events can be interpreted in several ways under different paradigms that might exist at some point in time. It is much less true in the social sciences. There, different paradigms produce different facts. As an example, Blyth points to the claim of the monetarists (the sheep’s clothing of the neoliberals) that Keynesianism failed in the 1970s in a way that monetarism didn’t. Within the Keynesian paradigm, that wasn’t so, but the monetarists seized control of the narrative, and the bad performance of the economy was taken as evidence of failure of Keynesianism. Blyth says that the key step was the construction of the evidence of the performance of the economy by the monetarists as failure.

Blyth claims that the 70s did not constitute a natural test of Keynesianism, for reasons he discusses in footnote 8 and are beyond my power to assess. I’ll add that the solution of the monetarists was to hike interest rates and hike unemployment to ridiculous levels to stamp out inflation. The result was a catastrophe for the middle class and the working class, and it made life even more miserable for the poor. There was no reason to stomp on workers to end inflation, but there was a determination to protect the interests of the rich. This, I think, is the direct opposite of any policy Keynes would support.

In the constructivist view, then, truth is a matter for contest among the people allowed to participate in the discourse. Blyth quotes Hall:

Politicians, officials, the spokesmen for social interests, and policy experts all operate within the terms of political discourse that are operative within the nation at a given time, and the terms of political discourse generally have a specific configuration that lends representative legitimacy to some social interests more than others . . . and defines the context in which many issues will be understood (Hall 1993, 289).

This analysis focuses our attention on the actual decision-makers, not just the economists themselves, but the group with authority in any given setting to determine the bounds of discourse. Blyth points out that each of the schools of economics, rational expectations theorists, real business cycle theorists, post-Keynesians and Austrians, along with the neoliberals and the outright laissez-faire school of political economics, have explanations for the Great Crash, but they are all incommensurate, totally different paradigms. The argument, the social argument, is over which will dominate the discourse. That is a sociological problem, not a problem of economics.

Blyth uses this framework to analyze the persistence of neoliberal economics. I’ll summarize them

1. It takes time to work out a new system.

2. After Kuhn, people expect an all or nothing change. It’s quite possible that we have a failure of a paradigm, but no new paradigm to replace it.

3. Economics professors have tenure, and a huge stake in preserving their status.

4. Institutions like the World Bank, the IMF, the European Community Bank and others are slow to change for the same reasons economics professors won’t change.

5. The neoliberal consensus had taken such deep root and its adherents were in control of so many institutions that there was no way to get the public involved in demanding change. The few prominent economists calling the neoliberals out had to spread their attacks over such a huge area that there was insufficient firepower.

Blyth concludes:

… the singular lesson of the recent crisis for the policy paradigms model is that the sociological can trump the scientific precisely because the locus [of] authority did not shift despite the facts. Mere facts will (sometimes) not be allowed to get in the way of a good ideology. Being seen to fail, Obama’s stimulus, for example, can trump actual failure, such as Eurozone austerity packages. In such a world, the “truth” about the crisis and the ideas that made it possible really does depend upon what the most powerful members of a group (or society) consent to believe.

This explains why nothing changed: the people who define the policy also define the evidence and the tests that might question the policy. But there’s more, for another day.

Keynes on Paradigm Change

John Maynard Keynes wrote about paradigm change long before Thomas Kuhn’s The Structure of Scientific Revolutions. In a 1926 essay, The End of Laissez-Faire Keynes discusses the lingering doctrines of Laissez-Faire economics well into the period economists were for the most part persuaded by the examples of Alfred Marshall, and the proponents of the marginal utility school that the main ideas of laissez-faire were wrong. Keynes was a brilliant writer, witty and insightful, but he was also a fine scholar. This isn’t a long essay, and it is certainly worth reading, for the giraffe analysis if nothing else. I am going to pick out a few points that show why Keynes thought old and strange ideas cannot be rooted out of economics. Here’s the laissez-faire he is talking about:

Finally, in the works of Bastiat we reach the most extravagant and rhapsodical expression of the political economist’s religion. In his Harmonies Économiques, [he writes]

I undertake [he says] to demonstrate the Harmony of those laws of Providence which govern human society. What makes these laws harmonious and not discordant is, that all principles, all motives, all springs of action, all interests, co-operate towards a grand final result … And that result is, the indefinite approximation of all classes towards a level, which is always rising; in other words, the equalisation of individuals in the general amelioration.

That sure sounds like any Republican or corporatist Democrat, any TV economist or any person who plays economist on TV, and it’s just a shade riper than the average commenter on an article in which Bernie Sanders is identified as a Social Democrat.

Keynes identifies several social and political issues which led to this florid statement. There was struggle against monarchy, which led Locke and others to fetishize private property and the freedom to do as one will with that property. There was a philosophical basis in the Social Contract ideas and the theories of the Utilitarians. There was Darwin and his scientific colleagues who seemed to argue for the necessity of competition for evolution. There was the “corruption and incompetence of eighteenth-century government”, coupled with the successes of the early industrialists. There was the support of the economists of that time, a new group, but once seemingly versed in science, saying that government interference with private property would be bad.

He explains that although economists of the day generally supported laissez-faire, it wasn’t they who preached the gospel as laid out by Bastiat. Instead, it was the “popularisers and the vulgarisers”, who pushed the doctrine into the public mind, and it was the philosophers, not the economists, whose views it fit best. He quotes the popularisers, including the fabulous Mrs. Marcet, and I can’t resist:

CAROLINE. The more I learn upon this subject, the more I feel convinced that the interests of nations, as well as those of individuals, so far from being opposed to each other, are in the most perfect unison.

MRS B. Liberal and enlarged views will always lead to similar conclusions, and teach us to cherish sentiments of universal benevolence towards each other; hence the superiority of science over mere practical knowledge.

The economists turned away from this stuff immediately, Keynes says, treating it as a useful idea but hardly one with evidentiary or theoretical support. But the idea remains fixed in the public mind. To be clear, Keynes agrees that government should be limited, but he firmly believes that limits on the use of private property of various kinds and a sensible government are both crucial to controlling the practice of capitalism. The idea that the government could do nothing useful, which underlies laissez-faire as taught by the likes of Mrs. Marcet, is foreign to Keynes, as he shows in Part IV of the essay.

In Part III, Keynes dismantles this analysis. Here’s a taste:

This assumption, however, of conditions where unhindered natural selection leads to progress, is only one of the two provisional assumptions which, taken as literal truth, have become the twin buttresses of laissez-faire. The other one is the efficacy, and indeed the necessity, of the opportunity for unlimited private money-making as an incentive to maximum effort. Profit accrues, under laissez-faire, to the individual who, whether by skill or good fortune, is found with his productive resources in the right place at the right time. A system which allows the skilful or fortunate individual to reap the whole fruits of this conjuncture evidently offers an immense incentive to the practice of the art of being in the right place at the right time. Thus one of the most powerful of human motives, namely the love of money, is harnessed to the task of distributing economic resources in the way best calculated to increase wealth.

Shades of Thomas Piketty. Keynes’ primary target is professors of economics who teach the the simplest and most reductive assumptions as the norm, with all of the messy complications of reality excised. “They regard the simplified hypothesis as health, and the further complications as disease.” He says that the alternatives, Marxian socialism and protectionism, are terrible themselves. Third, there’s this:

Finally, individualism and laissez-faire could not, in spite of their deep roots in the political and moral philosophies of the late eighteenth and early nineteenth centuries, have secured their lasting hold over the conduct of public affairs, if it had not been for their conformity with the needs and wishes of the business world of the day.

And in conclusion to that analysis, he writes in Part IV:

Let us clear from the ground the metaphysical or general principles upon which, from time to time, laissez-faire has been founded. It is not true that individuals possess a prescriptive ‘natural liberty’ in their economic activities. There is no ‘compact’ conferring perpetual rights on those who Have or on those who Acquire. The world is not so governed from above that private and social interest always coincide. It is not so managed here below that in practice they coincide. It is not a correct deduction from the principles of economics that enlightened self-interest always operates in the public interest. Nor is it true that self-interest generally is enlightened; more often individuals acting separately to promote their own ends are too ignorant or too weak to attain even these. Experience does not show that individuals, when they make up a social unit, are always less clear-sighted than when they act separately.

Keynes believed that a capitalist economy could be made to work better through government actions as the situation demanded. “Our problem is to work out a social organization which shall be as efficient as possible without offending our notions of a satisfactory way of life.” I would have written that we should have a satisfactory way of life, made as efficient as possible, but maybe that’s what Keynes meant.

Given these forces, it’s hard to see the basis for Keynes’ hope that the principles of laissez-faire might be eradicated, and, of course, they weren’t. They govern the economic thinking of the Republicans and the corporatist Democrats even today, as the vote on the TPP indicates. They are people who ignorantly repeat the tropes of laissez-faire without reading their original proponents: “… we should consider their arguments preposterous if they were to fall into our hands.“

That’s certainly true, more so today than ever. It points to the central reason why stupid economic ideas cannot be vanquished:

To suggest social action for the public good to the City of London is like discussing the Origin of Species with a bishop sixty years ago. The first reaction is not intellectual, but moral. An orthodoxy is in question, and the more persuasive the arguments the graver the offence.

A Possible Paradigm of Neoliberal Economics

In this post I ask what the paradigm of economics might be, and if there is one. I did not address the question of the exact nature of the paradigm as discussed by Kuhn, leaving it at the broadest possible level: the theories, instruments, methods, prejudices and so on common to a community of scholars working in a fairly specific area of human knowledge. The general question of the nature of the paradigm is the subject of a number of papers, most concluding that the concept is too unclear to support careful analysis. That’s the position taken by George Stigler in a remarkable paper, Does Economics Have a Useful Past? 1 Hist. of Pol. Econ. 225 (1969). Stigler dismisses Kuhn because he can’t find an example of a paradigm that completely defeats a prior paradigm.

To be concrete, the marginal utility revolution of the 1870s replaced the individual economic agent as a sociological or historical datum by the utility-maximizing individual. The essential elements of the classical theory were affected in no respect. (A possible, but uncertain, aftereffect in twenty years was the development of the marginal productivity theory.) Until Kuhn gives us criteria of a revolution (or a paradigm) which have direct empirical content, it will not be possible to submit his fascinating hypotheses to test.

I assume Stigler means that Kuhn’s ideas aren’t applicable to economics. Certainly the book is full of examples from physics and chemistry of theories that completely replace older theories, leaving the old to as nothing more than objects of interest. Let me propose one such idea for economics. It is a certainty of economics that taxes exist for the purpose of raising revenue for the government. That was probably true before the advent of fiat money. When nations left the gold standard, it became untrue, as the Chairman of the Federal Reserve Bank of New York, Beardsley Ruml, wrote in 1946 in a paper titled Taxes For Revenue Are Obsolete. This idea is as revolutionary as the Copernican Revolution. It forms the basis of Modern Money Theory, and both the idea and the elaboration into a coherent theory are fiercely ignored or fiercely fought by the dominant economists. As it happens, this idea is leaking into public discussion despite their best efforts.

I have little else to add to this discussion about the nature of paradigms. I’ll follow Stigler in accepting that there are communities of scholars engaged in the same general areas of study, and in these communities, there is a mutual agreement on theories, instruments, methods, measurements, and even prejudices, and these guide the thinkers in their day to day efforts. Stigler considers this a good picture of economics, and for my purposes, it serves to connect Kuhn’s ideas to economics.

The neoclassical school dominates economic discourse and is widely taught as authoritative at every level in the US. N. Gregory Mankiw, Harvard professor and author of the leading economics textbook, wrote this in a New York Times column in May 2009:

Despite the enormity of recent events [meaning the Great Crash], the principles of economics are largely unchanged. Students still need to learn about the gains from trade, supply and demand, the efficiency properties of market outcomes, and so on. These topics will remain the bread-and-butter of introductory courses.

Let’s try to tease out the paradigmatic points of the neoliberal school. Mankiw’s best-selling economics textbook contains these 10 principles of economics:

  1. People face tradeoffs

  2. The cost of something is what you give up to get it
  3. Rational people think at the margin
  4. People respond to incentives
  5. Trade can make everyone better off
  6. Markets are usually a good way to organize economic activity
  7. Governments can sometimes improve market outcomes
  8. A country’s standard of living depends on its ability to produce goods and services
  9. Prices rise when the government prints too much money
  10. Society faces a short-run tradeoff between Inflation and unemployment

The primary method of this school is mathematical modeling, which adds at least two covert assumptions, that collective and individual human behavior is continuous enough so that it’s reasonable to use college calculus, and that aggregate behavior is nothing but the sum of individual behaviors which exist independently of each other at all times. The theory is premised on the idea that the motivation of all people is efficiency, and that economic efficiency is the most prized value in a society, with all other goals held as secondary. The models are used to give normative policy advice.

This school of thought, to follow Stigler, replaced Keynesianism. P. 228. Why? Stigler suggests that a school of thought cannot survive the life of its leader. That seems very odd, because many of the ideas of the neoliberals are taken from the past. As Stigler says:

The young theorist, working with an increasingly formal, abstract, and systematic corpus of knowledge, will seldom find it necessary to consult even a late-nineteenth-century economist. He will assume, just as the mathematician or chemist assumes, that all that is useful and valid in earlier work is present — in purer and more elegant form — in the modern theory. P. 217-8

I won’t belabor the obvious point that every element of the neoliberal school is contested. Instead, I continue to focus on this question. The canonical explanation of the rise of neoliberalism is that Keynesianism failed in the 1970s, and was replaced by neoliberal economics which offered a better solution to the problem that Keynesianism stumbled over. That explanation leaves a bunch of questions. Not the least is exactly why the events of the 1970s were somehow a failure of economic theory. The solution offered by neoliberalism was the traditional conservative solution: hammer the workers and coddle the capitalists. Why is that a better solution? Remember, Keynes believed that the goal of economic recovery was to give people useful work to do [see paragraph 5], not to help the rich. And why isn’t neoliberalism facing extinction in the wake of its disastrous failure? Both Kuhn and Keynes have something to offer on this question, and I’ll take that up next.

Paradigm Change in Science and Economics

In this post, I discussed normal science, a term used by Thomas Kuhn in The Structure of Scientific Revolutions to describe the day to day work of scientists, focusing on the example of my brother’s work on transmission of pain in the body. In normal science, Kuhn explains, people expect the puzzles they choose to work on will have solutions that can be worked out using the paradigm, and if the first try doesn’t get the solution, scientists just keep plugging away, sharpening their instruments, their theories, their rules of engagement and trying to eliminate prejudices until they get a solution. And mostly, they do. That’s a good description of my brother’s work.

If not, generally they assume they failed, not that the answer doesn’t have a solution inside the paradigm’s limits. They put that problem to the side, and work on a related problem or maybe just move on to something different. Frequently the problem disappears as more and better techniques are created, measurements become better, theories evolve and prejudices are conquered. But if unsolved puzzles accumulate, there is growing pressure on the paradigm, and growing unease among the scientists working in the area. Kuhn gives examples:

The state of Ptolemaic astronomy was a scandal before Copernicus’ announcement. Galileo’s contributions to the study of motion depended closely upon difficulties discovered in Aristotle’s theory by scholastic critics. Newton’s new theory of light and color originated in the discovery that none of the existing pre-paradigm theories would account for the length of the spectrum, and the wave theory that replaced Newton’s was announced in the midst of growing concern about anomalies in the relation of diffraction and polarization effects to Newton’s theory. P. 67, fn omitted.

This is the crisis state. It is a necessary, but not sufficient, condition for a change in the paradigm. Kuhn analogizes the situation to political revolutions:

Political revolutions are inaugurated by a growing sense, often restricted to a segment of the political community, that existing institutions have ceased adequately to meet the problems posed by an environment that they have in part created. In much the same way, scientific revolutions are inaugurated by a growing sense, again often restricted to a narrow subdivision of the scientific community, that an existing paradigm has ceased to function adequately in the exploration of an aspect of nature to which that paradigm itself had previously led the way. P. 92

Another necessary condition for a paradigm shift is the existence of a new paradigm. Scientists cannot work without a paradigm, so until a new one obtains a concensus, they struggle on under the old one. New paradigms are suggested and tested, but Kuhn points out that there isn’t any way to prove that one is better than the other, because proofs only exist inside paradigms. The new paradigm has to satisfy the relevant scientific community that it will solve the old problems, and open the way to new problems. But this is a matter of persuasion, not of scientific proof, because the standards of proof are connected to a paradigm; they do not exist in some Platonic state above it all.

One final point. Kuhn says that in scientific revolutions, the new paradigm completely replaces the old one, and he gives plenty of examples.

There’s more to be said about the process of paradigm change, but this will suffice for this post. In the wake of Kuhn’s work, several papers were published trying to identify paradigm shifts on the order of the Copernican Revolution in the history of economics. One such is The “Structure of Revolutions” in Economic Thought, a 1971 article by Martin Bronfenbrenner. He thinks the history of economics is more like the Hegelian dialectic, thesis, antithesis and synthesis, than the catastrophic destruction of the previous paradigm.

Bronfenbrenner identifies three revolutions in economics as

1. The classical school, based on Adam Smith’s Wealth of Nations and David Hume’s Political Discourses.
2. The marginal utility revolution, dating to about 1870, led by John Stuart Mill and David Ricardo.
3. The Keynesian revolution, about 1936.

He adds the response of the Chicago school as a possible fourth, and time has proved his suggestion correct.

It should be obvious that none of these revolutions destroyed the older view. Instead, they sit side-by-side, if uneasily and with some overlap. Bronfenbrenner doesn’t see a problem with the survival of the natural law as a partial explanation of 20st Century capitalism, and assumes that the future will include some of those ideas as well. This is clear from his approval of Paul Samuelson’s textbook. I point out the problems with that view in several posts here and at Naked Capitalism, including this one.

Like others, Bronfenbrenner points out that Kuhn’s definition of the term “paradigm” is loose at best. For purposes of this post, it’s sufficient to regard it as the entire set of theories, understandings, prejudices, instruments, and interpretations of the measurements of instruments that guide the scientist in the course of normal science. It is, however, important to note that neither Bronfenbrenner nor any of the other writers I’ve seen so far try to explain the sense in which the Classical School, the Marginal Utility School, the Keynesians or the Chicago School, or, for that matter, any of the other schools, constitute a paradigm in a way similar to the way General Relativity acts as a paradigm for physicists and astronomers.

That offers two more or less neutral explanations of why economists aren’t all freaked out by the failure of their theories demonstrated by the Great Crash. First, they may well assume that events like the Great Crash are just anomalies that future work will solve. That would explain the response of Gary Becker, “You need a theory to beat a theory.” Link here. Becker couldn’t imagine an alternative theory, so he just continued to work inside his old one, as if his Chicago School were a paradigm.

Second, Bronfenbrenner is right that old economic theories never die. They cannot die. Instead, in his view, they will be assumed into the heaven of some synthesis, hopefully with the favorite views of each economist on top.

As a road map for the rest of this series, what does all this say about the claims of authority of economists?

Paradigms in Economics

I am fascinated by the fact that economists do not seem fazed by the failure of their almost unanimous policy recommendations of deregulation and tax cuts, as I discuss here and here. Almost in unison, they chanted for decades that reducing taxes and regulation would spur growth for the benefit of all of us. The Great Crash didn’t faze them, as these posts show. So why not?

One plausible explanation is that these people are acting in bad faith in the sense Sartre uses this term. They are free to change their minds about their theories, but they are not willing act on, or even to face, that freedom because it might cost them something. This explanation seems to be behind several of Paul Krugman’s recent columns and blog posts, asking how people can have a claim to expertise when they give the same advice no matter the circumstances, and when the evidence and even the structure of their explanations contradict their advice. I think there are plenty of intellectually dishonest economists, but surely there are plenty of intellectually honest economists too.

After my previous posts a correspondent suggested I take a look at Thomas Kuhn’s The Structure of Scientific Revolutions. In the wake of Kuhn’s book, a number of scholars attempted to apply the theory to economics. I think it’s helpful to look at the failures of economics through this lens.

Kuhn starts by describing what he calls normal science: the day to day practice of scientists. Their work is based on an infrastructure consisting of theories of various strengths, instruments, and techniques that together make up a paradigm. This paradigm organizes their thinking so that they have an idea of what they are doing when they do physical and thought experiments. Kuhn says that normal science uses the paradigm to solve puzzles. The puzzles themselves are set up by the paradigm, and the scientist expects to be able to solve them using the rules and equipment of the paradigm.

Here’s an example. One of my brothers was a scientist with a deep interest in the transmission of pain through the nervous system to the brain, and in analgesics, pain-killers. In the 80s, he began to wonder about the pain-killing effect of marijuana. Here’s a reasonably comprehensible paper he co-wrote in 2001, discussing the state of work on cannabinoids.

In the paper he talks about single-cell studies. We talked about this a couple of times while he was doing this work. He told me that his lab had worked out a technique for inserting a tiny filament into a brain cell of an anesthetized rat and counting how many times and how often it fired, and some other things about it. He explained how he thought that happened, and what it meant physically. He described the instruments he used in general terms, and some of the interesting ways he was using computer chips to monitor the results. I asked why. I thought it might be useful, he said.

For him, neurotransmission of pain was a huge puzzle. He wormed away at it most of his adult life. Each little step he took seemed likely to advance a detailed understanding of the puzzle, or create an instrument that might help him and his colleagues take another step. A giant puzzle. A game. The same things were going on in other labs, as the footnotes show. One of the researchers he cites wondered if the body generates substances like cannabinoids. That guy found an endocannabinoid, a naturally occurring cannabinoid, which he named anandamide, from the Sanskrit word for internal bliss. Not only a puzzle, but an opportunity for cool puns.

Kuhn’s examples are older, and from physics and chemistry, but they exhibit the same pattern. In both cases, normal science depends on a collegial understanding of the instruments, the things being measured and a shared general understanding of the way the thing being studied works.

Kuhn offers three foci of normal science: learning about the facts that the paradigm suggests are most revealing about the nature of things; facts that can be used to check the paradigm; and empirical work to articulate the paradigm in the greatest possible detail, clearing up ambiguities and reaching for further problems suggested by the paradigm.

How does economics fit into this picture? What is the paradigm? What are the problems economists are trying to solve? What is “normal economics”?

Here’s one explanation from David Andolfatto of the St. Louis Fed:

But seriously, the delivery of precise time-dated forecasts of events is a mug’s game. If this is your goal, then you probably can’t beat theory-free statistical forecasting techniques. But this is not what economics is about. The goal, instead, is to develop theories that can be used to organize our thinking about various aspects of the way an economy functions. Most of these theories are “partial” in nature, designed to address a specific set of phenomena (there is no “grand unifying theory” so many theories coexist). These theories can also be used to make conditional forecasts: IF a set of circumstances hold, THEN a number of events are likely to follow. The models based on these theories can be used as laboratories to test and measure the effect, and desirability, of alternative hypothetical policy interventions (something not possible with purely statistical forecasting models).

In previous posts I note that recommendations arising from models that do not and cannot predict crashes is worse than useless, it’s downright dangerous. Another kind of problem is that there are big disagreements about the models: whether the assumptions are correct, what they actually model, how they do it, why and whether they work and under what circumstances. Further, there are a number of schools of economics each with its own models and its own set of assumptions, overt and covert. In fact, it isn’t quite clear what the economics paradigm is, or are. These and other issues are for another day.

Big Data: An Alternate Reason for Hacks Past and Future?

[Fracking sites, location unknown (Simon Fraser University via Flickr)]

[Fracking sites, location unknown (Simon Fraser University via Flickr)]

On Monday, MIT’s Technology Review published an interesting read: Big Data Will Keep the Shale Boom Rolling.

Big Data. Industry players are relying on large sets of data collected across the field to make decisions. They’re not looking at daily price points alone in the market place, or at monthly and quarterly business performance. They’re evaluating comprehensive amounts of data over time, and some in real time as it is collected and distributed.

Which leads to an Aha! moment. The fastest entrant to market with the most complete and reliable data has a competitive advantage. But what if the fastest to market snatches others’ production data, faster than the data’s producer can use it when marketing their product?

One might ask who would hack fossil fuel companies’ data. The most obvious, logical answers are:

— anti-fossil fuel hackers cutting into production;
— retaliatory nation-state agents conducting cyber warfare;
— criminals looking for cash; and
— more benign scrip kiddies defacing property for fun.

But what if the hackers are none of the above? What if the hackers are other competitors (who by coincidence may be state-owned businesses) seeking information about the market ahead?

What would that look like? We’re talking really big money, impacting entire nation-state economies by breach-culled data. The kind of money that can buy governments’ silence and cooperation. Would it look as obvious as Nation A breaking the digital lock on Company B’s oil production? Or would it look far more subtle, far more deniable? Continue reading

Will Economists Replace Lawyers as First Against the Wall?

The field [economics] is filled with anxious introspection, prompted by economists’ feeling that they are powerful but unloved, and by robust empirical evidence that they are different.
The Superiority of Economists, by Marion Fourcade, Etienne Ollion and Yan Algan.

In this post at Naked Capitalism, I explain that one big reason normal people don’t love economists is that they refuse to take any blame for causing the Great Crash. As a group, economists insisted that it would be great to tear down the New Deal financial regulatory system, without ever considering the potential costs of a crash. It wasn’t just that their models didn’t predict the Great Crash, it’s that their models won’t ever predict crashes. Until someone got around to tweaking them, their models did not even predict the damage a crash might cause. They had no way to evaluate the costs of crashes, but they ignored those costs, mostly on ideological grounds. They insisted to policy makers, legislators, regulators and politicians, and not least, their wealthy supporters, that things would be great if we just got rid of regulation. They were proven absolutely wrong. Then they insisted that more of the same garbage was the right solution, and their supporters agreed. And so it came to pass that we got a lousy recovery that only benefited their patrons. But that’s hardly the only reason people don’t love economists.

You’d expect some self-criticism from even the most narcissistic economists in the wake of their utter failure, but that didn’t happen. Here’s an interview of Gary Becker of the University of Chicago in December 2010 by economist Catherine Herfeld who begins by asking him whether the economics profession is in crisis. No, says Becker. Economists might begin to consider some mildly different problems, maybe, but no. Models can’t be expected to predict crashes, he says, and people respond to incentives. Economists already knew those things, so the Great Crash has no lessons for them.

Almost all economists agree with Becker’s two points. Their models and their methodology are not a problem, and do not require major changes. One crucial assumption of economists is that consumers are rational actors. When Herfeld presses Becker on the issue of the validity of that assumption and the risks that assumption entails, Becker explains so what? What’s your theory? “You need a theory to beat a theory,” he says. Policy advice based on Becker’s theories has been tried out. That advice sucks. We’d have been better off doing nothing than crashing the economy as an empirical test of his assumptions and the theories based on them. So, no. You don’t need a theory to beat a theory. Adults change their minds when their ideas fail. That’s another reason people despise these guys.

But that kind of intellectual arrogance is typical of economists, as we learn from The Superiority of Economists, by Marion Fourcade, Etienne Ollion and Yan Algan. The authors show that as a group economists are known for their absolute confidence in their ability to understand the economy and prescribe for us lesser mortals. They also show that economists are an insular group, not much interested in the work done in other fields of study. Here’s a demonstration of that. Herfeld asks Gary Becker this question:

[R}ationality is a concept that originated in philosophy and its various economic formulations and uses have been discussed extensively in the philosophical literature on the methodology of economics, such as by Alexander Rosenberg, Philip Mirowski, D. Wade Hands, and Mark Blaug. Were you ever interested in that literature? Or where did you get inspiration from when thinking about improving how rationality is conceived of in economics?

[Becker] Primarily, I get inspiration from my own discipline, economics. For example, I wrote my doctoral dissertation on racial discrimination. …

Becker can’t see any reason to learn what scholars in other fields think of rationality, or, apparently, racial discrimination, or anything else, for that matter, because, you know, he was a student of Milton Friedman, and he read Popper and Carnap. The rest of this answer and the next few show how Becker conceives of the intellectual life. It is exactly what Fourcade et al. describe, insular, hierarchical and to me at least, undeservedly arrogant. They describe the influence of economists in a lengthy section including this:

The upshot of economists’ confident attitude toward their own interventions in the world is that economics, unlike sociology or political science, has become a powerful transformative force. Economists do not simply depict a reality out there, they also make it happen by disseminating their advice and tools. In sociological terms, they “perform” reality. Aspects of economic theories and techniques become embedded in real-life economic processes, and become part of the equipment that economic actors and ordinary citizens use in their day-to-day economic interactions. In some cases, the practical use of economic technologies may actually align people’s behavior with its depiction by economic models. By changing the nature of economic processes from within, economics then has the power to make economic theories truer. Cites omitted.

So, there’s a third reason to loathe economists. They think human nature can and should change to match their models and their value systems, which are based on economic efficiency and unfettered markets. I don’t agree. Among other things, as I discuss in detail here, markets deal only with short run decisions, not with the long-term consequences of those decisions, which can easily lead to disastrous results. Just ask yourself how markets will allocate precious ground water in California, and ask how many almonds and how much cheap oil today are worth the end of the water supply that grows much of our food.

Here’s the fourth reason. Of course people respond to incentives, though that’s just one of a large number of influences on decisions. The question is who comes up with the incentives. Becker points out that people who took out subprime loans were responding to incentives, as if those borrowers caused the Great Crash. Who set those incentives up? Was it the poor people who got clobbered by those loans? Of course not. It was the lenders who were freed from all restraints by economists and their enablers among the rich and the politicians. Those economists who provided the policy justifications had no conception of the risks they were encouraging others to take while they pocketed their consulting fees. And after the crash, they, and specifically Becker, defended themselves by blaming the victim.

No wonder normal people don’t care for these people.

Software Is Not Capital if You’re Not a Software Company

PikettyCapital_coverThe Economist trumpets Thomas Piketty’s Capital and his theory, r > g, has had its first serious rebuttal, glowing like a proud parent over graduate student Matthew Rognlie’s work.

Note this bit:

Mr Rognlie mounts three main criticisms of these arguments. First, he argues that the rate of return from capital probably declines over the long run, rather than remaining high as Mr Piketty suggests, due to the law of diminishing marginal returns. Modern forms of capital, such as software, depreciate faster in value than equipment did in the past: a giant metal press might have a working life of decades while a new piece of database-management software will be obsolete in a few years at most. This means that although gross returns from wealth may well be rising, they may not necessarily be growing in net terms, since a large share of the gains that flow to owners of capital must be reinvested.

Emphasis mine.

Most commercial software used by corporations, including the example of database-management software, is licensed. Users are licensees, not owners.

Software doesn’t necessarily obsolesce, either. I’ve worked for businesses using software that was as much as twenty years old. Small businesses, in particular, can continue to run well on old accounting software, provided they don’t need highly granular reporting.

What does become obsolete is the hardware. If software no longer runs on an older system, or if it is no longer serviced by the licensor (ex: Windows XP), the licensee has simply reached the limit of the license.

This includes upgrades by software manufacturers for reasons of security improvements: if users don’t upgrade for improved security, they’re outside the limits of the license.

The only entities that might be able to claim software is capital are software companies. This might not even be the case if capital is limited to the licenses they’ve granted and claimed as assets — any accountant, tax attorney or IP attorney want to respond to this?

The confusion about software’s nature probably lies in our accounting and tax systems, which may treat software as an amortizable intangible asset. (Feel free to correct me in comments as I am not an accountant, nor a tax preparer, nor a tax attorney.)

But most commercial software remains a licensed product.

Companies are also moving toward “software as a service” (SaaS), provided a license to access software on software providers’ systems. Microsoft’s Office 365, Google Apps, Salesforce.com are examples of SaaS. There are even further reductions in companies’ need for investment in hardware when subscribing to “infrastructure as a service” and “platform as a service,” like IBM, Amazon, and other technology companies offer.

These are contracted services — definitely not rapidly depreciating capital assets.

What exactly does Rognlie mean by “modern forms of capital” when his understanding of software is flawed?

I haven’t looked deeply at the rest of the arguments Rognlie offered as a rebuttal to Piketty’s theory. This bit checked me short, giving me concerns about his remaining points addressing returns on wealth, and on distribution of net capital income.

[UPDATE: Do read Ed Walker’s comment about this piece in The Economist.]

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bmaz @RPullen @stephenlemons @Steve_Irvin That is pretty much an incoherent response. But whatever.
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emptywheel @pastordan REALLY not a fireworks fan, especially living in place where everyone sets them off. Was interesting learning abt buying process
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emptywheel I also managed to buy most of the beer left in the little convenience store still open, so I traded beer for lessons in fireworks.
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emptywheel Fourth of July trivia: I got stuck sleeping on the floor of Nagoya airport w/one of the main fireworks buyers from the NE once.
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emptywheel RT @WarOnTheRocks: How China can use the #OPMhack data to identify undercover intelligence officers http://t.co/7t2kKtRX9e
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bmaz @RPullen @stephenlemons @Steve_Irvin When an arbitrary, by all appearances racist, "umpire" calls anything, it is total laughable bullshit.
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emptywheel @billmon1 Also, American hubris says we'll never get in a dogfight with another industrial policy, all the contrary evidence notwithstanding
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emptywheel @billmon1 It helps if you think of it as an industrial policy instead. Pilots aren't encouraged to turn their head in industrial policies.
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emptywheel @billmon1 Fred: It doesn't much matter because USG will keep paying Lockheed no matter what we do.
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