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MMT and Mainstream Economics

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Posts in this series. This post begins with links to all posts in this series.

In The Deficit Myth Stephanie Kelton explains in lay terms the fundamental ideas of Modern Monetary Theory and shows that they can be used to organize a economy that works for everyone. Throughout this series I have occasionally pointed to ways that MMT differs from mainstream economics. In this post I will try to get those ideas organized.

1. Elements of Mainstream Economics.

Let’s start with this quote from the J.W. Mason review of the book:

But in my view it’s better—both more accurate and more productive—to see [MMT] as a body of arguments within an older Keynesian tradition of economics. Contrary to the sense you might get from both supporters and detractors, it’s not a crystalline logical structure where, if you remove one piece, the whole thing collapses. Rather, like most emerging bodies of thought, it’s a ramshackle assemblage of parts built at different times for different purposes, tied together with loose solder of association and inference rather than tight bonds of deduction.

The boldfaced part of this sounds to me like a fair description of mainstream economics. We can see some of the assumptions and axioms of mainstream economics in this list by Harvard economist and textbook author N. Gregory Mankiw of ten things economists agree about. The link is a good refresher course in introductory economics.

One crucial assumption is that rational people think at the margin. By “rational” Mankiw means “systematically and purposefully doing the best you can to achieve your objectives.” [1] This is a reference to marginal utility theory, invented by the mathematician William Stanley Jevons around 1870. Jevons’ book is premised on the utilitarianism of Jeremy Bentham. [2] Marginal thinking pervades mainstream economics. [3]

As an example, consider the notion of Pareto Optimality, invented by Vilfred Pareto, another early economist with a STEM background. The idea is that we add up all the individual utilities of all the members of a society at a point in time and get a total. If we change some policy, it will affect the individual utilities. If the new policy makes some people better off and doesn’t make anyone worse off, we approve the policy.

So, for example, suppose a corporation has excess cash. It could distribute the money to shareholders or it could give raises to all the workers who created the excess. Either way is fine under Pareto Optimality. In the real world, the money goes to the shareholders, and the workers are rightly hostile about their stagnant wages. If you don’t like this as a normative principle, you’ll really despise Kaldor-Hicks Optimality.

Other things that went into the early stages of economic theory are based on conditions at the time. That’s why we see the word “markets’ taking a central place. No one thinks that markets of today bear any resemblance to the markets known to Jevons or Adam Smith. It’s also why commodity money, like gold, has a central place, even though the US has only offered fiat money for decades. And it’s one reason we have this mystic reverence for capital and capital accumulation, which we have been taught was the engine of our current prosperity. This reading of history obscures the roles of slavery, government give-aways of land and mineral rights to the wealthy, and the misery of the recessions that unbridled capitalism created.

We have completely forgotten why we have these ideas. We don’t realize that we are centering the ideas of Jeremy Bentham. We never ask why we should prioritize maximizing utility for each individual, or ask ourselves what the balance is between the utility of the day, the decade, or the nation or our children might be. We forget the role of enslavement in the accumulation of capital, and deny the role of government. We ignore the damage capitalism has done to hundreds of millions of us over our history. We don’t question the need for more and more capital accumulation to push the economy where we want it to go. We don’t even ask what ends we want the economy to fulfill. We think and act like we are still on the gold standard.

I realize that many mainstream economists are more or less conscious of all this. But this is the thinking that dominates in our political discourse about the economy. All our politicians, most reporters and pundits (and all right-wing reporters and pundits), and most of us, think and act as if in essentials the “economy” is the same today as it was 150 years ago.

There is a strong tendency in mainstream economics to treat the status quo as if it were the result of the operations of natural laws. This tendency is illustrated in first part of this post.

2. MMT as an alternative.

MMT proceeds from a completely different place. It has no roots in philosophy. It seems to me that MMT is in the tradition of Pragmatism, the American philosophy of Charles Peirce, William James and John Dewey. [4] MMT starts with questions: what is money, and how does it work in our economy? There is no normative principle at work. MMT theorists proceed empirically, studying the way we use money throughout our economy. Money is a thing, and we need to understand its nature and its use. A big part of The Deficit Myth is devoted to examining these questions.

Separate and apart from this inquiry, we need to ask ourselves what we think makes for a good society. This inquiry isn’t about money or the economy, but about our goals. [5] In the US we make these decisions democratically. [6] We elect leaders by majority rule, and we lean on them to legislate and enforce our preferred policies. MMT shows that we can have legislative policies that support our overall desires. That claim, that we can have the things we want, is the real lesson of The Deficit Myth.

Of course, MMT doesn’t attempt to overthrow the entire edifice constructed by mainstream economics. Pragmatic theory says that we only change what we have to as our understanding improves. This means, for example, that ideas formed from an examination of data about other parts of the economy are not necessarily overturned by MMT. But even so, the ideas of MMT are a tool for examining the entire structure.

Conclusion.

Both political parties agree that our society can’t have what we want an need because there is no money, so we must suffer the status quo. Speaker Pelosi tells us she will impose PAY-GO. Joe Biden’s adviser Ted Kaufman says that we can’t do anything because “When we get in, the pantry is going to be bare.” In practice, this means we can only have whatever the richest people think is best for us. It’s not true. Speaking personally, it makes me angry when I see it in practice, long lines at food banks, people forced to risk their health to earn enough to eat, lead-ridden water systems in Flint and elsewhere, to name a few.

We need politicians who can read Kelton’s book. Those politicians need advisers who have studied the expanding literature of MMT. Mainstream economics is a dead end for our nation, and it will take the rich down with the rest of us as the planet catches fire and we suffer one horrible disaster after another.

Note: this is the last post in this series. Please feel free to use the comments to ask any questions or comment on any aspects of MMT.
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[Graphic via Grand Rapids Community Media Center under Creative Commons license-Attribution, No Derivatives]

[1] I don’t qualify as rational under this definition. My objectives are rarely systematic, and often I’m not conscious of them. They change from time to time based on my understanding of possibilities and probabilities, as well as contacts with my fellow humans directly and through books. The closer people are to me, the more they have the ability to influence my objectives. Many of the systematic efforts I’ve made failed and others have to be realigned with new and different objectives. And it’s absurd to think that most of my everyday purchases are made with some objective in mind beyond passing fancies. I’m too lazy to change things unless I have to, so often I stay with one system when another would be cheaper and better. And so on.

[2] Jevons’ book, Principles of Economics (1871), is available to read online. It’s an effort to put Bentham’s theories of utilitarianism into the form of a calculus of pleasure and pain. This is from the Preface to the Second Edition:

As to Bentham’s ideas, they are adopted as the starting-point of the theory given in this work, and are quoted at the beginning of chapter ii.

[3] I look at these ideas in several posts, here among others.

[4] I give a short primer on Pragmatism in three posts, here, here, and here.

[5] This question is beyond this series, but I can offer something on the edge of philosophical as a starting place: The Needs Of The Soul, a short essay by Simone Weil. Or listen to a podcast by Partially Examined Life, episode 250.

[6] This is not the place to discuss the problems with our democracy, which I acknowledge are great.

Democracy Against Capitalism: Competing Stories About Wages

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Ellen Meiksins Wood’s book Democracy against Capitalism, tells a story of capitalism at odds with the story economists tell. At the root of this is her view that we make a big mistake when we separate politics from economics. Here’s an example, summarized from three prior posts, one at Emptywheel, and this one and this one at Naked Capitalism. The original posts give more detailed discussions.

Chapter 12 of Samuelson and Nordhaus’ intro textbook Economics (2005 ed.) is titled How Markets Determine Incomes. They rely on marginal utility theory, invented by William Stanley Jevons, an English mathematician and economist and described in his 1871 book The Theory of Political Economy discussed here. Their explanation uses this chart. P. 238.

The y-axis is the marginal product of labor, with all other inputs held constant. The x-axis is the amount of labor, here the number of employees. We treat the labor as continuous so we can have a nice smooth curve, but in the real world it would look like a flight of stairs. The authors tell us that the employer will add workers until the marginal increase in revenue from the last worker is zero. They tell us that the bottom rectangle is wages, and the top triangle-ish shape DEN is rent. That’s because they are basing their explanation on John Bates Clark’s model from about 1900, and the idea is that this chart describes a farm. But they mean that this works for the economy as a whole, so it includes all workers on one hand, and all capitalists, that is, those who own the factories, smelters, coal mines, etc. on the other. This is their discussion:

Clark reasoned as follows: A first worker has a large marginal product because there is so much land to work with. Worker 2 has a slightly smaller marginal product. But the two workers are alike, so they must get exactly the same wage. The puzzle is, which wage? The MP (marginal production) of worker 1, or that of worker 2, or the average of the two?

Under perfect competition, the answer is clear: Landlords will not hire a worker if the market wage exceeds that worker’s marginal product. So competition will ensure that all the workers receive a wage rate equal to the marginal product of the last worker.

But now there is a surplus of total output over the wage bill because earlier workers have higher MPs than the last worker. What happens to the excess MPs…? The rest stays with the landlords as their residual earnings, which we will later call rent. Why…? The reason is that each landlord is a participant in the competitive market for land and rents the land for its best price. 237-8, emphasis in original.

Clark saw this as the result of the Natural Law, and pronounced it just. This is the model taught to generations in introductory economics. The logic seems questionable, but it doesn’t matter because it isn’t how things actually happen, as I demonstrate in the linked posts.

How would a Marxist like Wood describe this model? She divides society into two groups, the producers, in this case, the farmers, and the appropriators, in this case the landlords (ignoring detail), or the workers and the capitalists. At an earlier part of the history of this society, the land was handed to the landlords, or they took it violently when government was fragmented and power represented government. Wood is talking about England, but something similar happened in the US. As a result, the producers, here the farmers, were separated from the means of production, meaning the land and perhaps some of the tools and animals needed to grow crops, and the landowners were able to expropriate the surplus created by the producers. This is a rough description of what Marx called primitive accumulation (again ignoring details and not precisely following Wood).

Primitive accumulation didn’t happen by accident. It was done by some form of coercion by some sort of ruling class. Gradually the ruling class consolidated into states, and the process continued through the arms of the state. As an example, consider Polanyi’s description in The Great Transformation of the process of “enclosure” as it was called in England.

Turning to the chart, we ignore the marginal productivity stuff and treat the line NE as the level appropriators currently pay the producers. It is as low as the appropriators can make it, using both their control of the state, and their control of the process of production. If you have any doubts about that, read the discussion of the Phillips Curve and especially a paper by Simcha Barkai here. The capitalists appropriate the triangle DEN, which represents the surplus labor, for themselves.

As always, the disposition of surplus labour remains the central issue of class conflict; but now, that issue is no longer distinguishable from the organization of production. The struggle over appropriation appears not as a political struggle but as a battle over the terms and conditions of work. Kindle Loc. 804-806

The organization of production is controlled by the appropriators with the coercive assistance of the State as needed. If the producers were smart, they would struggle with the appropriators over that surplus. They’d elect governments that would take their side in the struggle over the allocation, they’d resist and force change. There is nothing but political power that requires payment of all of the surplus labor to capital.

So now we have two stories. To me, the Samuelson/Nordhaus/Clark story is dumb. It takes the economy as a given, as if things had always been this way. In other versions of their story, we get a few shards of carefully selected history that pretend to find seeds of capitalism in earlier times. Mostly, though, it’s a vision of capitalism as an inevitable and fixed system as available for study as a cadaver.

In addition, this story makes the outcomes seem pre-ordained, and leads people to think that interference with the process is both useless and somehow dangerous, certain to produce even worse results. And, it’s a just-so story: all the numbers appear to come out in perfect equilibrium as if by magic.

Wood’s story is easy to understand. It’s based in history, none of that man-made natural law mumbo-jumbo. It doesn’t call for absurd assumptions to make everything work out beautifully. It’s easy to see how this story can motivate action, and, of course, reaction. And here’s the key point: it’s easy enough to tell the this story without direct reference to Marx.

Mankiw’s Principles of Economics Part 3: Rational People Think At The Margin

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The introduction to this series is here.
Part 1 is here.
Part 2 is here.

Mankiw’s third principle: Rational People Think At The Margin. His definition is:

Rational people systematically and purposefully do the best they can to achieve their objectives, given the available opportunities.” Principles of Macroeconomics 6th Ed. at 6

He defines marginal change: a small incremental adjustment to a plan of action. He teaches that rational people often compare the results of marginal changes to make decisions. Finally we get to his major premise:

A rational decision maker takes an action if and only if the marginal benefit of the action exceeds the marginal cost.

The first example is dinner. The choice, Mankiw says, is not between fasting and eating like a pig, but whether to eat another spoonful of mashed potatoes. At exam time, the choice is not blowing them off versus pulling all-nighters, but whether to put in an hour on your notes or goof off for that hour. His next example is seat prices for airplanes. The airline should sell seats at the price above the marginal cost of flying the passenger. Then we get the water/diamonds example. Water is essential for life, but it’s cheap. Diamonds are an extravagance, but they are very expensive.

All of this is in support of a central element of neoliberal and mainstream economics, that economies can be modeled by treating them as made up of rational agents. This idea fits neatly into Mirowski’s commandments of neoliberalism, specifically number 6: Thou Shalt Become The Manager Of Thyself. This means that individuals must learn to act rationally to decide upon a set of investments in themselves and changes in their behavior that will improve your appeal to people with money so they will give you money to work for them.

The food example is straight-forward enough, but how is the choice made? Some people are raised to clean their plates, and they do even if they could have skipped the last few forkfuls. Some people feel differently about meat than about French fries or carrots. Some people are abstemious, and always leave food. Others make the choice at the outset, by serving themselves a fixed amount and then eating all of it. Suppose the person would prefer to eat the last few bites of pork chop and skip dessert? If all these are rational choices for individuals, what possible generalization about eating is there? What, if anything, can this principle predict? How would Mankiw use that idea to model eating dinner?

The study example is fascinating. I remember my college days, and I ‘m sure I didn’t rationally choose whether to goof off with my friends or to study for finals. I chose, but it was random. And how would you calculate the benefit of one hour of study versus one hour of relaxing? Is that a real possibility?

The airline example is obvious to anyone familiar with basic business principles. It certainly isn’t an indication of “rationality” in the sense Mankiw is using the term. It merely requires an understanding of the difference between fixed costs and variable costs.

Then there’s the water/diamonds example. Here’s Mankiw’s explanation, so you won’t think I’m being snarky:

The reason is that a person’s willingness to pay for a good is based on the marginal benefit that an extra unit of the good would yield. The marginal benefit, in turn, depends on how many units a person already has. Water is essential, but the marginal benefit of an extra cup is small because water is plentiful. By contrast, no one needs diamonds to survive, but because diamonds are so rare, people consider the marginal benefit of an extra diamond to be large.

So water is cheap because people have a lot of it? Of course, there is plenty of water in most parts of the country, in our commonly held lakes, rivers, underground acquifers, and water run-off. As a commonly-owned asset, it’s free, if you could get it. But it has to be cleaned, delivered, and disposed of. That means the real question is why do we have a lot of clean water at the tap and few diamonds? The real reason is that our ancestors decided to make sure we all had clean water to drink, and explicitly chose to keep the “free market” out of it.

There are plenty of diamonds, though they are hard to find and dig up. The diamond business is controlled by a monopoly that artificially restricts the supply. Our ancestors made sure that didn’t happen to water. To see this clearly, think about the price of a bottle of water at the movies. There we have artificial scarcity, produced by the theater’s policy against bringing in snacks. Just ask yourself whether you want to buy your water from a profit-maximizing monopoly, say the Comcast or the DeBeers of water. Maybe you’d like to buy your water from the private company that didn’t have a system in place to detect the foul chemicals in the water supply of Charleston, WV?

So now let’s see how this rationality principle works in practice. Consider retirement savings. What would it mean operationally to say that people act rationally when making decisions about saving and preparing for retirement? What does this principle tell them to do? How should they invest? What should they do to protect themselves against losing big in those investments? What happens if they are hurt and can’t work, or if their spouse gets hurt and they need to quit work to take care of them? How do you calculate the value of a dollar today against the value of that dollar in retirement? For a short lesson in the prevalence of financial literacy, look at this paper, or this site.

Finally, it isn’t just one choice. There is a chain of choices in life, each one eliminates other choices and creates new choices and possibilities, each with its own probability of success. In the retirement example, you might have a 75% chance of correctly guessing at how much to save, a 95% chance of getting an honest financial adviser, a 60% chance that the investments will be very successful, and related chances of less good outcomes. Your chances of getting the best result are about 43%, and that’s before you consider the general state of the economy when you need money, continued good health, unexpected possible current uses for your money, good relations with your partner and your partner’s success in contributing, and all the other variables. That tells you that most people will be somewhat successful, a few will be wildly successful, and a fair number will crash and burn. The reality is that most families have very little success, and are dependent on Social Security and Medicare for a decent retirement. Even people who do reasonably well need those social arrangements to secure a good retirement.

This analysis shows that the margin plays little or no role in the lives of ordinary humans. It’s just a construct used to simplify human life in a way that permits economists to justify their use of calculus.

Here are some possible conclusions:

1. This principle makes sense when considered in the very short run, like the mashed potatoes example. For any longer term, it feels more or less random, mostly because there is no way to determine the probabilitiies. Some people get lucky and win the game of life. Others don’t get lucky. The number of things that seem perfectly rational at a point in time either work, or they don’t, and the results are unpredictable. That accords with my understanding of markets as minute by minute affairs. In the longer run, investment and housing markets are a real threat to the marginal thinking of Mankiw’s rational people.

2. We all want to think we are pursuing their goals systematically and purposefully, Mankiw’s definition of rational people. We want to believe our success is the result of their personal skill, and many people apparently feel justified in looking down on, and even punishing, the losers. I’d say the reality is that it’s better to be lucky than rational.

2. By deciding that the economy is full of rational people, the door opens to armchair speculation. Hmmm, says Mankiw, if I were faced with a bowl of mashed potatoes, here’s how I’d decide how much to take. I’m rational, so that means everyone would act that way. So, I’ll model mashed potato eating based on purely rational me. In exactly the same way, they figure out how they prepare for retirement, and draw conclusions about the way rational people act and build that into their models. No.

3. I do not think this is the definitive discussion of the role of rationality in human decision making. The entire subject of rational agents has been subjected to criticism on philosophical and practical grounds, and I hope to get to it at some point.