Friday, May 02, 2014

The Argument on the Left: Does the Great Recession Justify a Paradigm Shift? (Part 2)

-- Posted by Neil H. Buchanan

In yesterday's post, I discussed an ongoing debate between some top-flight left-leaning economists, who are disagreeing about whether the failures of economic policy that led to (and then failed to deal adequately with) the Great Recession are a reason to radically rethink modern economics.  As I noted, the main combatants are Paul Krugman on the near-left (who defends the orthodox approach), and Tom Palley on the further-left (who advances heterodox approaches).

Most of my post yesterday was devoted to setting up the stakes of the debate, largely to show that the left-leaning economists in positions of relative power and prestige have nothing to fear from a serious challenge to the orthodoxy.  These are smart people, some of whom are already at least familiar with "heterodox" thinking and could adapt to a broader conversation.  They face no existential personal threat, because they have tenure (and, in some cases, great fame) and already have the ears of the political elite.

The substantive question, then, can be addressed without fear of un-feathering anyone's nest.  Do we really need to open up economics beyond the very narrow methodological orthodoxy that has increasingly dominated the profession over the past several decades?  Krugman's answer is, in essence, that there is nothing wrong with mainstream economic theory, because its failure to predict the crisis prior to 2008 is forgivable (because it was really a failure to notice changes in the banking sector, not a failure of the theory itself), and its track record since then has been quite good.

To be clear about that second point, Krugman is saying that orthodox Keynesianism has a great track record post-2008.  People who worked from the standard Keynesian approach got pretty much everything right, from the non-threat of inflation due to massive monetary easing to the stagnating effects of fiscal austerity.  Yes, there are people who got it all wrong, representing roughly half of the "respectable" economics profession, but they got it wrong because went rogue, abandoning textbook theory in the pursuit of political agendas.  If politicians had known nothing other than undergraduate-level macro as propounded in the mainstream textbooks -- and, importantly, if they had actually followed what the textbooks said -- we would have come out of the crisis much sooner and with more momentum.  There would have been less human suffering, and the future would look brighter.

So what could people like Palley be arguing about?  To a large degree, the debate is not about whether standard Keynesian theory would have been a better guide than its chief conservative alternative (the latter of which amounts to a revivalist faith in the miracles of free markets, complete with confidence fairies and all that).  Certainly the heterodox left agrees that the anti-Keynesian policies of our era have been an enormous mistake.  The debate, in the end, is about whether such mistakes could be avoided in the future if we open up mainstream economics to a broader set of theoretical approaches.

Here, Krugman starts to go off the rails, essentially saying, "Well, my friends and I weren't poisoned by the supposedly dangerous consequences of a non-heterodox world, so orthodoxy must not be all that dangerous."  But that merely says that the orthodox approach is not 100% infectious.  Perhaps, however, the 50% infection rate could have been reduced if the economics profession had attracted and trained more people in a more open intellectual environment.

As Palley points out, the orthodox approach is based on the idea that the economy is inherently self-regulating, unless one builds special assumptions into the models.  That, in turn, gives laissez-faire approaches the presumption of truth, because one can only win the debate if one posits and then successfully defends the insertion of one or more assumptions that change the baseline predictions.  This leads to lots of discussions about "myopia" and "bounded rationality," for example, which are then endlessly debated as if it makes sense to assume as a default that people have perfect foresight and unbiased logic.

Krugman, again, says essentially that he can win those debates, so there is no problem.  He then defends his use of "New Keynesian" models, which is a hybrid approach that tries to reach Keynesian results from models based on hyper-rational atomistic individuals.  His defense amounts to the ultimate modernist justification: Hey, it's just a model, folks.  Everyone knows that what ultimately matters is how well the models predict the real world.  No one really thinks that the assumptions have to be true.  Models are just tools, to be used or abandoned as needed.

I do not want to revisit the modernist-postmodernist debate here.  I will say that modernism requires a great deal of confidence in one's ability to know what the truth is in the first place.  Despite my skepticism, however, I definitely see why Krugman is frustrated.  What is the big deal?  If my approach gets it right, it gets it right.  Everything else is just academic noise.

I should also say that I understand Krugman's frustration with many on the heterodox left (although not Palley).  Before I transitioned out of economics and into the legal academy, I spent a fair amount of time learning heterodox theory, which meant that I listened to a lot of people who were angry about being frozen out of modern economics.  Their anger was justified, but it was also toxic.  Most (but not all) of the people I met were engaged in self-undermining exercises, attacking people with sympathetic views for even the slightest lapse, and engaging in the kind of destructive personal nastiness that later came to typify online comment boards across the internet.

Krugman has been attacked by those guys on more than one occasion, to his great annoyance.  But that does not justify his general dismissal of heterodoxy.  Again, Palley is not being nasty, and he is offering a serious argument about the dangers of maintaining the academic status quo.  His position deserves a serious response, but Krugman and his side have thus far mostly said, "Why are you saying that we got it wrong, when we got it right?"  (To be fair, Palley did miss the fact that Krugman has been rather loudly saying, for some time now, that allowing wages to fall would not improve matters.  I understand Palley's larger point, but that was a needless oversight.)

As I discussed in my post last Friday, a key part of the argument between the orthodox left and the heterodox left hinges on the the theoretical validity of "production functions," which simplify the world by saying that we can measure "capital" as one number and "labor" as one number, put them into a mathematical equation, and see how much output the economy will produce.  Thomas Piketty's new book relies in large part on models that are built upon such functions.  But not just any production functions.  He relies on production functions that are built so that both labor and capital are paid according to their relative contributions to the output of the economy, with nothing left over.

In response to heterodox objections to this approach, Krugman again argues that it does not matter whether production functions are "true," and that the implicit assumptions about distributive justice (capital and labor supposedly being paid what they should be paid, based on their relative productivity) can be overcome by noting that the people who own capital do not necessarily deserve to own it or to reap its rewards.

As I argued last Friday, that is strategically dangerous, but at least it is coherent.  Yet Krugman never responded to what I view as Palley's most important point, from his very first blog post that kicked off this debate.  Palley wrote: "The conventional character of Piketty’s theoretical thinking rears its head in his policy prescriptions. His neoclassical growth framework leads him to focus on taxation as the remedy. There is little attention to issues of economic institutions and structures of economic power because these are not part of the neoclassical framework."

And this is where the importance of Palley's case for heterodoxy comes into focus.  He is correct that orthodox (aka neoclassical) economics has nothing to say about economic institutions and power, because all of that is part of what people like Krugman assume away in their "simple little models that help us understand the world, but shouldn't be viewed as the absolute truth."  Famously, Paul Samuelson (in some ways the father of all orthodox Keynesians, or at least their chief public spokesman) once said that it does not matter whether workers hire capital, or capital hires labor.  His point was that the models would work the same, no matter how capital and labor happen to get together.

Why does this matter?  What Palley is saying is that we constrain our choices by assuming away certain institutional realities.  If we do not allow for the possibility that capital and labor are not monolithic concepts, and if we ignore the legal rules that determine how much capital "earns" in the first place, then we are left with a very narrow set of policy responses.

And if the remaining policy instrument -- tax increases -- is politically nonviable, then we have nothing left in our arsenal, because we have assumed it all away.  Maybe those harmless, simple little models are not so harmless after all.


Michael C. Dorf said...

Might the current debate over raising the minimum wage illustrate this divide? The right says that raising the minimum wage causes unemployment--which is correct under the pure neoclassical theory. Krugman et al can say, no, that doesn't account for the stimulative effect of the extra dollars earned by minimum wage workers, but this is a correction to the neoclassical theory, which must then be justified empirically (a mixed bag in this case) and theoretically (much easier to do in a recession than during a period of growth). Maybe Krugman and the other left-leaning neoclassicists can win this debate, but they start from a huge disadvantage, because the obvious first-order effect of increasing labor cost is to increase price, which decreases demand, which decreases production, thus decreasing activity, thus increasing unemployment. A heterodox economist who begins with the power dynamic between labor and capital is not running uphill in this way.

Anonymous said...

What I wonder is how much of the passion for orthodoxy that you subscribe to Krugman is a reflection of an academic narrative. Some people in the academy like interdisciplinary efforts because they believe that heterodoxy increases explanatory power and others resent them because they feel that interdisciplinary efforts are dilutive to stature. For some people the notion of heterodoxy itself carries a certain existential fission because once the door is opened the line drawing exercise between politics and economics or between economics and psychology becomes blurry. Some people find security in tight academic boxes--constraining choices is exactly the point.

So the core question is: what is economics and how is it different than some other discipline? Perhaps Krugman has to subscribe to orthodoxy because if he didn't he would not view himself as an economist anymore. Indeed, you and I are the perfect examples--we got so interested in economic heterodoxy we went right out the door into other fields. Goody for us--but perhaps Krugman simply doesn't want to go down that road.

David Ricardo said...

While Mr. Dorf’s comment on the economics of minimum wage increases is not directly applicable to this post, it should be addressed because it illustrates that economic analysis and policy decision must be viewed in a complex world.

He is correct in his analysis that increasing the minimum wage will, other things being equal, lead to lower employment of minimum wage workers. But in the real world other things are not equal. And just because there is a negative side effect to policy (there is always a negative side effect, hence the basic tenet of economics that there is no such thing as a free lunch) does not mean that the policy is incorrect or even damaging.
When negative side effects occur we do not abandon their cause, we deal with them. If a highly beneficial medicine has harmful side effects then treatment and actions are taken to ameliorate them. The same can and should be done in economics. If increased free trade harms some industries, government should take steps to reduce or eliminate that harm, not by abandoning the policy but by helping those who are harmed to adjust to the new economic conditions. If reducing the use of coal to generate electricity harms the coal miners the answer is not to continue using coal, it is to help those who are harmed.

Mr. Dorf is a passionate vegan. But the movement away from consumption of meat and dairy products will have devastating economic impact on those who rely on that consumption for their economic well being, including Mr. Dorf’s employer Cornell with its world class agricultural education and its support and promotion of the meat and dairy industries. So the answer here is not to stop promoting less meat and dairy consumption, it is to incorporate in the program assistance for those who through no fault of their own are harmed by the changes.

If indeed an increase in the minimum wage causes some unemployment, then the proper response is to educate, train and mentor those unemployed so that they become employed. In fact were the government to highly invest in such programs, it would reduce the supply of minimum wage labor and the minimum wage would rise without statutory changes. A market solution to low income/low wages! Gosh, something even conservatives would applaud if they were really interested in the welfare of low income individuals.

The world does not stop at first order effects.

theyenguy said...

Economics is the ordained life experience of humanity, and is a paradigm presenting the experience of money in an age.

As communicated in Ephesians 1:10, economics is the paradigm and stewardship of all things by Jesus Christ in every epoch, bringing them to maturity and perfection, much like a ship’s captain completes the manifest before setting sail.

Economics is defined as the life experience between a person and another, a corporation, and the state, that is government; either it be ethical or pathological; economics is the trust and flow that comes from sovereignty, and the model that best presents economics is the Dispensation Economics Manifest.

An economy is defined as the life experience that comes from the administration of the credit and trade that comes from a household or stronghold. An economy exists for life and death experience, and is determined by the prevailing interest rate of the monetary regime and its monetary policies and schemes.

All be economists, as the field of economics is not restricted to NYT pundit Paul Krugman, or to ivory tower academicians, such as Oxford’s Simon Wren-Lewis.

Economics is money based; money is defined as the credit and trade that comes from the administration of a household or stronghold; debt based money bears interest, which is defined as the cost of money.

The banker regime established the freest of all economies in the history of mankind; beginning in 1999 with the repeal of the Glass Steagall Act and the provision of the Euro, it birthed and established the investor as the centerpiece of economic action.

The beast regime of regional governance and totalitarian collectivism, seen in Revelation 13:1-4, emerged on October 23, 2013, as Jesus Christ opened the first seal of the scroll of end time events, seen in Revelation 6:1-2, to provide the experience of diktat money replacing the democratic nation state and banker regime, which provided fiat money, to enable the bond vigilantes to begin calling the Interest Rate on the US Ten Year Note, ^TNX, from 2.48%, and thus pivoted the world from the paradigm of liberalism, meaning freedom from the state, into that of authoritarianism.

Liberalism featured democratic nation states which provided policies of investment choice and schemes of credit. But now with the failure of credit, seen in China, Russia, and the US Small Caps trading lower, authoritarianism is the new normal, and features regional governance which provides policies of diktat and schemes of debt servitude where the debt serf is the centerpiece of economic activity.

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