Tuesday, 8 September 2015

An FAQ for Mainstream/Neoclassical Economists

I have received some standard criticisms from visiting mainstream economists – straw man, ignorant, economists aren’t all Milton Friedman-esque free marketeers, etc. Suffice to say I’ve heard it all before and it is rarely, if ever, accompanied by substantive engagement. So, if you are a visiting neoclassical economist who disagrees with me, please read this FAQ before you comment, as it should answer a good deal of your objections. I will update this post every so often to revise it in light of new developments.

How can you be so arrogant as to think you can debunk centuries of theory?
I’m not arrogant; I simply align with the evidence, and the fact is that neoclassical theory has failed at foreseeing, preventing and modelling the repeated crises of capitalism since its inception. After a crisis many models appear which present ‘special case’ events in which the economy destablises, but the core is always preserved and, once the crisis is over, we return to business as usual.
Furthermore, I do not claim a substantial degree of originality – I am mostly channeling centuries of what should have been incredibly damaging critique, though I will add some of my own from time to time.
Neoclassical economics isn’t even a thing! There’s economics and then there’s people like you.
The defining characteristic of neoclassical economics is the methodological core, which has 3 main components:
(1) Methodological individualism – the economy is modeled on the basis of the behaviour of individual agents.
(2) Methodological instrumentalism – individuals act in accordance with certain preferences rankings, to attain some end goal that they deem desirable.
(3) Methodological equilibration – given the above two, economics asks what will happen if we assume equilibrium. This can be either the ‘undergraduate’ definition of equilibrium (a steady state) or the ‘DSGE’ definition of equilibrium ( a time path). In both cases the insistence on equilibrium handcuffs economists, and in both cases it is never really asked whether the economy is actually in equilibrium.
Our models seemed to do a good job in the boom – why are you throwing the baby out with the bathwater?
This implies no causal link between the boom and the bust, and reflects the fact that neoclassical models can only model the crisis as exogenous, or a result of ‘one off’ factors that destablised an otherwise stable economy. Conversely, I align with the idea that capitalism has underlying tendencies towards instability, and no special or exogenous factors need to be invoked.
The models also didn’t ‘do well’ in the boom – you don’t need economists to have an economy. In fact, aside from Keynes post-WW2, I cannot think of an example where modern macroeconomics has resulted in a policy that created widely shared prosperity. Many of the most successful modern economies had their policies designed by lawyers or engineers, such as Southeast Asia, whilst modern developed economies all developed before neoclassical economics really took off. They also generally used protectionism to do this, something to which mainstream economists object. If macroeconomics cannot be used to design good policy, what is the point in having it?
At a more advanced level, our models incorporate the things you speak of. How can you be so ignorant?
First, bear in mind that this criticism effectively concedes that econ101, which is all most people who learn economics ever learn, is flawed because it doesn’t incorporate vital elements. Economists often appeal to econ101, but what if an engineer did this? Wouldn’t you be slightly worried that he’d missed out some important nuances? No physics textbook ends without introducing friction, because then it would be useless. Yet economists generally appeal to econ101 when discussing tariffs, rent control, the minimum wage and so forth, without acknowledging that the real story is far more complex than that.
However, as for the complex models, Noah Smith explained it best:
The whole notion of thinking of each interesting feature of the economy as a “friction,” and then of considering only one or two “frictions” at a time, has been very detrimental. For one thing, it makes it hard to develop a useful model of the economy, since the actual economy contains many, many “frictions” (so many that the “frictions” together are usually more important than the “frictionless” dynamics that supposedly “underlie” them). Also, the “one friction at a time” approach makes it very difficult to generate any alternatives to the classical “core theory” of Walrasian general equilibrium.
If the foundations of your theory – which are what I’m attacking – are flawed, then it doesn’t matter how many epicycles you’ve added later on. And the epicycles analogy is accurate. Macroeconomic models exist to explain basically every phenomenon, but generally only seek to explain one ‘aspect’ of the economy at a time. Models do not exist which can explain, say, the stagflation of the 1970s and the 2008 financial crisis. The DSGE paradigm is one that can be tweaked endlessly to explain any ‘deviation,’ all while the standard assumptions are preserved. Remember, epicycles were not abandoned because they couldn’t explain the orbits of planets (they can explain anything); it was because they became overly convoluted and complicated, all while preserving a core set of assumptions. In the case of DSGE, economists can’t even claim empirical verification, seeing as most DSGE papers don’t even bother to mention evidence.
OK, so what are your main problems with neoclassical economics?
In general: framing, assumptions and various notions of equilibrium. In particular: finance/banking, labour markets, utility and the theory of the firm. I have written in more detail on these elsewhere, for which I will provide links below.
Have you read Milton Friedman? The assumptions of a theory don’t matter, all that matter are its conclusions.
The fact that Friedman doesn’t properly define the word ‘assumption’ in that paper means he could be advocating any methodology whatsoever. Suffice to say, he’d love the octopus that correctly predicted world cup outcomes. Real science has clear parameters for the different types of assumption and when they are appropriate. Economics does not.
Have you read the Lucas Critique? Heterodox theories generally ignore microfoundations.
The Lucas Critique is valid but, of course, has been misused by economists. Lucas’ suggestion that we model based on the ‘deep parameters’ of human behaviour is impossible – no such parameters exist, aside from perhaps eating and reproducing. What Lucas really meant by ‘deep parameters’ was the preference-driven individualism outlined above, but this is as vulnerable to his own critique as any other postulate about human behaviour.
Designing policy will always and forever involve carefully examining the interactions between policy and behaviour, but it should never involve dismissing alternative theories out of hand ‘because Lucas Critique.’ Real scientists know that ‘more is different’, and aggregation and emergent phenomena are perfectly valid starting points. This does not become different because of economist’s special pleading.
P.S. Lucas was not the first to make this argument – Keynes did, as did Phillips himself, the main guy Lucas was aiming his critique at. It’s also worth noting that endorsing the microfoundations position and the Friedman position simultaneously is contradictory.
Even if markets aren’t all that great and people aren’t rational, how can the government improve on these outcomes?
This framing stems from the neoclassical bizzare-o world of governments versus markets. Nobody suggests that safety engineers need to be invulnerable, and similarly, designing a system in which ‘irrational’ people are better able to operate does not require omniscience. Limited liability laws are a great example of a hidden ‘intervention’ that many ignore, but work well and clearly do not require the government to ‘know better’ than market participants.
You speak of heterodox economics but seem quite friendly to Keynes. Doesn’t abandoning economics mean throwing out Keynes too?
Keynes was as heterodox as they come, although his work was completely misinterpreted by people like Hicks (who, later on, admitted his mistake). He rejected exogenous money, the idea that sticky wages cause demand side recessions, and the idea that the interest rate was determined by savings and investment. He was also the first to incorporate Knightian uncertainty into economics, something his mainstream followers rarely, if ever, mention. He had not fully escaped neoclassical economics when he wrote The General Theory, but he was well on his way.
Austrians did a good job of predicting the crisis, and they are heterodox. Why don’t you pay attention to them?
The only major difference between Austrians and ‘free market’ neoclassicists is that the former do not advocate central banking. They both suffer from similar framing issues, use similar methodology and come to almost the exact same policy conclusions – it’s no surprise that they have little trouble siding with each other. For those reasons, I cannot take their cries of heterodox seriously (most of them, anyway – Lachmann and others like him have some valuable contributions). See here for my brief overview of Austrianism, and here for why I think they are similar to neoclassicals.
What are some of your major critiques?
The fact that firms barely even understand how economists model their pricing habits, let alone conform to the models; for a theoretical approach as to why, see Piero Sraffa’s paper.
The swathes of empirical evidence in favour of endogenous money.
The well documented problems that arose during the Cambridge Capital Controversies, and were acknowledged by mainstream economists, before being ignored.
The simple observation that the marginal productivity of labour is a worthless concept because capital and labour are virtually always employed simultaneously.
I wrote a brief critique of comparative advantage here. More important is the fact that rich countries did not get rich through free trade.
See my series on Steve Keen’s Debunking Economics for some detailed criticisms of economic theory.
The 2008 crisis (and the other, repeated crises of capitalism) pose a major problem for the discipline, despite what economists may say.
My most comprehensive rejection of Friedman’s (incoherent) ‘assumptions don’t matter’ position is here.
For some notes on the accusation that heterodox economists straw man mainstream economics, see here; see here for common mistakes made by heterodox economists. See here for what I believe is the real difference between heterodox and  mainstream economics.
Some less directly theoretical but still important issues are the neoclassical misinterpretation of Keynes, and the related general lack of regard for the history of thought. I also have issues with how neoclassical economics frames economic debate. Finally, I feel economists underestimate the importance of institutions.
I don’t hate you anymore because of this fantastic FAQ. Where can I find other blogs like yours?
Robert Vienneau, a Sraffian/post-Keynesian blogger. The go-to person if you want to get highly technical.
Lord Keynes‘, a post-Keynesian and harsh critic of ABCT.
Yves Smith, author of ECONNED, which details the role of economics in facilitating the crisis. A mixture of financial analysis and criticisms of orthodox economics.
Steve Keen, the economist who most accurately predicted the crisis by looking at private debt levels, and who has been criticising mainstream economics from every angle for decades.
Mattias Vernengo at Naked Keynes, a strong proponent of the criticisms from the Cambridge Capital Controversies and a good place for alternative heterodox approaches.
Lars P Syll, a frequently updated heterodox blog with a number of cross posted articles. Syll himself specialises in critiques of the statistical/econometric approaches used by economists.
Frances Coppola, who is not an economist but an ex-banker, is essential for understanding how banking actually works.
See also Daniel Kuehn and Noah Smith, neither of whom are heterodox but both of whom are willing to engage with alternative schools of thought.
There’s a reason people like Keen, Galbraith and Hudson are not well regarded by the mainstream, you know.
Galileo, etc. Just because we have shiny buildings now doesn’t mean our theories can’t be way off.
You heterodox nutters are so negative! Do you even have any alternatives?
I have only a couple of my own posts on this: alternative versions of supply-demand and exploring a unifying principle for economics, as well as a brief comment on alternatives to the Efficient Markets Hypothesis.I have also commented on Steve Keen’s ‘Minsky’ Model and Keynes’ views on monetary policy, both of which I broadly agree with.
Other than myself, Robert Vienneau has various posts on Sraffian and Kaldorian models; Cameron Murray has a theory of return-seeking (not profit-seeking) firms; Econophysicists have some interesting work (though it’s not without its problems).
Overall, I broadly align with the Sraffian/Classical notion of society having to reproduce itself and this (roughly) determining prices, rather than the neoclassical idea that resources are allocated by optimising decisions and relative scarcity. On top of this, I adhere to the mark up approach of pricing (simply because it’s what firms actually do) with constant or decreasing returns to scale, and a theory of endogenous money.
P.S. If your response still contains the words ‘ignorant’ and ‘straw-man’ please consider whether you are just dredging up the standard style of response that all mainstream economists use to avoid some uncomfortable truths, and whether you have actually engaged with what I’ve said. Ignorance and straw-manning are possibilities, but after the crisis of 2008 I’d say the burden of proof lies on economists to provide robust defences of their theories, rather than merely behave as dismissive and arrogant reactionaries when challenged.

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