Economist J. W. Mason: “When We Turn to Concrete Economic Questions, There Isn’t Really a ‘Mainstream’ at All.”

There is a mix of common-sense opinions, political prejudices, conventional business practice, and pragmatic rules of thumb, supported in an ad hoc, opportunistic way by bits and pieces of economic theory.

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“I don’t see…any method…at all.”

By J. W. Mason

I’ve felt for a while that most critiques of economics miss the mark. They start from the premise that economics is a systematic effort to understand the concrete social phenomena we call “the economy,” an effort whose methods unfortunately are unsound. But I don’t see any method at all.

It seems to me that Deirdre McCloskey was right: Economics is not the study of the economy. Economics is just what economists do. Economic theory is essentially a closed formal system; it’s a historical accident that there is some overlap between its technical vocabulary and the language used to describe concrete economic phenomena. Economics the discipline is to the economy, the sphere of social reality, as chess theory is to medieval history: The statement, say, that “queens are most effective when supported by strong bishops” might be reasonable in both domains, but studying its application in the one case will not help at all in applying it in in the other.

A few years ago Richard Posner said that he used to think economics meant the study of “rational” behavior in whatever domain, but after the financial crisis he decided it should mean the study of the behavior of the economy using whatever methodologies. (I can’t find the exact quote.) Descriptively, he was right the first time; but the point is, these are two different activities. Or to steal a line from my friend Suresh, the best way to think about what most economists do is as a kind of constrained-maximization poetry. It makes no more sense to ask “is it true” than of a haiku.

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One consequence of this is that radical criticism of the realism or logical consistency of orthodox economics does nothing to get us closer to a positive understanding of the economy. Another consequence is that when we turn to concrete economic questions there isn’t really a “mainstream” at all. Left critics want to take academic orthodoxy, a right-wing political vision, and the economic policy preferred by the established authorities, and roll them into a coherent package. But I don’t think you can. I think there is a mix of common-sense opinions, political prejudices, conventional business practice, and pragmatic rules of thumb, supported in an ad hoc, opportunistic way by bits and pieces of economic theory. It’s not possible to knock over the whole tottering pile by pulling out a few foundational texts.

More concretely: An economics education trains you to think in terms of real exchange — in terms of agents who (somehow or other) have come into possession of a bundle of goods, which they trade with each other. You can only use this framework to make statements about real economic phenomena if they are understood in terms of the supply side — if economic outcomes are understood in terms of different endowments of goods, or different real uses for them. Unless you’re in a position to self-consciously take another perspective, fitting your understanding of economic phenomena into a broader framework, this is going to mean expressing it as this kind of story, about the limited supply of real resources available, and the unlimited demands on them to meet real human needs. But there may be no story of that kind to tell.

Let’s suppose you’re an intelligent business journalist or policymaker trying to think through what economics tell us about current developments in the world using economics. (Maybe you pull out a good undergraduate macro textbook like Blanchard.) What are some of the major economic phenomena you might want to understand? For the US and most other developed countries, the list might look like:

– low and falling inflation

– low and falling interest rates

– slower growth of output

– slower growth of employment

– low business investment

– slower growth of labor productivity growth

– a declining share of wages in income

These are some of the main things you’d want to explain. What does the orthodox theory tell us?

The textbook says that lower inflation is normally the result of a positive supply shock — an increase in real resources or an improvement in technology. OK. But then what do we make of the slowdown in output and productivity?

The textbook says that, over the long run interest rates must reflect the marginal product of capital — the central bank (and monetary factors in general) can only change interest rates in the short run, not over a decade or more. In the Walrasian world, the interest rate and the return on investment are the same thing. So a sustained decline in interest rates must mean a decline in the marginal product of capital.

OK. So in combination with the slowdown in output growth, that suggests a negative technological shock. But that should mean higher inflation. Didn’t we just say that lower inflation implies a positive technological shock?

Employment growth in this framework is normally determined by demographics, or perhaps by structural changes in labor markets that change the effective labor supply. Slower employment growth means a falling labor supply — but that should, again, be inflationary. And it should be associated with higher wages: If labor is becoming relatively scarce, its price should rise. Yes, the textbook combines a bargaining mode of wage determination for the short run with a marginal product story for the long run, without ever explaining how they hook up, but in this case it doesn’t matter; the two stories agree. A fall in the labor supply will result in a rise in the marginal product of labor as it’s withdrawn from the least productive activities — that’s what “marginal” means! So either way the demographic story of falling employment is inconsistent with low inflation, with a falling wage share, and with the showdown in productivity growth.

Slower growth of labor productivity could be explained by an increase in labor supply  — but then why has employment decelerated so sharply? More often it’s taken as technologically determined. Slower productivity growth then implies a slowdown in innovation — which at least is consistent with low interest rates and low investment. But this “negative technology shock” should again, be inflationary. And it should be associated with a fall in the return to capital, not a rise.

On the other hand, the decline in the labor share is supposed to reflect a change in productive technology that encourages substitution of capital for labor, robots and all that. But how is this reconciled with the fall in interest rates, in investment, and in labor productivity? To replace workers with robots, someone has to make the robots, and someone has to buy them. And by definition this raises the productivity of the remaining workers.

Which subset of these mutually incompatible stories does the “mainstream” actually believe? I don’t know that they consistently believe any of them. My impression is that people adopt one or another based on the question at hand, while avoiding any systematic analysis through violent abuse of the ceteris paribus condition.

To paraphrase Leijonhufvud, on Mondays and Wednesdays wages are low because technological progress has slowed down, holding down labor productivity. On Tuesdays and Thursdays wages are low because technological progress has sped up, substituting capital for labor. Students may come away a bit confused but the main takeaway is clear: Low wages are just the natural outcome of economic fundamentals, of structural factors – whatever those may be.

So what’s the right answer? Well, it’s hard to say. And that’s the point. To read many criticisms of economics, the problem is just one key bad assumption, or one key methodological flaw. But that implies the rest of the structure is basically sound – or that understanding the dynamics of capitalist eocnomies would be straightforward if we just took off our ideological blinders. But it’s not straightforward, it’s very hard. And if the kind of formal abstractions developed by economists are not contributing to that work, neither are negative critiques of those abstractions. How is a raven unlike a writing desk? An endless number of ways, and enumerating them will leave you no wiser about either corvids or carpentry.

This article was originally published at The Slack Wire.

2016 July 15

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  • Scarcity vs. abundance and “what is money?” are the psychological blocks preventing one from understanding economics.

  • Haynes Goddard

    This is all macroeconomics. What about microeconomics?

    • SarahRose472

      Came here to say this. There is a huge split in economics between micro and macro. Micro has pretty solid foundations and methods, and definitely has a mainstream.

      For the first half of this article the author refers to “economics” when he really means “macroeconomics.” (Which is also what most people mean when they try to criticize the discipline of economics — most people don’t care about what microeconomists research)

      I agree that recent critiques of macroeconomics miss the mark. But what I think this article is illustrating is not that macro doesn’t have any METHOD, but rather, macro doesn’t have any ANSWERS. That’s exactly what the example about the Blanchard textbook shows. Have we figured out the causes and effects of inflation? In short, no.

      In some ways I think that’s the scarier critique for laypeople to understand — economists don’t know nearly as much as laypeople might assume. And it’s not just because they are dumb or making flawed assumptions, it’s because these are very, very hard problems to solve.

  • John M Legge

    Education in logical thinking isn’t necessarily wasted, even if the teaching is based on the glass bead universe rather than the one we inhabit. Men were throwing, slinging and shooting sharp objects and hitting their targets thousands of years before Newton published the laws of motion and in spite of Aristotle’s plausible but false exposition of the same. Doctors helped at least some patients in spite of the rubbish that they had been taught in medical school. (Doctors also killed people who might have survived without their help. Louis XIV’s son and grandson died in their doctors’ care; Louis’s great grandson survived to become Louis XV because his nurse barred the door to the nursery and wouldn’t let the doctors in.)

    Sometimes conventionally trained economists do some good; often they do very little harm; but occasionally, as with the rape of Greece by the Troika, they emulate the Black Death. Exposing the inconsistencies in economics and the unreality of the assumptions and axioms on which neoclassical economics is based is a precondition for delegitimising their larger policy predictions.

  • Nicholas Gruen

    Thanks J.W.M.

    Your piece reminded me of the opening of Alisdair Macintyre’s After Virtue, which I quote from the Internet Encyclopaedia of Philosophy.

    ‘MacIntyre begins After Virtue by asking the reader to engage in a thought experiment: “Imagine that the natural sciences were to suffer the effects of a catastrophe…. A series of environmental disasters [which] are blamed by the general public on the scientists” leads to rioting, scientists being lynched by angry mobs, the destruction of laboratories and equipment, the burning of books, and ultimately the decision by the government to end science instruction in schools and universities and to imprison and execute the remaining scientists. Eventually, enlightened people decide to restore science, but what do they have to work with? Only fragments: bits and pieces of theories, chapters of books, torn and charred pages of articles, hazy memories and damaged equipment with functions that are unclear, if not entirely forgotten. These people, he argues, would combine these fragments as best they could, inventing theories to connect them as necessary. People would talk and act as though they were doing “science,” but they would actually be doing something very different from what we currently call science. From our point of view, in a world where the sciences are intact, their “science” would be full of errors and inconsistencies, “truths” which no one could actually prove, and competing theories which were incompatible with one another. Further, the supporters of these theories would be unable to agree on any way to resolve their differences.’

    I remember first reading this about thirty years ago thinking it was a perfect description of economics.

  • William Meyer

    All of the theories you describe share a common theme–the “driver” of the theory is some social force or trend. “Positive supply shocks”, “marginal product of capital”, “negative technical shock”, “slowdown in innovation”, etc. None emphasize individual human agency. If all these “social trend” theories taken together produce an incoherent response, perhaps we should consider some item currently left out, or at possibly deliberately obscured: political power. Scales won’t balance the way the theory of the lever would suggest if they have a thumb on them. I find it odd the way your description of economics–which appears to be fairly standard–undercuts or ignores the notion that “he who writes the rules, largely determines the distribution of the gold”. It would, I suppose, make one of the main purposes of economics in modern Western society’s–providing highly mathematical justifications or apologies for the current distribution of political power–more difficult to take the position that economies are socially-constructed edifices designed to produce certain pre-selected outcomes, and not very much like billiard balls bouncing around a pool table.

  • There’s no mystery. There has been a long-term increase in rents, at the expense of wages, as a proportion of total income, and, relatedly, an increase in inequality. This is deflationary, since the rich spend a smaller proportion of their incomes, as spelt out by Keynes and, I suspect, anticipated by Marx. The deflationary effect was delayed by a massive expansion of the credit available to consumers, but since the collapse of the housing bubble that has ceased to be the case. Perverse incentives make share buyback more attractive to the decision-makers of major companies than investment in new capacity, and in any case there is no incentive to invest in new capacity when there is no demand for its products. Decline in output per worker is not something for which we could expect a single overall explanation. I would suggest looking at what activities are or are not offshored. Manufacturing, for example, is much more easily offshored than stacking supermarket shelves.

    Regarding the social function of what passes for economics in public discourse, William Meyer is spot-on, and echoing JK Galbraith. An extreme example is the deficit reduction economics of Osborne, which now, one hopes, has been quietly dropped.