Economics

Orthodox Economics Has Become a Place Where Visions Die and Hopes Are Banished

Why liberal economists dish out despair

Share with your friends










Submit
More share buttons
Share on Pinterest

By Gerald Friedman

When I conducted an assessment of Senator Bernie Sanders’ economic proposals and found that they could produce robust growth, the negative reaction among powerful liberal economists was swift and vehement. How much, I wondered, did this reflect personal disappointment being rationalized into a political economy of despair? Professional economists tend to embrace an economic theory that government can do little more than fuss around the edges. From that stance, what do they have to offer ordinary people for whom the economy is not working? Not a whole lot.

It has certainly been a rough seven years for the liberal economists in the Obama Administration. Economic recovery has been slow, the slowest in the post-World War II era. Ambitious programs for reform of social insurance programs (such as unemployment insurance) and for public investment have been scaled back, and back. Yes, there is much that these economists who served Obama can be proud of: more people have health insurance, and the economy did not collapse. But the constant slog must have taken a toll. Having experienced so many compromises and disappointments, perhaps it is easier to say to those who expect more that it just can’t happen. There is comfort in the Thatcherite phrase: There Is No Alternative (TINA).

Get Evonomics in your inbox

The angry reaction to my report revealed that by some combination of rationalization and the dominance of neoclassical microeconomics since the 1970s, liberal economists have virtually abandoned Keynesian economics, which supported the notion that governments can and must intervene in the economy to ensure the best results for society. These economists went back to pre-Keynesian thinking, where price fluctuations are supposed to equilibrate supply and demand at full employment with an optimal distribution of good and services. The very suggestion that government action can result in increases in growth rates or wages is now taken to be obviously wrong. Adopting the language of neoclassical micro welfare economics, everything is already as good as can be — all that government can do is to make it worse. Criticisms of the orthodox model and its policies are deemed worthy of scorn, to be dismissed tout court because they are obviously at variance not only with textbook economics, but with what we need to believe to rationalize failure.

The closing of the economists’ mind

The reaction to my paper — the casual and precipitous conclusion that it must be wrong because it projects a sharply higher rate of GDP growth — comes from the assumption that the economy is already at full employment and capacity output. It is assumed that were output significantly below full employment, then prices would fall to equilibrate the two. This is the political counsel of despair. It is based on classical economic theory and the underlying acceptance of Say’s Law of Markets (named for the great Classical economist Jean-Baptiste Say), which says that total supply of goods and services and the total demand for goods and services will always be equal. The shoe market creates the right amount of demand for shoes — it works out so neatly that the true measure of the supply of shoes, of potential output, can be taken by measuring actual output. This concept is used as a justification for laissez-faire economics, and the view that the market mechanism finds a harmonious equilibrium. It explains why even in the depths of the economic crisis, Christina Romer, former Chair of the Council of Economic Advisers in the Obama administration, who was always skeptical of fiscal policy and Keynesian economics, and why Jared Bernstein, former Chief Economist and Economic Adviser to Vice President Joseph Biden under Obama, who should have known better, wrote that the economy would return on its own to full employment. They predicted, quite wrongly, that the proposed Obama stimulus would accelerate this recovery by 6 months.

The return of Say’s Law has distorted the way liberal policy elites view the economy. Consider the Congressional Budget Office’s (CBO) decision in 2014 to explain away years of slow growth by dramatically revising downwards its estimate of potential output. No longer do we have an output gap of 9 percent; instead the gap was redefined as only 2 percent because the real level of capacity is reevaluated as the level actually produced on the assumption that we must be at full employment. And how do we know that we are at full employment? Because we are producing the capacity level of output.

CBO has similarly downgraded estimates of potential GDP growth with historically low rates of labor force growth and slow productivity growth; instead of the 3 percent average annual growth of the 1959-2007 period, or the 4 percent growth 1947-73, we are to expect no more than 2 percent growth. While there is some referencing of demographic changes, these estimates conveniently align future growth projections with the otherwise-disappointing recent growth performance. This reevaluation says to policy elites, “Hey, we are doing as well as can be expected.” To the general public it says, “Sorry, nothing more can be done for you.” TINA.

The economics and politics of despair

There is, of course, a politics as well as a psychology to this economic theory. If nothing much can be done, if things are as good as they can be, it is irresponsible even to suggest to the general public that we try to do something about our economic ills. The role of economists and other policy elites (Paul Krugman is fond of the term “wonks”) is to explain to the general public why they should be reconciled with stagnant incomes, and to rebuke those, like myself, who say otherwise before we raise false hopes that can only be disappointed. But this approach leaves liberals like Hillary Clinton with few policy options to offer in response to the siren call of demagogues like Donald Trump. And it makes the work of self-proclaimed “responsible” elite economists that much more pressing. They have to work even harder to persuade the public that nothing can be done to head off the challenge of Trump and other irresponsible politicians who capitalize on the electorate’s appetite for change. They have to slap down critics like myself. “Responsible” elite economists have to keep the party of “good arithmetic” from overpromising at all costs.

Were the orthodox classical economists correct, then of course their politics would follow. But what if they are wrong? What if government action could, in fact, raise growth rates or narrow disparities? What would be the expected value of a higher GDP growth rate? Would it be worth some academic debate, even if it leaked into the public realm? Might this debate even serve a socially useful function by giving voters an alternative to the xenophobic political economy of Donald Trump? Many Americans believe that government action can improve economic conditions, especially for workers, and many of these support Trump because they see him as the only candidate who is even willing to consider government action to help working Americans. These voters can look long and hard at the “responsible” Clinton platform for some policy, for any policy to raise growth rates and narrow income disparities. But they won’t find it, because policy elites have closed their minds to the possibility of change.

An agenda for further research?

I admit that I have always lived surrounded by people who agree with me. At Columbia, Harvard, and now Amherst, Massachusetts, I have sought friends and colleagues who largely agree with me. While I enjoy the comfort that comes from an affirming community, it may be that I was not well served by the homogeneity of views. While I knew intellectually that the mainstream had abandoned Keynes and reembraced Say’s Law, I didn’t take this shift seriously. It seemed too absurd to me; honestly, I thought they were only kidding. Since I have spent most of my life refuting classical economics, and since my colleagues and friends agreed with me, I assumed that everyone did.

Had I included some mainstream economists in my narrow social circle, then I would have been better prepared for the substantive reaction to my report. On the other hand, as an intellectual activity, I was well served by the debate because it forced me to deal with ideas that I had previously rejected only too casually. I was helped in this by some of the orthodox folks who expressed second thoughts about my work (such as Kevin Drum). I am grateful to the Christina Romer and her husband David Romer, and to Justin Wolfers because, while they remain firmly opposed to my work, they took the time to explain their approach and helped me to articulate my own views more clearly. Our respectful exchanges allowed me to help them to understand the points of divergence in our models and gave me insight into the nature of my own approach.

This engagement of alternative visions could be a useful basis for the type of rethinking of macroeconomics favored even by some who remain in the orthodox camp, such as Olivier Blanchard, former chief economist at the International Monetary Fund,.

The debate has identified certain areas for empirical investigation that might help us not only to choose between the models but perhaps to find times and places where one or the other approach may be more useful. At a minimum, we have a research agenda for many graduate student papers and dissertations.

  • The strength of Verdoorn’s Law associating productivity growth with economic growth rates and the level of labor shortage.
  • The impact of pro-growth government investment policies – including investment in Research and Development as well as investments in roads, bridges, and other public utilities.
  • The investment accelerator and its role in fiscal stimulus, or in theories of secular stagnation.
  • The determinants of changes in labor force participation and the effect of increasing employment opportunities.
  • Responsiveness of immigration, especially undocumented, to labor demand.
  • The sensitivity of US imports to economic growth, an issue complicated by the international role of the dollar.

Restoring controversy to economics

Controversy reflects the disagreements and uncertainty that alone can lead to intellectual progress. It is time to inject some of these into orthodox macroeconomics. We have been ill-served by a smugly sure macroeconomics both in imagination and policy. Amazingly, the crisis of 2007-9 has left intact the dominant pseudo-Keynesian orthodoxy; maybe the kerfuffle around my report will help to open some space for constructive dialog in a profession that has clearly grown too complacent.

Originally published at the Institute for New Economic Thinking.

2016 April 21


Donating = Changing Economics. And Changing the World.

Evonomics is free, it’s a labor of love, and it's an expense. We spend hundreds of hours and lots of dollars each month creating, curating, and promoting content that drives the next evolution of economics. If you're like us — if you think there’s a key leverage point here for making the world a better place — please consider donating. We’ll use your donation to deliver even more game-changing content, and to spread the word about that content to influential thinkers far and wide.

MONTHLY DONATION
 $3 / month
 $7 / month
 $10 / month
 $25 / month

ONE-TIME DONATION
You can also become a one-time patron with a single donation in any amount.

If you liked this article, you'll also like these other Evonomics articles...




BE INVOLVED

We welcome you to take part in the next evolution of economics. Sign up now to be kept in the loop!

  • I don’t think we know the magnitude of effects that changing government policy can have on growth– and that is really the subject of this piece rather than conventional macroeconomics. However, I think there are probably good reasons to believe that policies that assume that government policy makers will have some insight that private market actors lack is likely to be counterproductive.

    John Cochrane has an excellent summary of policy changes that do not rely on such as assumption and thus more likely to increased growth (but it is hard to predict the magnitude of the effect). See http://johnhcochrane.blogspot.com/2015/10/economic-growth.html

    • Brad Lewis

      I don’t understand why we would begin by assuming that Keynesian policies must
      assume that “government policy makers will have some insight that private market actors lack.” If private market actors lack demand, their problem is not that their insights disagree with government policy makers: given the level of demand, it is rational for them not to invest and produce enough. We have somehow forgotten what a Fed chairman in the Depression (Marriner Eccles) who had only a high school education could figure out on his own: that the conventional wisdom among businessmen that cutting government spending and protecting themselves financially by laying people off would help the economy was exactly wrong, because of a fallacy of composition. Parts of his book Beckoning Frontiers, which are probably used in one undergraduate economics course–mine–make the point quite decisively and clearly. The full argument is too long to repeat in a comment, but consider two of his points: his banks survived a major bank run in Utah, but he recognized afterwards that while he had made the right decision for his bank to survive, what he did reduced demand and made the rest of the banking system worse. His lumber mills were still very productive but if he paid his workers nothing he still would have a loss. It’s time we relearned the lessons.

      • There is precious little evidence that “lack of demand” (a phrase that obfuscates more that it elucidates) is the cause of problems. Likewise there is similarly little evidence that hamfisted attempts at “stimulus” (an oft suggested cure for lack of demand) generally have much of an effect. More often preferences have changed in response to new information or insight and the actions taken by the government have the result of delaying adjustment to those changes rather than curing the ill of a “lack of demand.” It is possible in some circumstances such action might be useful (e.g. extreme price stickiness), but many unlikely things need to turn out to be true for this to be the case– and knowing whether these things are true is not something we (esp. the government) are good at.

        • Jan de Jonge

          DWA. Since when is a “a phrase that obfuscates more that it elucidates” an argument instead of just plain rhetoric? Maybe, you should consult reports of the IMF with the repeating advice that governments should increase demand by either investing in infrastructure and/or by increasing wages.

          • Of course it’s rhetoric. (To which you responded with an argumentum ad verecundiam.) But I invite anyone to give a good definition of lack of demand that can be distinguished from a change in preferences– that is the argument made later in the paragraph.

          • Jan de Jonge

            You agree that your answer to Brad Lewis was plain rhetoric? And you think that it is helpful in a discussion?
            Do you know the distinction between ‘a demand’ and ‘a preference’?
            If so, please explain. If not, consult an introductory in economics.

        • rosswilliams

          “There is precious little evidence that “lack of demand” (a phrase that obfuscates more that it elucidates) is the cause of problems.”

          I have yet to run across a failing business that wouldn’t be saved by enough demand from customers. You can argue government can’t help, but it is silly ideology to argue it isn’t important.

          • @rosswilliams Now who is falling prey to the fallacy of composition? (Which is the whole point I was making.) At the micro level more demand for the goods of a specific business means that people chose to spend resources to in exchange for the goods/services of that business. At the aggregate level you are largely shifting “demand” around from one business to another unless (as indicate above) you make some pretty unrealistic assumptions.

          • rosswilliams

            The fallacy is that the economy is a zero sum game and that demand for one service or product inevitably diminishes demand for something else.

          • @rosswilliams:disqus It is certainly not true “that the economy is a zero sum game”. But it is equally untrue that resources used for A are also available for B. It is also untrue that you get to a positive sum via inflation (monetary stimulus) or government spending (fiscal stimulus). Absent extraordinary assumptions those tend to destroy more value than they create because they are effectively reallocations of resources divorced from information about the revealed preferences of market participants.

            To tie back to my original point: statements like “we need to increase aggregate demand” mask avoid the issue of what that really means at the micro level.

          • rosswilliams

            More ideology. The goal is to stimulate aggregate production, creating the resources for both A and B. The way to do that is to increase demand. So resources spent on A do not necessarily diminish resources available for B. To the contrary, they may be the means to providing those resources. That is what is meant by not being a zero sum game.

            There are many obvious examples of government spending that have that effect. At least they are obvious if you aren’t blinded by ideology.

          • @rosswilliams:disqus As you keep using ad hominems, and the discussion is not advancing this will be my final response. The whole point of these posts is that there is not a good way to simply “increase demand” that does not diminish resources available for other uses. That is why I said that “lack of demand” is a phrase that obfuscates more that it elucidates,

          • rosswilliams

            ” there is not a good way to simply “increase demand” that does not diminish resources available for other uses. ”

            You are back to your zero sum argument again. A teenager spending the summer working at a productive job instead of lying on the beach does not diminish the resources available in the economy.

            And there have not been any “ad hominems”. My responses have been limited to disputing your repeated assertion of that zero sum claim about economic growth.

      • Steve Davenport

        At the micro economic level, a firm would be irresponsible not to lay off surplus workers in the face of falling demand for its output.

        The Fed can offer 0% lowns and government authorities can offer firms a 5 year tax holiday but they would have little cause for adding more employees if they do not see enough demand to support the new hires.

        Only a macroeconomic stimulus in the form of transfer payments to the unemployed, government investments in infrastructure and, yes, sometimes bailing out an entire industry, can revive demand and give firms an incentive to hire more workers.

        As we move forward in time, we will increasingly find it necessary to simply put money directly in peoples pockets as industries will become more automated and require fewer humans to produce their good and services.

  • Keynesian and then some…

    We became the world’s leading superpower when we invested heavily in that most socialist of
    institutions known as the US Military… We became the world’s
    greatest think tank with rather massive investment in public
    education, right up through post doctoral education and research…
    The NIH, CDC, NREL, NASA, DARPA, NSA, NRO, etc… (the list of
    government offices that support enormous quantities of research and
    development is hundreds of acronyms long) keep the USA at the
    forefront of the vast majority of all the, “next big things.”

    Common carrier infrastructure
    (roads, bridges, highways, airports, seaports, electricity grids,
    telecommunications connectivity, water, sewerage, etc, etc, etc…)
    have literally paved the way for the US economy to thrive.

    We have succeeded in efforts that
    we didn’t even understand when proposed (e.g., “Getting a man to
    the Moon, and safely back to Earth, in this decade…”)

    Ladies and Gentlemen, it is the
    original group activity and funding organization known cumulatively
    as the taxpayers of these United States of America that made it
    possible for Americans, and many others through out the world, to
    stretch to that next goal; reach for the next frontier and create the
    next big thing.

    “What if…?” requires
    motivation and assistance at the most basic levels and we, in the
    USA, have been blessed with the will to provide it. If we
    continue to climb back into our shells, because it’s all just so
    overwhelming, we become the disappointment we deserve.

    Get over it! Get busy!
    DO something!

    Get our Keynesian enabled
    backsides in gear!!!

    • Steve Davenport

      I am a proud former member of the U.S. Army and have jokingly refered to it as “welfare in cammoflauge”

      Free housing?, free money for school? Free health care? Wow, a Republcan nightmare 😂

  • No matter which system of economics you employ, the fact is that without the political will on the part of Congress nothing will get done. And so far, Congress has failed to pass meaningful reforms, legilsation to fund infratructure programs, and other bills which would aid the poor and middle class by giving them good paying jobs. They do not so deliberately, because they are practicing political discrimination against the will of the people, who elected a black president. Now, they are bound up in absurd and fallacial disputes about laws which, on their base, lack any substantive or even marginally useful importance to the basic needs of the people. The money is there if they will reallocate it, but they refuse to do even that; instead pigeonholing the bills or leaving them to die in committee. So we must wait until November for the people to make their will known, and investment in our economic substrate will languish in the meantime. It will take a disaster such as a bridge crumbling to pieces from metal fatigue, causing more deaths, to make them wake up and face facts.They have not earned a farthing of their salaries by such inaction, and they are interested only in getting reelected, so we are all doomed to see the economic results of their folly.

  • rosswilliams

    Economists serve the wealthy and powerful. They don’t get hired by poor, the working class or the middle class. Their policy suggestions all run through a filter that protects the interests of the wealthy and powerful, regardless of their ideology. The ideological debate is largely about how to best serve those interests. In short, economists of all political stripes have little to offer to those of us whose livelihood depends on our wages or salary.

  • CharlieR

    There’s a lot of comments here stating that microeconomic theory doesn’t consider the social benefits (or costs) of production but this is quite far from reality. Microeconomics is not based on a bunch of idiots claiming that the free market is the best thing ever. Instead free market analysis of supply and demand is described as explaining the private costs and benefits to individuals within the economy.
    A sanitary company, given the supply of able and willing workers is high, is able to pay a low wage and in doing so will maximise its private benefits without considering the social benefits of the work (why would a corporation care about the people around it). This is known as an externality and, believe it or not, microeconomics explores the properties of these and how to remove the disparity between private and social benefits. The typical tools here taxation, substation, and price floors and ceilings (less preferred since it is not Pareto efficient). This is part of what keynes, mentioned above, is known for (see ‘The General Theory of Employment, Interest and Money’).