How To Defend Capitalism

"It is possible to defend our economic system on the ground that, patched up with Keynesian correctives, it is, as he put it, the 'best in sight'. Or at any rate that it is not too bad, and change is painful. In short, that our system is the best system that we have got.

Or it is possible to take the tough-minded line that Schumpeter derived from Marx. The system is cruel, unjust, turbulent, but it does deliver the goods, and, damn it all, it's the goods that you want.

Or, conceding its defects, to defend it on political grounds - that democracy as we know it could not have grown up under any other system and cannot survive without it.

What is not possible, at this time of day, is to defend it, in the neo-classical style, as a delicate self-regulating mechanism, that has only to be left to itself to produce the greatest satisfaction for all.

But none of the alternative defences really sounds very well. Nowadays, to support the status quo, the best course is just to leave all these awkward questions alone." -- Joan Robinson, Economic Philosophy: An Essay on the Progress of Economic Thought (1962): p. 140.

These days, economists are not trained to competently address these questions. For one thing, economists would have to read both history and philosophy as part of their academic work.

The defenses Robinson offers for capitalism do not say any particular embodiment of capitalism does not require a lot of patching up.

I think Robinson's position that markets cannot be regarded as a "delicate self-regulating mechanism" has become even stronger in the last half-century. For my purposes, never mind looking out your door at our current situation. Consider what we now know about economic theory. My point is not merely that economists have no proof of the stability of a (unique?) equilibrium in models of markets. My point is that what we know about the question suggests that markets, in such models, are not likely to approach equilibrium. I am thinking of, for instance:

• the Sonnenschein-Mantel-Debreu theorem.
• Franklin Fisher's demonstration that one should impose the assumption of "no favorable surprise" to ensure an approach to general equilibrium.
• Fabio Petri's explanation that the Arrow-Debreu model cannot allow production to occur along the approach to equilibrium (since production will change part of the data defining the equilibria, namely the initial endowments).

Apparently, the situation is no better from the perspective of game theory.

I think that this perspective on equilibrium leads one to disbelieve that capitalism can be made self-regulating by establishing or restoring competitive forces that do not seem to be operative today. In short, Mark Thoma is simply wrong.

David Ruccio and "Larry, the Barefoot Bum" also have comments about Mark Thoma's editorial. I've previously noted that Marxist exploitation is compatible with perfect competition and every factor receiving the full value of their marginal product. I've also previously expressed my opinion that Marxist exploitation is not about describing an injustice when capitalism is viewed under the aspect of eternity.

References

• Franklin M. Fisher (1983). Disequilibrium Foundations of Equilibrium Economics, Cambridge University Press.
• Franklin M. Fisher (1989) "Games economists play: A noncooperative view", RAND Journal of Economics. V. 20, N. 1 (Spring) [To read].
• Fabio Petri (2004). General Equilibrium, Capital and Macroeconomics: A Key to Recent Controversies in Equilibrium Theory, Edward Elgar.
• Joan Robinson (1962). Economic Philosophy: An Essay on the Progress of Economic Thought.

The Economic Consequences Of Mr. Draghi

This post is somewhat on current events, and about topics I'm even less expert in than usual. I suggest that a certain historical analogy might be useful for understanding certain aspects of the Greek crisis¹. Not that I'm willing to propose a solution. I look to, for example, Yanis Varoufakis for more informed takes on the Euro².

John Maynard Keynes, in 1925, wrote a pamphlet, "The Economic Consequences of Mr. Churchill". Keynes' title is a suggestion of his previous best-seller, The Economic Consequences of the Peace, another work in which Keynes foresaw the dire consequence of then current events. In the case of Churchill, Sir Winton was then serving as Chancellor of the Exchequer.

Britain had gone off the gold standard during World War I. Churchill oversaw the restoration of the gold standard, with the Treasury insisting on establishing the foreign exchange value of the pound sterling to its pre-war parity in gold. Apparently, according to Keynes, the market value was about 10% below that at the time. The foreign exchange rate of a currency combines with the general price level to determine the standard of living in terms of foreign goods. If the British wanted to maintain their then-current standard of living, and Churchill insisted on the pre-war parity, then prices and costs, including wages, must drop 10%. And this process of deflation could be expected to be resisted. In fact, widespread unemployment and general labor unrest were some of the economic consequences of Mr. Churchill. I think you can see some of these consequences in the 1926 general strike in Great Britain.

Churchill refused to acknowledge the necessity of devaluing the pound. In the case of Greece, they do not have control over the value of their currency, as long as they remain on the Euro. So they cannot devalue their currency. But, as in the case of the British population in the 1920s, they are being asked for the functional equivalent - that is, for a general reduction of prices and wages throughout the country. Maybe the consequences in Greece will resemble the consequences in Britain in the 1920s. I don't see how this is likely to increase the odds of Greece fully paying back their external debts.

Footnotes:

1. I think of this post as, perhaps, an illustration of the usefulness of studying economic history and the history of economics. Even if you conclude that my suggested analogy is too facile, you might accept that discussing it is a useful point of departure.
2. D-Squared also has a view on the topic, given certain constraints.

Playing With Fractals

Figure 1: An Enlargement Of A Piece Of The Mandelbrot Set

A number of years ago, I loaned Heinz-Otto Peitgen and Peter H. Richter's 1986 book, The Beauty of Fractals: Images of Complex Dynamical Systems to a relative. This is a coffee-table book that, apparently, was issued as a companion piece to a digital art exhibition. This book was returned to me at Christmas.

So, for fun, I've been writing a fractal-drawing program. I'm not sure what the point of this is, besides reviewing certain aspects of Java programming. I don't plan on distributing my program, even if I did include some help capabilities, icons for various windows, and such like. I deliberately have not looked at any programs that may be out there on Windows, Icon, Mouse, Pointer (WIMP) platforms. I eventually did look at a free app for a touch interface. This app cued me to think about assigning colors on a logarithmic scale, with lighter shades being near the Mandelbrot set boundary.

In software development, a difficulty is often how to define what you want to do. And one can always think of additional capabilities. In my case, at some point I included capabilities to save and load the current state, to print the current canvas, and to provide user-control over the number of iterations and various colorings. I struggled with how to define coloring algorithms. I'm curious about how one might implement Sigel discs, that is, regions of convergence for limit points and cycles within a Julia set. A history capability would also be nice.

Anyways, I haven't been reading all that much economics while taking this excursion into recreational mathematics.

Figure 1: A Julia Set

Some Stupid Stuff From David Levine

Suppose you can get people to refer to some theory or principle that you advocate as "Motherhood and Apple Pie". A rather stupid way to argue against opponents is to rely on the mere label. So one can argue against a strawperson - one can say that one's opponents are against motherhood and apple pie. Economists happen to have this nonsensical rhetoric strategy readily available, given some of the names of their models. For example, if one were a fool or a knave, one could say that opponents of Dynamic Stochastic General Equilibrium models all preferred static, deterministic, partial equilibrium models - obviously not as good a thing.

David K. Levine insults the reader's intelligence in this way. He has an article, "Why Economists Are Right: Rational Expectations and the Uncertainty Principle in Economics" (part I, part II) in the Huffington Post. He focuses on the label "Rational Expectations:

"In simple language what rational expectations means is 'if people believe this forecast it will be true.' By contrast if a theory is not one of rational expectations it means 'if people believe this forecast it will not be true.' Obviously such a theory has limited usefulness. Or put differently: if there is a correct theory, eventually most people will believe it, so it must necessarily be rational expectations. Any other theory has the property that people must forever disbelieve the theory regardless of overwhelming evidence -- for as soon as the theory is believed it is wrong.

So does the crisis prove that rational expectations and rational behavior are bad assumptions for formulating economic policy? Perhaps we should turn to behavioral models of irrationality in understanding how to deal with the housing market crash or the Greek economic crisis? Such an alternative would have us build on foundations of sand. It would have us create economic policies and institutions with the property that as soon as they were properly understood they would cease to function." -- David K. Levine

I know of nobody who advocates constructing models based on irrational expectations. On the other hand, I can easily imagine a model in which diverse agents might have different theories of the world and rely on different heuristics. Maybe the agents in such a model might not converge on a single model for the world. (Levine does mention issues of convergence, in a wholly inadequate way, in Part II of his article. Even if one accepted his emotionally-charged story, economists still lack any general argument for convergence to a rational expectations equilibrium.) One might construct such a model of short term interest rates. The equilibrium interest rate at any moment of time would be a balance of bullish and bearish forces.

These are hardly unknown ideas in economics. I am drawing directly on Chapter 12 of Keynes' General Theory of Employment, Interest, and Money. G. L. S. Shackle called this a restless equilibrium. Paul Davidson wrote about human decision-making in an environment characterized by processes, of which some are non-ergodic. Nowadays, one might experiment with implementing agent-based models in computer simulations. I could even cite Brad DeLong, Andre Shleifer, Larry Summers, and Robert Waldmann's work on noise traders. Economists in these sort of traditions are well aware of the impact of economic theory on the behavior of economic agents. They even explain why agents might find it rewarding to knowingly persist in behavior based on assumptions that prices will continue deviating from fundamentals, if the idea of a fundamental price is even coherent. Some somewhere have even talked about "performativity".

In short, Levine has completely failed to grapple with the economics literature at all. He is merely misrepresenting the state of play to a popular audience.

So far, I have not mentioned Levine's rationalization of why economists cannot predict crashes and depressions (or even identify bubbles?). Now, clearly some economists did forecast our current hard times. Steve Keen is probably one of the most well-known. But I'll turn to another incident. On 10 July, K. Bastiaensen, P. Cauwels, D. Sornette, R. Woodard, and W.-X. Zhou predicted a crash of the Shanghai Composite index. They stated the crash, with certain confidence estimates, would come between 17 to 27 July 2009. The China Shanghai composite index was around 3,400 during the week of 27 July. And it was around 2,860 during the week of 31 August, a decline of 16%. According to Levine, these successful predictions are just a matter of those with secret methods sometimes being lucky:

"If I say every year 'there will be a crisis this year' eventually I will be right. If 100 people each pick a different year then one of them is bound to be right. A reliable method of predicting a crisis must be a rule that anyone (or at least anyone with the requisite technical expertise) can apply and reach the same correct conclusion as anyone else using the same method."

I am not totally unsympathetic to the above view. But notice that according to the theory of rational expectations, people with divergent theories, models, and heuristics do not exist. On Levine's view, how can he account for the existence of such a range of predictions? How is it that the agents in the model are possessed of superhuman powers not available to mere mortal economists looking on?

Selected References

• K. Bastiaensen, P. Cauwels, D. Sornette, R. Woodard, and W.-X. Zhou (10 July 2009). "The Chinese Equity Bubble: Ready to Burst".
• Paul Davidson (1983-1984). "Rational Expectations: A Fallacious Foundation for studying Crucial Decision Making Processes". Journal of Post Keynesian Economics, V. 5.