Steve Keen On His Breakaway From Nonsense In Marginalist Economics

Steve Keen appeared on the 30 April epsiode of 1Dime Radio, a podcast. Towards the start, he tells a story:

"My change actually came from a very technical piece of economics because my first-year lecturer is a still a good friend these days, Professor Frank Stillwell - back in those days, he was Doctor Frank Stillwell – explained what's called the theory of the second-best in the first-year lectures. And this is something you normally learn in a third or fourth-year honors course or master's or PhD qualifying. And by the time you’ve got to that level, most people were being so saturated with neoclassical thinking that they would have just regarded it as, 'Oh, that’s a nice little curiosity', and they forget about it. What it showed was that = I think it got the originators the Nobel prize at one point – they show that if you were two steps away from what's regarded as perfection by neoclassical economics, then moving one towards it, and not the whole two, would actually make social welfare worse. And the example that Frank used was if you have wage negotiations, the ideal according to neoclassical theory is that you have workers who bargain on their own personnel right and firms who, again, bargain for employees on an individual basis – no collusion within labour or capital.

But the real world is you’ve got trade unions on one side and employer associations on the other. So in the neoclassical view, you get equilibrium where the worker gets paid their marginal product. That's the ideal. When you allow that there's both trade unions and monopolies (employer associations), you move to another point where it's indeterminate what the wage will be and it’s a bargaining point which might make the firms better off or the workers better off compared to the ideal. But if you abolish one or the other, either get rid of the trade union or get rid of the employer association, the outcome is necessarily lower social welfare than the previous case where had both the trade union and the employer association.

And I fell for the conventional argument. I accepted all the idea of supply and demand and equilibrium and so on. And then to have if pointed out that if you take into account the reality there’s plenty of distortions from what's called the perfectly competitive ideal, then getting rid of them sequentially will make things worse. I thought, there's got to be something wrong with the theory if you can simply demolish it so easily. So I checked my textbook. There was no mention of the theory of the second-best there

I then went down to the economics department library, which is in the same building as where the lectures were, the Merewether Building at Sydney University. And I went looking for the journal papers. I found the original. And then I was horrified that this is not covered in the textbooks.

So I went to the journals again looking for the most recent journal papers. And I found one by Paul Samuelson which was called – first of all I found a journal paper by a Marxist and that surprised me. That was in the Cambridge Journal of Economics by Bhaduri. And I was amazed that a Marxist got into a journal. That surprised me. But then I read Samuelson, a paper called 'A summing up'. And he basically conceded defeat in a debate over the definition of capital which I did even know was happening. But it was actually taking place between 1960, when Piero Sraffa published A Production of Commodities by Means of Commodities, through to the – probably petered out in the late sixties. No mention of it, Samuelson conceded defeat in that paper, but you read his textbook which I had at the time – no recognition of the dispute there either. So I thought I'm being lied to by my textbooks.

And I stopped reading the textbooks. I read them anyway for reference, obviously. But I go and take a look at the journal papers and seeing what's being said in the journals. And the gap between what I was being taught versus the journals wasn't a case that I was getting the simplified version in the textbooks and the sophisticated stuff is in the journals. I was seeing completely contrary results for absolutely fundamental arguments in the textbooks. And I just thought these textbooks are mendacious. Whether they know it or not, they're lying about the nature of economics.

So that was my breakaway point and I’ve never looked back. So that's why I regard economics as unscientific in the extreme, because there have been so many anomalies and so many logical disproofs, and so many empirical failings, this theory should not even be around anymore. It should be like phlogiston in chemistry. But it still dominates economics today. And they are so bloody arrogant about it. That's the other terrifying thing. They are so sure that they’ve got the right answers to everything when history and logical analysis shows that they've got the wrong answers to everything." -- Steve Keen (My transcription)

Richard Lipsey and Kelvin Lancaster published 'The general thory of second best' in 1956-1957, in the Review of Economic Studies. Neither won the Nobel prize. Lancaster won the John Bates Clark medal, which is very prestigious.

Keen does not go into this, but I think a distinction exists between the theory of the second best and the results of the Cambridge capital controversy (CCC). John Eatwell is good on this disticntion. The theory of the second best is one of a number of imperfections and frictions, like transaction costs, information asymmetries, principal agent problems, externalities, search costs, and incomplete contracts. Underlying these imperfections and frictions is an ideal theory. But the CCC shows that this ideal theory is incoherent. Maybe I am too firm on this distinction. If you are clear on all these imperfections and frictions, you know that the ideal is unattainable anyways, whatever policy the government adopts. Talk of government non-intervention in the economy is incoherent.

I think Keen is conflating Amrit Bhaduri's 1969 Economic Journal article, 'On the significance of recent controversies on capital theory: a Marxian view' with later articles.

Paul Samuelson did modify the tenth edition of his textbook. But later editions are befuddling.

I might as well say something about how I developed my views, keeping in mind that I have never been an academic economist. Sometime in the 1980s, I came across a reference to Robinson as the 'British Galbraith'. I had always like Galbraith, who I thought of as a popular writer and advocate of liberalism. So I looked up Joan Robinson's writing. I came across much about Sraffa and the Cambridge capital controversy. I ended up reading some of the same journal articles as Keen. I do not know that you should trust my self-depiction, but perhaps I continued looking for some, any response that defends what is in the textbooks for intermediate microeconomics. I could see that the question was not merely whether aggregate production functions, in macroeconomics, are a useful simplification.

Those defending marginalist economics in the CCC do not end up supporting the view in the textbooks. Capital is not a factor of production. If follows that interest is not a payment for the services of a factor of production. The aggregate production function is theoretically unfounded. Marginal productivity is not a theory of distribution. Equations relating payments to marginal products are merely part of the formulation of a system of general equilibrium. No theoretical foundation exists for well-behaved supply and demand functions in, say, labor markets. Maybe I am wrong, but I see it as very difficult to defend mainstream academic teaching as well-informed and honest.