Nonsense In Mankiw's Introductory Textbook

Marginalist economics was shown to be incoherent about two thirds of a century ago. It collapsed just around the issues Marx investigated more than a century and a half ago. How does the ownership of capital goods result in the owner obtaining a return? Mainstream economists address their inadequacy by refusing to talk about their demonstrated inconsistencies.

Those who understand the theory have available a certain form of amusement. They can quickly locate confusion in mainstream textbooks. I happen to have available the eighth edition of N. Gregory Mankiw's Principles of Economics (2018). I may have missed something. Over the course of hundreds of pages, he confuses capital, as a factor of production supplied by households, physical capital goods, deferred consumption, and finance.

Mankiw is careful, I guess, in what he does not say. He has "capital" meaning physical goods, for a while. There seems to be no explanation of the level of interest or dividend payments to households. Households trade consumption between now and later. These savings are not related to changes in the capital stock, although a later section on savings and investment confusingly suggests that some unspecified relationship exists. An aggregate production function has an argument for physical capital, with no discussion of units of measurement. And this all falls by the wayside when he gets to macroeconomics. He presents the obsolete theory of loanable funds, even with silliness about the crowding-out effect of government deficits.

Section 2-1d is "Our first model: the circular flow diagram." With the usual confusion, in one half of the diagram, households supply firms with the factors of production. Capital is "building and machines". At this point, you have a blast furnace in your back yard, which you rent to a steel manufacturer.

Chapter 18 is "The Markets for Factors of Production", and Mankiw emphasizes labor markets. The non-wage part of the national income "went to landowners and to the owners of capital - the economy's stock of equipment and structures - in the form of rent, profit, and interest" (pp. 361-362). Mankiw does not seem to know of any difficulties raised for labor markets or the supposed marginal productivity theory of distribution by the Cambridge capital controversy. "Put simply, highly productive workers are highly paid, and less productive workers are less highly paid" (p. 37).

Capital is like land. "The purchase price of land or capital is the price a person pays to own that factor of production indefinitely. The rental price is the price a person pays to use that factor for a limited period of time" (p. 375). A box on p. 376 is titled "What is capital income?" He brings up interest, dividends, and retained earnings but has no explanation for their levels:

"In our analysis, we have been implicitly assuming that households own the economy’s stock of capital - ladders, drill presses, warehouses, and so on ... In fact, firms usually own the capital they use, and therefore, they receive the earnings from this capital... [I]nstitutional details are interesting and important, but they do not alter our conclusion about the income earned by the owners of capital. Capital is paid according to the value of its marginal product, regardless of whether this income is transmitted to households in the form of interest or dividends or whether it is kept within firms as retained earnings."

Chapter 21 is the theory of consumer choice. Mankiw has the analysis of the trade-off between leisure and work. Section 21-4c treats "How Do Interest Rates Affect Household Saving?" Figure 15 shows the budget constraint and indifference curves for an example of intertemporal choice (p. 444).

Chapter 25 is "Production and Capital" and is part of the treatment of macroeconomics. A box on the production function is on p. 523. Section 25-3a is "Savings and Investment":

"Because capital is a produced factor of production, a society can change the amount of capital it has. If today the economy produces a large quantity of new capital goods, then tomorrow it will have a larger stock of capital and be able to produce more goods and services. Thus, one way to raise future productivity is to invest more current resources in the production of capital. Because resources are scarce, devoting more resources to producing capital requires devoting fewer resources to producing goods and services for current consumption. That is, for society to invest more in capital, it must consume less and save more of its current income. The growth that arises from capital accumulation is not a free lunch: It requires that society sacrifice consumption of goods and services in the present to enjoy higher consumption in the future."

I do not know what skipping my dinner has to do with manufacturing more ladders to outfit employees of firms with orchards and apples to be picked. Neither does Mankiw, of course.

Chapter 26 treats Saving, Investment, and the Financial System. "Now the interest rate is the price that adjusts to balance supply and demand ... for funds in financial markets" (p. 542). Banks and mutual funds are "financial intermediaries" "directing the resources of savers into the hands of borrowers." Mankiw presents the usual national income accounting, with savings and investment in monetary (financial units). "In the language of macroeconomics, investment refers to the purchase of new capital, such as equipment or buildings." He has the crudest loanable funds model. He presents the argument that government deficits crowd out private investment (p. 554) as if it were scientific fact. (On page 590, a box from David Neumark has the usual archaic nonsense about minimum wages causing structural unemployment.)

Mankiw's textbook lacks an explanation of the returns to ownership and an acknowledgement of the existence of this gap. He could argue that this reflects mainstream economics, which is apologetics.

A Characterization Of Neoliberalism From Wendy Brown

I have been reading Brown (2015). She acknowledges neoliberalism is difficult to define:

"Three decades out, rich accounts by geographers, economists, political theorists, anthropologists, sociologists, philosophers, and historians grappling with these questions have established that neoliberalism is neither singular nor constant in its discursive formulations and material practices. This recognition exceeds the idea that a clumsy or inapt name is draped over a busy multiplicity; rather neoliberalism as economic policy, modality of governance, and order of reason is at once a global phenomenon, yet inconstant, morphing, differentiated, unsystematic, contradictory, and impure, what Stuart Hall calls a 'field of oscillations' or Jamie Peck calls 'unruly historical geographies of an evolving interconnected project.' Neoliberalism is a specific and normative mode of reason, of the production of the subject, 'conduct of conduct,' and scheme of valuation, yet in its differential instantiations and encounters with extant cultures and political traditions, it takes diverse shapes and spawns diverse content and normative details, even different idioms.

Thus the paradox of neoliberalism as a global phenomenon, ubiquitous and omnipresent, yet disunified and nonidentical with itself. This dappled, striated, and flickering complexion is also the face of an order replete with contradiction and disavowal, structuring markers it claims to liberate from structure, intensely governing subjects it claims to free from government, strengthening and retasking states it claims to abjure. In the economic realm, neoliberalism aims simultaneously at deregulation and control. It carries purpose and has its own futurology (and futures markets), while eschewing planning. It seeks to privatize every public enterprise, yet valorizes public-private partnerships that imbue the market with ethical potential and social responsibility and the public realm with market metrics. With its ambition for unregulated and untaxed capital flows, it undermines national sovereignty while intensifying preoccupation with national GNP, GDP, and other growth indicators in national and postnational constellations."

Brown's emphasis is on how neoliberalism remakes the self. Under neoliberalism, people are all regarded as independent entrepreneurs, each trying to increase their human capital. This conception extends to areas that do not necessarily have anything to do with money. How much time should invest in relationships? What best practices should parents adopt in raising their children?

This way of thinking about people contrasts with an older notion of the utility-maximizing consumer. Our preferences form a field that we move around in through exchange. I think John Stuart Mill is important for articulating a pre-marginalist view of economic man. Homo economicus has a history and has varied over the development of political economy.

Brown and Marcuse both share a concept about how capitalism corrupts our non-working time. In One Dimensional Man, Marcuse deplores the prevalence of instrumental reason. For Brown, the neoliberal concept of the self is not a member of a social class. In the neoliberal view, we no longer have workers and capitalists. We are longer examples of homo politicus. I think of Hannah Arendt as an idealized picture of political man, what we could be reasoning together in the public square, in the agora. Brown also mentions homo legalis, the subject of right and an emphasis of Foucault and his concept of governability.

Reference

• Wendy Brown. 2015. Undoing the Demos: Neoliberalism's Stealth Revolution. Zone Books.

On The Uselessness Of Economists

If you believed something different, you wouldn't be sitting where you are sitting

Suppose one wants to discuss capitalism versus socialism or some smaller matter. One might think the discipline of political economy, now known as economics would be helpful. But it is not.

What is taught in most universities in the United States was shown to be nonsense more than half a century ago. I find it hard to account for this except on the grounds of political ideology. I realize that most academic economists and their students that persist do not experience themselves as propagandists. And it does take some study to master the mathematical models, even if they are incoherent.

Obviously, exceptions exist. I am most aware of the economics departments at the University of Massachusetts at Amherst, the New School, the University of Missouri at Kansas City, and the University of Utah. And I think the situation might be different in some other countries. At least, they can list some prominent universities like the above. Furthermore, in taking courses in academic economics, one should learn something useful about how national products and income accounts are kept. Many economists might think they are doing measurement without theory, that these theoretical incoherences that I go on about do not matter to them. And there are many partial models that might be useful in a narrow context.

These sort of questions should have clear answers: For some model, what are the parameters and and what are the variables found in the solution? For each parameter or variable, what are the units of measure? Lately, I have been recommending a John Eatwell lecture on the bomb that Piero Sraffa placed at the foundations of economic theory. Working through Kurz and Salvadori's 1995 textbook is also a good way to understand my favorite devasting criticism of marginalist economics.

Smith's natural prices, Ricardo's prices of production, and Marshall's normal prices all characterize a long-period position or equilibrium, depending on the theory. Marginalist economics is about the allocation of given resources. The quantity and initial distribution of capital goods are among the givens, at least in Walras' formulation. Supply and demand are supposed to clear in all markets in equilibrium, and the capitalists obtain the same rate of profits in all markets. This model is ovedetermined and inconsistent. Walras was mistaken.

Taking the numeraire quantity of capital and its initial distribution as given was another incorrect marginalist approach. The physical composition of capital is supposed to be endogeneous. But prices of capital goods are found as solutions of the model. The quantity of capital is simultaneously inside and outside the model. Knut Wicksell realized this approach does not work. And waiting or abstinence cannot explain profits either.

So from about 1930 to the 1970s, marginalists abandoned long period theory in their most general models. The Arrow-Debreu-McKenzie model of intertemporal equilibrium is the cumulation of this trend. In the model, commodities are distinguished by physical properties, when they are available, and the state of the world. Prices are established in forward markets, found at the start of time.

This is a model of supply and demand in some sense. Households maximize utility subject to constraints. Plans are precoordinated, and all markets clear for all time. On the other hand, one can not draw well-behaved supply and demand schedules at the level of the market, as is shown by the Sonnenschein-Debreu-Mantel theorem.

Economists cannot explain how any economy would get in or approach such an equlibrium. Franklin Fisher investigated this question. Fabio Petri notes that the givens of initial quantities of capital equipment would change if production goes on while the economy is in disequilibrium. The equilibria consistent with the givens are not the equilibria that would be approached. The model does not depict tendencies in any possible capitalist economy.

Given an equilibrium, however, the forward prices embody predictions of what spot prices would be. Mainstream economics, when talking about dynamics, often mean the time paths of these spot prices. A conceptual problem arises here. If markets can open and close later, the model is not the Arrow-Debreu-McKenzie model. Anyways, the rate of profits is not the same among industries at any time period, since prices are typically not stationary.

Mainstream economists have basically given up, as I understand it, on trying to develop any general approach to explaining prices and distribution in a capitalist economy. I think the textbooks are not clear on this point. I like some of the bits of mathematics, such as game theory, in some of these textbooks.

Why study this stuff? Even though academic economists are mostly trapped in an intellectual ghetto, they still have a connection to what ideas are hegemonic. And the disciple of economics provides a puzzle for the sociology of 'knowledge' and the philosophy of science. If academic economists were merely useless, the world would be improved.

Jeremy Rudd: "Why I hate economics"

Jeremy Rudd addresses the Cambridge Society for Economic Pluralism

Jeremy Rudd has written:

Mainstream economics is replete with ideas that 'everyone knows' to be true, but that are actually arrant nonsense. For example, 'everyone knows' that:

• aggregate production functions (and aggregate measures of the capital stock) provide a good way to characterize the economy's supply side;
• over a sufficiently long span - specifically, one that allows necessary price adjustments to be made - the economy will return to a state of full market clearing; and
• the theory of household choice provides a solid justification for downward-sloping market demand curves.

None of these propositions has any sort of empirical foundation; moreover, each one turns out to be seriously deficient on theoretical grounds¹. Nevertheless, economists continue to rely on these and similar ideas to organize their thinking about real-world economic phenomena. No doubt one reason why this situation arises is because the economy is a complicated system that is inherently difficult to understand, so propositions like these - even though wrong - are all that saves us from intellectual nihilism. Another, more prosaic reason is Stigler's (1983, p. 541) equally nihilistic observation that 'it takes a theory to beat a theory.'

Is this state of affairs ever harmful or dangerous? One natural source of concern is if dubious but widely held ideas serve as the basis for consequential policy decisions².

¹ For a useful brief against production functions, see Felipe and Fisher (2003); for the case against capital aggregates, see Brown (1980). The idea that the inherent stability of the economy is a concomitant of general-equilibrium theory is difficult to entertain seriously after giving Fisher (1983) close study; see Grandmont (1982) for some related macroeconomic arguments. Finally, Hildenbrand (1994) provides a sobering corrective to first-year demand theory.

² I leave aside the deeper concern that the primary role of mainstream economics in our society is to provide an apologetics for a criminally oppressive, unsustainable, and unjust social order.

The above quote is from a paper about inflations expectations. I wondered how far and on what grounds Rudd thinks this arrant nonsense extends. The talk in the video linked to the top of this post helps answer this question.

Mark Levin's American Marxism: Worse Than Worthless

Authortarians in the United States are currently competing to see who can publish the most stupid book. Mark Levin is a strong contender. Much more drivel exists in the book under review in this post than described here.

Levin goes on about selected philosophers in odd ways. I haven't seen others point out his curious grouping of Rousseau, Hegel, and Marx. They supposedly "argue for the individual's subjugation into a general will, or greater good, or bigger cause built on radical egalitarianism - that is, 'the collective good'" (p. 18). He has the usual misassignment of utopian schemes to Marx. I do not claim to understand Hegel, but I do not see why holding up the Prussia of his day is a matter of advocating egalitarianism.

The 1619 Project, created by Nikole Hannah-Jones, was originally published in the New York Times. Levin insults his readers by suggesting that the naivety of Walter Duranty, the Times Moscow bureau chief from 1922 to 1936, and Herbert Matthews 1950s' scoop interview with Fidel Castro are relevant to the validity of the 1619 project (pp. 110-111). This fallacy is called poisoning the well. But what does the 1619 project have to do with Karl Marx?

Levin is big on arguing strawpersons. He tells us that Marx does not appreciate the industrial revolution and "the technological and other advances" with which "capitalism has created unimaginable and unparalleled wealth for more people in all walks of life than any other economic system" (p. 4). "Longer workdays do not ensure wealth creation or growth" (p. 4). Levin is probably incapable of reading volume 1 of Capital or even noting the existence of part IV, on the production of relative surplus value. Finally, in arguing against supposed Marxist environmentalists, who critize Marx for emphasizing economic growth, he manages to quote (p. 157) Marx's praise for the bourgeois from The Communist Manifesto near where Marx writes "All that is solid melts into air."

Despite the above, Levin has very little to say about Marxism. Some of his rants are quite curious. A 1909 book by Herbert Croly, an author associated with the founding of The New Republic, provokes a numbe of pages (pp. 45-48). He is curiously obsessed with John Dewey's impact (p. 54 and p. 204) on education. Levin goes on about (pp. 32-39) a 1966 essay in the Nation, by Francis Fox Piven and Richard A. Cloward. I happen to recognize Piven and Cloward, but what this has to do with Black Lives Matter, Antifa, Critical Race Theory, or whatever else is unexplained.

Levin quotes Ayn Rand (pp. 153-158) and George Reisman as 'experts' when denying global warming. But let me turn from inappropriate arguments from authority back to strawpersoning. As others have noted, much of this book is long chunks of quotations from others. Sometimes he even manages to find somebody on his side who is worth studying. (I would not cite Hayek's The Fatal Conceit too much myself, given disputes about its authorship.) So he has many long passages from various academics. Although these passages are often long-winded academic prose with many polysyllabic passages, they are usually quite reasonable. Levin will then have a short passage supposedly saying what they say in other words. Rarely does his rephrasing have much basis in the quoted text. Sometimes it is a complete non sequitur.

But maybe Levin is just illiterate and can neither say what he means nor mean what he says.

"American Marxism exists, it is here and now, and indeed it is pervasive, and its multitude of hybrid but often interlocking movements are actively working to destroy our society and culture, and overthrow the country as we know it. Many of the individuals and groups who collectively make up this movement are unknown to most Americans, or operate in ways in which most Americans are unaware. Thus, this book is written to introduce you to a representative sample of them, some perhaps, more familiar than others, and to provide you with specific examples of their writings, ideas, and activities, so you can know of them and hear from them." (p. 12)

So he claims he is presenting a "representative sample of them", thus the strawpersons. This is supposedly a representative sample of "the individuals and groups who collectively make up this movement", where "the movement" is a "multitude of hybrid but often interlocking movements". Presumably, he took some care over this circular, vague, non-definition.

Here he says Critical Theory started in American universities in 1989:

"Indeed, in 1989, ... the seeds of a radical-fringe ideology, Critical Theory, which I discuss at length ..., and the unraveling of the existing society by weaponizing the culture against itself, began their early bloom throughout the American landscape, but with little public notice." (pp. 43-44)

Others have noted that Levin cannot even get his Nazi conspiracy theories right. As near as I can parse this non-sentence, Levin here says that higher education in science, technology, engineering, and mathematics are highly relevant for the degrowth movement (that is, the belief in their irrelevancy is expendable):

"Inasmuch as the purpose of this movement is to regress back to nature and a mere subsistence economy, where the communal psyche is anti-growth, anti-technology, anti-science, and anti-modernity, ironically the irrelevancy of higher education, graduate studies, and doctoral degrees, and the colleges and faculties themselves, particulary in the teaching of hard sciences, technology, engineering, and mathematics, are expendable." (p. 158)

This book fails at the level of the sentence, the paragraph, the chapter, and overall. It has no index.

Ignorance, incoherency, disdain for his reader - on which criteria is Levin the greatest?

Some People Who Have Shaped Economics

"The University [of Chicago] is the best investment I ever made in my life." -- John D. Rockefeller

Consider the following people and selected activities:

• Lewis Brown founded the American Enterprise Institute, in 1938.
• Jasper Crane cofounded the Foundation for Economic Education, in 1946.
• Leonard Read cofounded the Foundation for Economic Education, in 1946.
• Harold Luhnow, even before 1947, directed spending for the Volker Fund.
• Sir Antony Fisher funded the Institute for Economic Affairs, around 1956.
• Lord Ralph Harris, first general director of the Institute for Economic Affairs.
• Arthur Seldon, first editorial director of the Institute for Economic Affairs.
• F. A. Harper founded the Institute for Humane Studies, in 1961.
• Charles Koch funded the development of the Virginia school, notably including James Buchanan's work.
• Edwin Feuler, founded the Heritage Foundation, in 1973.
• Edward H. Crane founded the Cato Institute, in 1977.
• Eamonn Butler cofounded the Adam Smith Institute, in 1978.
• Madsen Pirie cofounded the Adam Smith Institute, in 1978.

I've written on the influence of fundings sources on the development of economics before. A developing body of scholarly literature explores the impact of the above list of people. The above list is not complete. For example, John Blundell seems to be an important fellow in the world hinted at above.

I think funding sources have been concentrated on the right. I suppose you can try to make a list not so concentrated on the right. George Soros and the Institute for New Economic Thinking, John Reed of Citicorp and Santa Fe Institute, John Podesta and theCenter for American Progress (CAP) would all be in the list. I do not know where funding for the Economic Policy Institute comes from. It seems to me a distinction exists between investigating ideas and trying to publicize conclusions you already believe.

The Interest Rate: Prime, Overnight, Or The Rate On T-Bills

As far as I am concerned, cost-push inflation is a manifestation of class conflict between workers and owners. In the late 1970s, Paul Volker and Ronald Reagan took the side of the owners. I am willing to accept that Volker genuinely believed in Milton Friedman's incorrect quantity theory of money. And, since then, workers have been getting a smaller share in increased productivity. Some obituaries of Paul Volker exhibit an understanding of what he did.

But I want to talk about my recollection of how interest rates have been covered in the press from that time. Of course, at any given time, there are a whole range and time structures of interest rates. When Volker drove the interest rate above 20 percent, the focus in news coverage was, as I recall it, on the prime rate, that is, the best interest rate commercial borrowers, such as large corporations, can obtain. My perception is that now, when movements in interest rates are reported on in the press, the emphasis is more likely to be on one of two rates. One is the overnight rate, that banks charge each other overnight. One can hear about the repo market, I guess, in this context. The other much-discussed rate is the rate on short term treasury bills (T bills).

Is my perception accurate? When did this change occur, if so? Is it actually an example of society learning? After all, the Federal Reserve has much more direct control over the latter interest rates and only indirect and tenuous control over the prime rate. Has Volker's demonstration that the quantity theory is wrong been generally taken on board?

Elsewhere

• Here is a post from a blog devoted to cybercommunism. The blogger is glowing about Paul Cockshoot's work on refuting Hayek's supposed refutation of the possibility of a post-capitalist society.
• William Milberg writes about how it is becoming more common to use the word "capitalism", a word mainstream economists had mostly stopped using.
• Herbert Giants and Rakesh Khurana write about the corrupting effects of neoclassical economics on what is taught in business school and then practiced by corporate elites.
• Osita Nwanevu writes, in The New Republic, about the enthusiasts that showed up at last weekend's Third MMT Conference.
• Lisa Schweitzer studies urban environments. In a blog post, she expresses irritation at Paul Romer's arrogance, admittedly filtered through a glowing New York Times article.
• A long time ago, Connie Bruck profiled George Soros in the New Yorker. Soros consciously thinks of himself as building on Karl Popper's The Open Society and its Enemies.

Elsewhere

This list is mostly a matter of aspirational reading.

• Maybe I want to read Ted Burczak's Socialism after Hayek. (The Amazon page has one of Herb Gintis' long reviews.)
• Binyamin Appelbaum's The Economists' Hour: False Prophets, Free Markets, and the Fracture of Society is not even out yet, and already some mainstream economists are whining about it on twitter.
• William R. Clark and Vincent Arel-Bundock have a paper, Independent but not indifferent: Partisan bias in monetary policy at the Fed, in 2012.
• Christopher Gandrud and Cassandra Grafström's Does presidential partisanship affect Fed inflation forecasts? is related.
• Mark Buchanan recommends that more attention be paid to the work of Ole Peters and others at the London Mathematical Laboratory. They have developed something called ergodicity economics, as a replacement for expected utility theory.

Scholars on Neoliberalism

The literature on neoliberalism is large. Here are some scholarly books on this subject or on related matters:

• The power of market fundamentalism: Karl Polanyi's critique, by Fred Block & Margaret R. Somers (2016).
• Undoing the demos: Neoliberalism's stealth revolution, by Wendy Brown (2015).
• The great persuasion: Reinventing free markets since the Depression, by Angus Burgin (2015).
• The strange non-death of neoliberalism, by Colin Crouch (2013).
• The birth of biopolitics: lectures at the Collège de France, 1978 - 1979, by Michel Foucault (2010).
• The illusion of free markets: Punishment and the myths of natural order, by Bernard E. Harcourt (2012). (I haven't read this one.)
• A brief history of neoliberalism, by David Harvey (2007).
• Masters of the universe: Hayek, Friedman, and the birth of neoliberal politics, by Daniel Stedman Jones (2014).
• Neoliberalism's demons: On the political theory of late capital, by Adam Kotsko (2018). (I haven't read this. Here is an interview with the author.)
• Democracy in chains: The deep history of the radical right's stealth plan for America, by Nancy MacLean (2017). (I haven't read this one. Here is Marshall Steinbaum's review.)
• Never left a serious crisis go to waste: How neoliberalism survived the financial meltdown, by Philip Mirowski (2013). (This is the most recent Mirowski book I have read. Here is a more recent paper by him.)
• Invisible hands: The businessmen's crusade against the new deal, by Kim Phillips-Fein (2010). (I haven't read this.)
• Globalists: The end of empire and the birth of neoliberalism, by Quinn Slobodian (2018).
• Rationality and the ideology of disconnection, by Michael Taylor (2010). (I haven't read this; it seems more narrowly focused on economic theory.)
• Crashed: How a decade of financial crises changed the world, by Adam Tooze (2018). (I haven't read this one.)

I think this literature has some common themes:

• Neoliberalism was always a global project. (Is there a whole literature on Latin America I am missing?)
• Markets are not natural, but a society organized around such must be created by a system of laws, along with instilling a "common sense" in the population so governed.
• Neoliberalism must be accompanied by control on or limitations of democracy.
• The development of neoliberalism was funded by extremely wealthy individuals around the world, who sought to prevent their project from receiving public scrutiny.
• Those academics funded to develop apologetics and guidance were always interdisciplinary, including those specializing in law and international relations, as well as in economics.

The literature also contains disagreements, including what institutions, groups, and individuals to emphasize in telling the story of the project of imposing neoliberalism on the world.

For Conflating Neoliberalism And Neoclassical Economics

Neoliberalism is a political project to remake the world into an unrealizable utopia. Neoclassical economics is a supposedly scientific effort to explain the world by its deviations from an unrealizable utopia. And they are both about how the world deviates from that utopia. This post is about this resemblance, not the differences, between neoliberalism and neoclassical economics.

This utopia consists of a society organized around markets¹. These markets require government to define property rights and enforce contract law. But, in the utopia, they are not to be embedded in a broader institutional setting that prevents their supposedly free adjustment. Examples of government-imposed inference with such self-regulation include minimum wages, rent control, laws against price-gouging, usury laws, subsidies for farmers to limit the size of harvests so as to maintain their income, payments to the able-bodied unemployed², and so on. Polanyi's claim is that such so-called interventions are bound to arise. The ideal which those enacting such laws were reacting against is unachievable, anyways. In the ideal, land, labor, and capital are treated as if they are only commodities. But land is the natural setting in which the economy takes place, and labor and capital involve social relations that cannot be reduced only to market relationships.

Both neoliberals and neoclassical economists often recognize their utopia must be constructed³, that it, will not emerge naturally, in some sense. The solution for problems with markets is said to be to construct more markets. I think about the tragedy of the commons, the theory of externalities^{4, 5}, and the emphasis in neoclassical welfare theory on Pareto optimality. A paradigmatic policy recommendation, for both neoliberals and neoclassical economics, is the establishment of markets for pollution permits.

Footnotes

1. I have been reading Block and Somers (2014), and I read Polanyi (1944) more than a decade ago.
2. Block and Somers approvingly cite revisionist history from Mark Blaug in the 1960s that challenged centuries-long interpretations of English Poor Laws, especially the Speedhamland system. I know Blaug through his (multi-edition) history of economics and his misrepresentations of Sraffians and the Cambridge Capital Controversy. So I was glad to see a cite where he seems to be correct.
3. This emphasis on the need for government to construct markets, to my mind, is a distinctive difference between classical liberals and sophisticated neoliberals.
4. Some mainstream economists defend themselves from critics by asserting that the critics attack a strawperson. Economists do not believe, they say, that markets are perfect. And they'll ask why are the critics not aware of the frequent teaching about externalities. This objection seems to me to be beside the point if neoclassical economists react, as many do, the existence of an externality by calling for policy for internalizing the externality (or, at least, imitating the result of such policies).
5. If one accepted neoclassical economics as a positive science, how could one call for any policy conclusion without an explicit statement of normative values at some low level of abstration?

References

• Fred Block and Margaret R. Somers (2014). The Power of Market Fundamentalism: Karl Polanyi's CritiqueHarvard University Press.
• Karl Polanyi (1944). The Great Transformation: The Political and Economic Origins of Our Time.

On The Ideological Function Of Certain Ideas Of Friedman And Barro

A Simple Keynes-Like Model

1.0 Introduction

I want to comment on an ideology that would lead to an acceptance of:

• Milton Friedman's Permanent Income Hypothesis (PIH)
• Robert Barro's so-called theory of Ricardian Equivalence

My claim is that Friedman and Barro were each responding, in their own way, to the (policy implications suggested by) Keynes' General Theory. So first, I outline, very superficially, some ideas related to the General Theory. I then briefly describe how Friedman and Barro each tried to downplay these ideas, before finally concluding.

I have a number of inspirations for this post, including Robert Waldmann's assertion that the denial of the PIH is consistent with the data; Brad DeLong noting Simon Wren-Lewis and Chris Dillow commenting on the incompetence of, say, Robert Lucas; and Josh Mason pointing out the nonsense that is taught in graduate macroenonomics about the government budget constraint and interest rates.

2.0 Governments Can End Depressions

The figure above illustrates some basic elements of Keynes' theory. This specification of a discrete-time, dynamic system includes an accounting identity for a closed economy, namely, that national income in any time period is the sum of consumption spending, investment, and government spending. And it includes a behavioral relation, namely, a dynamic formulation of a consumption function. In this system, consumption is the sum of autonomous consumption and a term proportional to national income in the previous period. One should assume that the parameter b lies between zero and one.

A policy consequence follows: government can lift the economy out of a depression by spending more. Government spending increases national income immediately. Through the consumption function, it has a positive feedback on next period's income, as well.

3.0 The Permanent Income Hypothesis

Suppose you are hostile to this policy conclusion and, like the current Republican party in the USA, dislike your fellow countrymen. How might you suggest a theoretical revision to the system structure to mitigate the influence of current government spending? One possibility is to suggest more terms enter the consumption function. With the proper manipulation, current government spending will have a smaller impact, since current income will have a smaller impact on consumption.

So, suppose the consumption function does not contain a term multiplying b by income lagged one period. Instead, assume b multiplies an unobserved and (directly) unobservable state variable which, in turn, is an aggregate of current income lagged multiple periods (Y_{t - 1}, Y_{t - 2}, ..., Y_{t - n}). Call this state variable "permanent income", and assume the aggregation is a matter of forming expectations about this variable based on a number of past values of income.

This accomplishes the goal. Current government spending can directly affect current income. But to have the same size impact as before on future income, it would have to be maintained through many lags. The policy impact of increased government spending is attenuated in this model, as compared to the dynamic system illustrated in the figure.

4.0 "Ricardian" Equivalence

One can go further with unobserved state variables. Suppose that households consume based less on recent income, but, once again, on expected values of future income. And suppose that consumers operate under the mainstream economist's mistaken theory of a government budget constraint. So consumers expect increased income today, if it results from increased government spending, to be accompanied by some combination of future decreased government spending and increased taxes. So the same current upward shock to the system causes an expectation of a future downward shock.

This is the theory of Ricardian equivalence. And, like the PIH, it suggests that Keynesian effects are not as dependable as otherwise would be the case.

5.0 Conclusion

The above story portrays economics as driven by results favorable to the biases and perceived self-interests of the extremely affluent. One would hope that academic economics is not entirely like this.

Economists Working To Increase The Pain And Misery Of Billions

"Over the last three decades, economists played an important role in creating the conditions of the 2008 crisis (and dozens of smaller financial crises that came before it since the early 1980s, such as the 1982 Third World debt crisis, the 1995 Mexican peso crisis, the 1997 Asian crisis and the 1998 Russian crisis) by providing theoretical justifications for financial deregulation and the unrestrained pursuit of short-term profits. More broadly, they advanced theories that justified the policies that have led to slower growth, higher inequality, heightened job insecurity and more frequently financial crises that have dogged the world in the last three decades... On top of that, they pushed for policies that weakened the prospects for long-term development in developing countries... In the rich countries, these economists encouraged people to overestimate the power of new technologies..., made people's lives more and more unstable..., made them ignore the loss of national control over the economy..., and rendered them complacent about de-industrialization... Moreover, they supplied arguments that insist that all these economic outcomes that many people find objectionable in this world - such as rising inequality..., sky-high executive salaries... or extreme poverty in poor countries... - are really inevitable, given (selfish and rational) human nature and the need to reward people according to their productive contributions.

In other words, economics has been worse than irrelevant. Economics, as it has been practised in the last three decades, has been positively harmful for most people." -- Ha-Joon Chang, 23 Things They Don't Tell You About Capitalism. Bloomsbury Press (2011).

Inside Job

National Public Radio broadcast an interview last evening with Charles Ferguson, the director of the soon-to-be-released documentary, Inside Job. It is apparently about recent financial shenanigans on Wall Street and the proximate causes of the global financial crisis. The director seemed to be struck about how unlikely it is that top financiers would be heading off to prison. He also was astonished about the pervasive advocacy and lack of ethics he found among economists. He mentioned economists writing articles to promote some industry and not disclosing funding, serving on corporate boards, and acting as expert witnesses in court cases.

NPR played a clip where Glenn Hubbard, the dean of the Columbia University School of Business, a former chair of the Council of Economic Advisors, and a Visiting Scholar (if you can call it that) at the American Enterprise Institute, basically threw Ferguson out of his office. Hubbard apparently did not want to talk about his outside sources of income.

Update: In the comments, Tomboktu links to the NPR piece. Elsewhere, Chris Bertram links to a piece by Charles Ferguson in the Chronicle of Higher Education.

Alternative Economics In Mechanics' Institutes And Think Tanks

Various nonacademic institutions have helped shaped the development of academic economics. Fred Lee, in his recent history, describes some aspects of the culture of university economics departments:

"Intellectual bullying of heterodox-interested graduate students; denying appointments, reappointments, and tenure to heterodox economists; red-baiting; and professional ostracism/discrimination" (Lee 2009)

In the United States around 1945, some institutions outside universities provided intellectual support and culture for left-wing intellectuals, including economists. I refer to schools for workers supported to some extent by the Communist Party:

• School for Jewish Studies (New York)
• Jefferson School for Social Science (New York)
• Abraham Lincoln School (Chicago)
• Samuel Adams School (Boston)
• Boston School for Marxist Studies
• Tom Paine School of Social Sciences (Philadelphia)
• Walt Whitman School of Social Sciences (Newark)
• Joseph Weydemeyer School of Social Sciences (St. Louis)
• Ohio School of Social Sciences (Cleveland)
• Michigan School of Social Sciences (Detroit)
• Seattle/Pacific Northwest Labor School
• Tom Mooney/California Labor School (San Francisco)

Under Truman, these schools were listed by the Attorney General as subversive. With continued McCarthyist oppression, none existed by 1957.

On the other hand, extremely rich reactionaries paid economists to argue for right wing views. This funding went to both universities and to think tanks set up since the workers' schools were shut down. Some examples:

• Harold Luhnow, who made his fortune selling furniture, is important for the history at, among other places, the University of Chicago (Van Horn and Mirowski 2009)
• Jasper Crane, a former executive of the DuPont Chemical Company was a major funder at one point of the Mont Pélerin Society (Phillips-Fein 2009)
• Sir Antony Fisher, who introduced factory farming into Great Britain, set up the Institute of Economic Affairs in Great Britain (Blundell 2007, Mitchell 2009)
• Leonard Read led the Foundation for Economic Education
• Edward H. Crane founded the Cato Institute in 1977

Perhaps the long history of oppression of economists with certain views and funding of economists with others has had some influence on what ideas are developed. The above only provides a very limited glimpse of political interventions into academic economics. Much more can be found for those willing to look.

References

• John Blundell (2007) Waging the War of Ideas,Third and expanded edition, Institute of Economic Affairs
• Colleen Dyble (editor) (2008) Taming Leviathan: Waging the War of Ideas Around the World, Institute of Economic Affairs
• Frederic Lee (2009) A History of Heterodox Economics: Challenging the Mainstream in the Twentieth Century, Routledge
• Timothy Mitchell (2009) "How Neoliberalism Makes Its World: The Urban Property Rights Project in Peru", in The Road from Mont Pélerin: The Making of the Neoliberal Thought Collective (ed. by Philip Mirowski and Dieter Plehwe), Harvard University Press.
• Kim Phillips-Fein (2009) "Business Conservatives and the Mont Pélerin Society", in The Road from Mont Pélerin: The Making of the Neoliberal Thought Collective (ed. by Philip Mirowski and Dieter Plehwe), Harvard University Press.
• Rob Van Horn and Philip Mirowski (2009) "The Rise of the Chicago School of Economics and the Birth of Neoliberalism", in The Road from Mont Pélerin: The Making of the Neoliberal Thought Collective (ed. by Philip Mirowski and Dieter Plehwe), Harvard University Press.

Performing Corporate Finance

1.0 Introduction

Economics can change the world, and not necessarily for the better. Mainstream economists often do not describe actual capitalist economies, but theorize an imaginary, supposedly ideal world in which everybody pursues their own self-interest, narrowly defined. Participants in this world are then sometimes encouraged by the theory to change institutions and their behavior to come closer to that imaginary world.

This post describes theories that encouraged corporations to become more vulnerable, by taking on large amounts of debt, and to become more short-run oriented, by focusing more on immediate stock market prices. I know about these two contributions to economics more from Bernstein and Cassidy's popularizations than the primary literature. I am deliberately treating some elements that I think have not much appeared in popular discussion since the advent of the global financial crisis.

2.0 Modigliani and Miller (M&M) and Capital Structure

The Modigliani and Miller theorem states that whether a corporation obtains financing with stocks or with bonds has no impact on its stock price. I gather that this follows from an arbitrage argument under admittedly unrealistic assumptions. An individual can buy stock with borrowed money. By buying stock on the margin, individuals can raise the leverage ratio from whatever corporations have decided on to whatever they like.

The M&M theorem serves as a baseline in corporate finance. One considers the implications of existing deviations from the theorem assumptions. Apparently the treatment for corporate taxes in the United States of dividends and interest is one such deviation. Interest on bonds can be deducted as expenses on corporate taxes; stock dividends cannot. Therefore financing by issuing bonds is to be preferred.

"This [proposition] carried not very flattering implications for the top managements of companies with low levels of debt. It suggested that the high bond ratings of such companies in which the management took so much pride, may actually have been a sign of their incompetence; that the managers were leaving too much of their stockholders' money on the table in the form of unnecessary corporate income tax payments [of] many millions of dollars." -- Merton Miller (1988), quoted in Bernstein (2005)

The implication is that corporations should increase their leverage.

3.0 Michael Jensen and Executive Compensation

Most owners (that is, holders of stock) of modern corporations are absentee owners. They would like corporate executives to act in a non self-dealing manner, against their own interests. This is a principal agent problem. The stock holder is the principal, the Chief Executive Officer (CEO), for instance, is an agent. In theory, the problem is how to structure executive pay and corporate incentives such that in value of stock is maximized. (I gather that in this theory, social norms about how stockholders, traders, and executives should behave doesn't come into it.) A supposed answer to the principal agent problem is to pay executives partly with stock options. They will then be encouraged to do their utmost to ensure the market price of the stock exceeds the price specified in their options.

References

• Peter L. Bernstein (2005) Capital Ideas: The Improbable Origins of Modern Wall Street, John Wiley & Sons.
• John Cassidy (2002) "The Greed Cycle: How the Financial System Encouraged Corporations to go Crazy", The New Yorker (Sept. 23): pp. 64-
• Michael C. Jensen and William H. Meckling (1976) "Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure", Journal of Financial Economics, V. 3, N. 4
• Meron H. Miller (1988) "The Modigliani-Miller Propositions After Thirty Years", Journal of Economic Perspectives, V. 2, N. 4 (Fall): pp. 99-120.
• Franco Modigliani and Merton H. Miller (1958) "The Cost of Capital, Corporation Finance, and the Theory of Investment", American Economic Review, V. 48, N. 3 (June): pp. 655-669

On The Road From Mont Pelerin

I have been reading The Road from Mont Pelerin: The Making of the Neoliberal Thought Collective, a collection edited by Philip Mirowski and Dieter Plehwe (Harvard University Press, 2009). One theme I find emergent in this book is the influence of funders (e.g., Harold Luhnow, Jasper Crane) on the redirection of economic thought, without any corresponding empirical evidence.

But I'm not yet ready to offer too many thoughts on this book. Instead I'm interested in the cover photo, reproduced as Figure 1.

Figure 1: Cover Photo

I cannot find photo credits in the book. Presumably, this photo is of attendees at a Mont Pelerin society meeting, maybe the first. Can anybody identify these people? Figure 2 letters them to facilitate referring.

• F. Ludwig Von Mises
• G. Friedrich Hayek

Figure 2: Cover Photo with Annotations

Principles of Neoliberalism

Some of these strike me as too absurd (e.g., 7, 9) to bother refuting:

1. "...contrary to classical liberal doctrine, [the neoliberal] vision of the good society will triumph only if it becomes reconciled to the fact that the conditions for its existence must be constructed and will not come about 'naturally' in the absence of concerted political effort and organization...
2. ...'the market' is posited to be an information processor more powerful than any human brain, but essentialy patterned on brain/computational metaphors... The market always surpasses the state's ability to process information...
3. ...for purposes of public understanding and sloganeering, market society must be treated as a 'natural' and inexorable state of humankind...
4. A primary ambition of the neoliberal project is to redefine the shape and functions of the state, not to destroy it...
5. ...Neoliberals treat... politics as if it were a market and promoting an economic theory of democracy...
6. Neoliberals extol freedom as trumping all other virtues, but the definition of freedom is recoded and heavily edited within their framework... Freedom can only be 'negative' for neoliberals (in the sense of Isaiah Berlin)...
7. ...capital has a natural right to flow freely across national borders. (The free flow of labor enjoys no similar right.)...
8. ...pronounced inequality of economic resources and political rights [is] not ... an unfortunate by-product of capitalism, but as a necessary functional characteristic of their ideal market system...
9. Corporations can do no wrong, or at least they are not be blamed if they do...
10. The market (suitably reengineered and promoted) can always provide solutions to problems seemingly caused by the market in the first place...
11. The neoliberals have struggled from the outset to make their political/economic theories do dual service as a moral code..."

-- Philip Mirowski, "Postface", in The Road from Mont Pelerin: The Making of the Neoliberal Thought Collective (edited by Philip Mirowski and Dieter Plehwe), Harvard University Press (2009)

(I've miscategorized this post since neoliberalism encompasses more than economics.)

Economists Without Ethics

As I understand it, the American Economic Association (AEA) is almost unique among professional organizations. The AEA does not have a code of ethics.

Red-Baiting Keynesian Textbooks

What economists know now is influenced by what they could teach in the past. Perhaps where we are now has something do with interventions in the past from outside of academic economics. I think, for example, of the suppression of Lorie Tarshis' full-throated Keynesianism.

Lorie Tarshis was a Canadian who attended Cambridge while Keynes was working out the General Theory. He attended Keynes' annual lectures from 1932 to 1935. With others, he brought Keynes' economics to Cambridge, Massachusetts. Tarshis was at Tufts. He later wrote the first introductory textbook to incorporate Keynesianism. I gather this textbook, Elements of Economics (Houghton Mifflin, 1947) predates Samuelson's textbook. Let's look at a reaction to the use of this textbook in teaching the introduction to economics at Yale:

"Marx himself, in the course of his lifetime, envisaged two broad lines of action that could be adopted to destroy the bourgeoisie: one was violent revolution; the other, a slow increase of state power, through extended social services, taxation, and regulation, to a point where a smooth transition could be effected from an individualist to a collectivist society. The Communists have come to scorn the latter method, but it is nevertheless evident that the prescience of their most systematic and inspiring philosopher has not been thereby vitiated.

It is a revolution of the second type, one that advocates a slow but relentless transfer of power from the individual to the state, that has roots in the Department of Economics at Yale, and unquestionably in similar departments in many colleges throughout the country. The documentation that follows should paint a vivid picture." -- William F. Buckley, Jr. God and Man at Yale: The Superstitions of Academic Freedom, Henry Regery, 1951, p. 46-47

Buckley applies his ideologically-charged nonsense to textbooks by Tarshis, Samuelson, and a few others.