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.

Elsewhere

Why Rationality is Wrong

• Above is a video by "Dr. Skeleman", first in a series.
• Nick Romeo, in The New Yorker, on The CORE textbook.
• Steve Keen's obituary of Janos Kornai.
• J. Barkley Rosser's comments on Kornai's passing. I feel I should have more to say. I recommend autobiography, By Force of Thought: Irregular Memoirs of an Intellectual Journey, although it is somewhat dry.
• J. Barkley Rosser's obituary of Peter Flaschel

Elsewhere

• A podcast interview with Philip Mirowski about how, roughly, neoliberals are exploiting the Corona Virus crisis in America.
• A book, Nine Lives of Neoliberalism, edited by Dieter Plehwe, Quinn Slobodian, and Philip Mirowski. Somewhere this is or was freely downloadable in PDF.
• A podcast interview with Marshall Steinbaum about the Chicago school of economics.
• A podcast episode, by two economics professor, trying to present an overview of Joan Robinson.
• A downloadable book, Labour and Value: Rethinking Marx's Theory of Exploitation, by Ernesto Screpanti.
• Two young friends discuss Steve Keen's book, Debunking Economics.

Keen's Debunking Economics Most Popular Among Popular Critiques

Table 1: Selected Critiques

Author	Book	Number Ratings	Mean Rating
Moshe Adler	Economics for the Rest of Us	21	4
Rod Hill & Tony Myatt	The Economics Anti-Textbook	13	4
Steve Keen	Debunking Economics, 1st edition	25	3 to 4
	Debunking Economics, 2nd edition	56	4 to 5
Paul Ormerod	The Death of Economics	10	3 to 4
John Quiggin	Economics in Two Lessons	2	4
John Weeks	Economics of the 1%	13	4 to 5

Steve Keen seems to be the most popular of those writing internal critiques of economics directed towards the common reader. I selected the above books and looked at rankings on Amazon's United States website. You can spend lots of time reading the comments.

I am not sure about how to characterize this genre. I am more focused on theory than offering political programs. Would Robert Reich's Saving Capitalism be excluded? But what about memoirs, such as John Perkins' Confessions of an Economic Hit Man, Stiglitz' Globalism and its Discontents, Thaler's Misbehaving, or Kahneman's Thinking Fast and Slow? These books seem to have much more ratings than the ones I list in the above table.

Why is Keen's book more popular than the other ones in the table? Keen often overstates his case. One reviewer said he confuses necessary conditions with sufficient ones. I'm covered here; I suggested to him, before publication of the first edition, that well-behaved aggregate excess demand curves might exist in special, numeric, cases even if all consumers did not have identical and homothetic preferences. But those who know of Alan Kirman's work, with others, in the 1970s know Keen has a point. You cannot find any other condition than Gorman form that is sufficient to have well-behaved aggregate excess demand curves. And this is true of many other of Keen's points. I had not realized before reading Keen that the standard textbook presentation of perfect competition assumes managers of firms are systematically mistaken in their understanding of the demand curves they face.

Anyways, neoclassical economics is mostly wrong or useless for internal, logical reasons.

Elsewhere

• Steve Keen and others, in a showy bit of performance art in London, have called for a reformation of economics. Imitating Luther, they have nailed some theses to a door. Here's some links:
• Guardian article
• Letters to the editor in response.
• New Weather Institute blog post.
• 33 Theses.
• An article by Ben Chu, in the Independent saying, more or less, let's not get carried away.
• I do not know who Charles Mudede is or what his platform is. His style is more popular and very different from mine. Examples:
• On Seattle's minimum wage, in which he brings up an imperfectionist thesis related to the Cambridge Capital Controversy.
• On Cornel West vs. Ta-Nehisi Coates. I think the idea that identity politics associated with post modernism accommodates neoliberalism is not new (see references below). I don't want to box Coates in, but the way he writes about the Black body in Between the World and Me is definitely a post modern trope. But he writes about it, I guess, because it make sense of his lived experience.
• I stumble upon a tweet by Duncan Weldon, in which he says he resolves every year to try and understand the Cambridge Capital Controversy.

References

• Samir Amin (1998). Spectres of Capitalism: A Critique of Current Intellectual Fashions, Monthly Review Press.
• Terry Eagleton (1996). The Illusions of Postmodernism, Blackwell.

Elsewhere

• Ian Wright has had a blog for about six months.
• Scott Carter announces that Sraffa's notes for are now available online. (The announcement is good for linking to Carter's paper explaining the arrangement of the notes.)
• David Glasner has been thinking about intertemporal equilibrium.
• Brian Romanchuk questions the use of models of infinitesimal agents in economics. (Some at ejmr say he is totally wrong, but others cannot make any sense of such models, either. I am not sure if my use of a continuum of techniques here can be justified as a limit.)
• Miles Kimball argues that there is no such thing as decreasing returns to scale.

Don't the last two bullets imply that the intermediate neoclassical microeconomic textbook treatment of perfect competition is balderdash, as Steve Keen says?

Emmanuelle Benicourt Influenced By Steve Keen?

I am thinking of absurdity number 3 below. I go a little further because I am amused by the well-established point with which I end this quotation.

"ABSURDITY N^o3 'For a price-taking firm, the demand curve for its own output is a horizontal line at the market price' (Unit 8.3)

This is false: the demand curve of a price-taking firm is not, and cannot be, horizontal: a firm supply, even if it is 'tiny', affects the price and then the demand of the good it produces.

The correct assumption should be that the firm believes that the demand curve is horizontal - an erroneous belief, but that is another story...

In their seminal article, Existence of an Equilibrium for a Competitive Economy, Kenneth Arrow and Gérard Debreu don't mention agents' beliefs but they,

'...instruct each production and consumption unit to behave as if the announcement of price p were the equilibrium value' (point 1.4.1, [Benicourt's] italics)

ABSURDITY N^o4 All agents are price-takers (competitive equilibrium)

...Now, any reasonable person will immediately ask: if all agents are price-takers, who set[s] prices? The e-Book answers (implicitly) this question with a circular reasoning...

Conclusion: 'A competitive market', as defined in the CORE e-Book, is not 'an approximation' of any existing market. It is not:

'...hard to find evidence of perfect competition' (Unit 8.3).

It is impossible.

The so-called 'competitive economy' model doesn't 'describe an idealised market structure' (Unit 8, p 44). It is not 'unrealistic' - any model is, by definition - it is irrelevant. In fact, it has nothing to do with capitalism. It can be considered, at most, as a variant of market-socialism models, with a benevolent planner setting prices, adding supplies and demands, etc." -- Emmanuelle Benicourt (2016). Is the CORE e-Book a possible solution to our problems? Real-World Economics Review, iss. no. 75, p. 135-142.

Steve Keen: Economists Are "Insufficiently Numerate"

"Curiously, though economists like to intimidate other social scientists with the mathematical rigor of their discipline, most economists do not have this level of mathematical education...

...One example of this is the way economists have reacted to 'chaos theory'... Most economists think that chaos theory has had little or no impact - which is generally true in economics, but not at all true in most other sciences. This is partially because, to understand chaos theory, you have to understand an area of mathematics known as 'ordinary differential equations.' Yet this topic is taught in very few courses on mathematical economics - and where it is taught, it is not covered in sufficient depth. Students may learn some of the basic techniques for handling what are known as 'second-order linear differential equations,' but chaos and complexity begin to manifest themselves only in 'third order nonlinear differential equations.' Steve Keen (2011). Debunking Economics: The Naked Emperor Dethroned?, Revised and expanded ed. Zed Books, p. 31

The above quotes are also in the first edition. Before commenting on this passage, I want to re-iterate my previously expressed belief that some economists, including some mainstream economists, understand differential and difference equations.

I misremembered this comment as being overstated for polemical purposes. But, in context, I think it is clear to those who know the mathematics.

I took an introductory course in differential equations decades ago. Our textbook was by Boyce and DiPrima. As I recall, we were taught fairly cookbook techniques to solve linear differential equations. These could be first order or second order and homogeneous or non-homogeneous. They could also be systems of linear differential equation. I recall some statement of an existence theorem for Initial Value Problems (IVPs), although I think I saw a more thorough proof of some such theorem in an introductory¹ real analysis course. We might have also seen some results about the stability of limit points for dynamical systems. Keen is not claiming that economists do not learn this stuff; this kind of course is only a foundation for what he is talking about.

I also took a later applied mathematics course, building on this work. In this course, we were taught how to linearize differential equations. We definitely were taught stability conditions here. If I recall correctly, the most straightforward approach looked only at sufficient, not necessary conditions. We also learned perturbation theory, which can be used to develop higher order approximations to nonlinear equations around the solutions to the linearized equations. One conclusion that I recall is that the period of an unforced pendulum depends on the initial angle, despite what is taught in introductory physics classes². I do not recall much about boundary layer separations, but maybe that was taught only in the context of Partial Differential Equations (PDEs), not Ordinary Differential Equations (ODEs). This is still not the mathematics that Keen is claiming that economists mostly do not learn, although it is getting there.

You might also see ordinary differential equations in a numerical analysis course. Here you could learn about, say, the Runge-Kutta method. And the methods here can apply to IVPs for systems of non-linear equations³. I believe in the course that I took, we had a project that began to get at the rudiments of complex systems. I think we had to calculate the period of a non-linear predator-prey system. I believe we might have been tasked with constructing a Poincaré return map.

According to Keen, a sufficiently numerate economist should know the theory behind complex dynamical systems, chaos, bifurcation analysis, and catastrophe theory⁴. I think such theory requires an analysis able to examine global properties, not just local stability results. And one should be interested in the topological properties of a flow, not just the solution to a (small number of) IVPs. Although this mathematics has been known, for decades, to have applications in economics, most economics do not learn it. Or, at least, this is Keen's claim.

Economists should know something beyond mathematics. For example, they should have some knowledge of the sort of history developed by, say, Fernand Braudel or Eric Hobsbawm. And they should have some understanding of contemporary institutions. How can they learn all of this necessary background and the needed mathematics⁵, as well? I do not have an answer, although I can think of three suggestions. First, much of what economists currently teach might be drastically streamlined. Second, one might not expect all economists to learn everything; a pluralist approach might recognize the need for a division of labor within economics. Third, perhaps the culture of economics should be such that economists are not expected to do great work until later in their lifetimes. I vaguely understand history is like this, while mathematics is stereotypically the opposite.

Footnotes

1. As a student, I was somewhat puzzled by why my textbooks were always only Introductions to X or Elements of X. It took me quite some time to learn the prerequisites. How could this only be an introduction? Only later work makes this plain.
2. Good physics textbook are clear about linear approximations to the sine function for small angles. Although our textbook motivated perturbation theory in the context of models of solar systems, I have never seen perturbation theory applied here in a formal course. Doubtless, astrophysicists are taught this.
3. Stiff differential equations is a jargon term that I recall being used. I do not think I ever understood what it meant, but I am clear that the techniques I think I have mostly forgotten were not universally applicable without some care.
4. Those who have been reading my blog for a while might have noticed I usually present results for the analysis of non-linear (discrete-time) difference equations, not (continuous-time) differential equations.
5. There are popular sciences books about complex systems.

S. Abu Turab Rizvi, Not Steve Keen

Notice the point about the need in neoclassical theory to assume that preferences satisfy Gorman's assumptions of identical and homothetic (non-varying with income) preferences:

"Extensions of the basic arbitrariness results to configurations of preferences and endowments which are in no way 'pathological', and are in fact more and more restrictive, indicate the robustness of S[onnenschein-]M[antel-]D[ebreu] theory.

For instance, an assumption which is often made to improve the chances of meaningful aggregation is that of homothetic preferences, which yields linear Engel curves and so no complicated income effects at the level of the individual. However, with only a slight strengthening of the requirements of Debreu's theorem, Mantel (1976) showed that the assumption of homotheticity does not remove the arbitrariness of A[ggregate] E[xcess] D[emand functions].

Moreover, the possibility that consumers have to be very different, or that unusual endowment effects need to take place, in order for SMD-type results to hold was refuted by Kirman and Koch (1986): even supposing consumers to have identical preferences and collinear endowments does not remove the arbitrariness of the AEDs. Of course, if preferences are simultaneously identical and homothetic, AED is a proportional magnification of individual excess demand (Gorman, 1953; Nataf, 1953) and the whole economy behaves as if it were an individual (obeying the Weak Axiom of Revealed Preference in the aggregate), but this is an extremely special situation. The Mantel and Kirman-Koch theorems effectively countered the criticism of SMD theory raised by Deaton by showing that the primitives can be arrayed in ways which on the face of it are very congenial towards generating well-behaved results, yet the arbitrariness property of AEDs remains." -- S. Abu Turab Rizvi, "The Microfoundations Project in General Equilibrium Theory", Cambridge Journal of Economics, V. 18 (1994): p. 362.

In short, neoclassical economists have proved (by contradiction, in some sense) that neoclassical microeconomics is not even wrong and that methodological individualism has failed.

Wynne Godley On Front Business Page Of New York Times

The New York Times, even outside of their editorial pages, seems to think their readership should know about the non-mainstream economists I generally like:

• 11 September 2013 profile of Wynne Godley.
• 18 July 2013 article on Steve Keen and how his work builds on Hyman Minsky.
• 5 July 2013 profile of Warren Mosler.
• 4 March 2009 article on the difficulties heterodox economists face in academia.
• 23 April 2008 profile of George Soros.
• 11 July 2007 article on heterodox economics.

I predict that this profile of Godley will get a more positive response from Post Keynesians and advocates of endogenous money than their profile of Warren Mosler did. One caveat: I think Godley was more about using his stock-flow consistent modeling to identify unsustainable trends, than to quantitatively predict the course of, say, Gross Domestic Product (GDP) over the next n quarters. (He also accepted the conclusions of the Cambridge Capital Controversy.)

Update: I should have noticed that the Jonathan Schlefer is the author of the article on Godley. L. Randall Wray comments.

Elsewhere

• Steve Denning, a writer for Forbes, describes Milton Friedman as being the source of "The world's dumbest idea". (I have written on Milton Friedman's confusion. incoherence, and lack of integrity, as well as Michael Jensen's (ir)responibility. See also Unlearning Economics.)
• Mike Konczal on Philip Mirowski's new book.
• Henry Scowcroft on the need for communicating economics to the public.
• Michael Lind on supposedly "Econ 101". Noah Smith complains about the public impression of what economists teach.
• Robert Neild on a 1981 anti-monetarism petition. I am especially amused about him losing his cool in a debate with Milton Friedman.
• Mark van Vugt and Michael Price, two psychologists, I gess, comment on Homo Economics. They link to a website which has David Sloan Wilson as editor in chief.
• Floyd Norris, in the New York Times, explains that Steve Keen foresaw the global financial crisis better than Ben Bernanke did.

Perfect Competition Is The Same As Monopoly If You Do The Math Right

1.0 Introduction

This post summarizes one aspect of a theorem presented and proved by Roy Radner (1980). I have previously expressed skepticism about the claim in the post title. I have also heard that, in game theory, anything can happen, but nothing need happen. So, I suppose, one should not be surprised in stumbling over a proof of the existence of almost any market behavior in the literature on game theory. But I was surprised.

2.0 Selected Assumptions

2.1 Non-Cooperative Firms

In the model considered here, no mechanism exists to enforce agreements among firms. In the jargon, only (extensions of) Cournot-Nash equilibria are considered here.

2.2 Firm Managers Making Approximately Optimal Output Decisions

Although not commonly stated, the textbook presentation of perfect competition assumes the managers of the firms are systematically mistaken about their optimum decisions. A homogeneous product is assumed to be produced by a finite number of firms in the industry, and the total industry output is finite. Managers are assumed to disregard any strategic reaction by other firms to variation in their own firm's output and to take the price of their product as given. But, for a given consumer demand function, the firm's (notional) variation in output results in a variation in prices. So the decisions of the managers can only be approximately optimal, in textbook theory.

Radner proposes the notion of an epsilon-equilibrium to formalize this idea that firm strategies are only approximately optimal. In such an equilibrium each firm's strategy is such that, for example, average profit is within epsilon of the maximum average profit achieved by an optimal strategy, given the strategies of all other firms. As is typical in mathematical analysis, one should think of ε as a given (small) parameter.

2.3 Sequential Market Interactions

Firms are not considered as deciding on a single quantity to produce in this model. Rather, each firm decides on a sequence of T quantity outputs, one for each of T successive periods. The parameter T is known as the lifetime of the industry. Each firm decides on the output in a given period as a function of the outputs of all firms in all previous periods. A strategy is a sequence of such functions, one for each firm. The firm chooses a strategy to maximize its average or total discounted profit over the lifetime of the industry.

2.4 Replication

The theorem outlined here is used to compare epsilon-equilibria for different (finite) numbers of firms in the industry. Radner defines the replication case to apply when the demand price is an unchanged function of the average output per firm. In some sense, the number of consumers increases, in the model, with the number of firms.

3.0 An Informally Stated Theorem

Theorem: Consider the model with the above assumptions. Let the number of firms increase, along with the lifetime of the industry, such that the number of firms remains small enough, when compared to the lifetime of the industry. For any finite number of firms, equilibria exist in which the firms act as a cartel, and the cartel lasts for any given duration, provided the lifetime of the industry is taken large enough.

4.0 Conclusion

I think of the point of this post to explore the result of tweaking textbook assumptions in the theory of perfect competition. Apparently, the results are sensitive to the exact statement and combination of assumptions. I gather that further research in microeconomic theory has confirmed that whether or not equilibria converge, as the number of firms increase, to the perfect competition model is a fine point. That is, equilibria may or may not converge to a model with a continuum of firms. Radner seems to feel exploring certain sets of assumptions is of more interest than other sets. I have chosen to emphasize a set of assumptions in which any finite number of firms may act like a monopoly, in a precise sense.

Another approach might be better in empirically describing firms in actually-existing capitalism.

Reference

• Roy Radner (1980). Collusive Behavior in Noncooperative Epsilon-Equilibria of Oligopolies with Long but Finite Lives, Journal of Economic Theory, V. 22: pp. 136-154

Aspects of the Keen-Stigler Critique of Perfect Competition

It seems to me that this echoes part of Steve Keen's point in Debunking Economics and, further, Keen's Physica A paper with Russell Standish:

"...the analysis has rested on one or another of several finite general-equilibrium models which share assumptions that together imply market power on the part of all households and firms and which also share the assumption of price taking by all households and firms.

The possible inconsistency of these assumptions has long been overlooked - since the pioneering work of Walras (1874) and continuing through to the modern period dominated by Arrow and Debreu (1954) and McKenzie (1954). Only very recently has it attracted attention; see Kemp (2005) and Kemp and Shimomura (2005). here I note only that the internal consistency in the models relied on can be maintained by adding the additional assumption that each household is incompletely informed (about the economy of which it is a member) or incompletely rational (unable to appreciate the implications of membership for its market power) or both." -- Murray C. Kemp (2010).

I learned from Keen that the textbook presentation of perfect competition assumes a curious mixture of omniscience on the part of firm managers and an inability to learn from systematic errors¹. As far as I know, no introductory or intermediate microeconomics textbook clearly states these assumptions.

Kemp is concerned with perfect competition in the theory of international trade, for example, in the theory of the small open economy. Is there literature assuming that each country produces infinitesimal quantities of whatever commodities they produce, analogous to the literature on the assumption that each firm in a market for a specific commodity produces an infinitesimal quantity? I do not see how such an assumption² can be consistent with the use of U-shaped cost curves in the textbook treatment of perfect competition. In the long-run, we are taught, the firm produces at the minimum point of the U-shape average cost curve. The existence of the downward-sloping portion of these U-shaped curves implies that the level of production in the long-run must be a strictly positive, non-infinitesimal quantity³.

Footnotes

1. I have recently learned that the literature on limiting behavior in models of mechanism design may be of relevance here. (Al Roth's whining and boundary patrolling is not encouraging.)
2. It would be some combination of mistaken to intellectually dishonest to cite Aumann (1964) in defense of an argument in which perfect competition is supposedly found as the limit in a model with a finite number of firms, as the number of firms increases without bound. Aumann explicitly argues that perfect competition cannot be derived as such a limit, and the cardinality of a continuum is bigger than the cardinality of the set of natural numbers.
3. It would be intellectually dishonest to "address" the logical inconsistencies of the theory of perfect competition described in this post by insulting Keen, based on his further arguments about monopoly. Those further arguments in Keen and Standish, for example, seem to assume firms treat variables over which they do not have control as decision variables. I do not find the logical aspects of those further arguments compelling, although I do find of interest their simulations, in which they do not make this error. But this footnote deals with a change of subject from this post.

References

• Steve Keen, Russell Standish (2006). Profit Maximization, Industry Structure, and Competition: A Critique of Neoclassical Theory, Physica A: pp. 81-85
• Murray C. Kemp (2005). Trade Gains" The End of the Road?, Singapore Economic Review, V. 50: pp. 361-368 [To read].
• Murray C. Kemp (2010). Normative Trade Theory under Gossenian Assumptions, in Economic Theory and Economic Thought: Essays in Honour of Ian Steedman (ed. by J. Vint et al.), Routledge.
• Murray C. Kemp and K. Shimomura (2005). Price Taking in General Equilibrium, American Journal of Applied Sciences, V. 6: pp. 95-97. [To read]

A Keen Defense

My major point in this post is to draw attention to the existence of Kapeller and Pühringer (2010).

Steve Keen's book, Debunking Economics, is mainly a compilation of well-established criticisms of textbook economics. He attempts as popular a presentation as the material will permit. These criticisms, in my opinion, leave textbook economics, both microeconomics and macroeconomics, in tatters¹.

Keen, in the first edition, also offered his own original criticism of the textbook theory of the firm under perfect competition. You can find various brouhahas on the internet over Keen's remarks. Between editions of his book, Keen has published, with others, a series of papers developing his criticism².

Some have asserted theories of perfect competition in models with a continuum of agents provide a defense of the textbook theory. As Kapeller and Pühringer point out, this is a change of subject. A non sequitur should not be a considered an adequate defense of the textbook model. Furthermore, the primary developer of models with a continuum of agents presents his approach as inconsistent with the textbook theory:

"Though writers on economic equilibrium have traditionally assumed perfect competition, they have, paradoxically, adopted a mathematical model that does not fit this assumption. Indeed, the influence of an individual participant on the economy cannot be mathematically negligible, as long as there are only finitely many participants. Thus, a mathematically model appropriate to the intuitive notion of perfect competition must contain infinitely many participants. We submit that the most natural model for this purpose contains a continuum of participants." -- Robert Aumann (1964).

It seems to me only four possibilities are open here:

1. Aumann is not talking, in his critical remarks, about the model of perfect competition taught in almost any intermediate microeconomics textbook.
2. Aumann is mistaken.
3. The economists who write and teach the self-contradictory textbook model are deliberately teaching self-contradictory models to their students.
4. The economists who write and teach the self-contradictory textbook model are ignorant.

I think only the third and fourth options are credible³. I can understand the difficulty of writing and teaching in an intellectually bankrupt discipline.

Update: Nick Rowe illustrates the willingness of some economists to teach nonsense to students: "To the individual farmer, who sees only a tiny slice of the whole demand curve, because even a 100% change in his output will cause only a tiny percentage change in total output, it will look perfectly flat." Note that in his post, even when considering the limiting case, he never considers the existence of a continuum of producers.

Update 2: Steve Keen, in the Business Spectator, re-iterates his critique of the incorrect neoclassical textbook theory of perfect competition. Tim Worstall lies to readers of Forbes. It is not true that "everyone subscribes" to the "usual basics of economics" that Keen debunks. It is not true that the bulk of Keen's book is about his "breakthroughs in showing us all the errors of our ways." One can accept almost all of Keen's demonstration of the mendacity of neoclassical textbooks without accepting any claim that Keen says is original with him. In fact, Keen notes that Stigler showed that perfectly competitive firms that are not systematically mistaken, if they produce a positive, non-infinitesimal quantity in equilibrium, will not produce at a level of output where the market price, Marginal Revenue, and Marginal Cost are all equated.

Footnotes

1. Some areas of economics, such as game theory or the recent popularity of instrumental variables and experiments (natural and otherwise), remain unaddressed by Keen.
2. Kapeller and Pühringer point to a 2008 paper published by Anglin in Physica A as a peer-reviewed response.
3. The existence of the downward-sloping part of the U-shaped average cost curve for the textbook firm hardly seems compatible with the existence of an infinite number of firms, each producing a quantity of zero units of an homogeneous good.

References

• Aumann, Robert J. (1964). Markets with a Continuum of Traders, Econometrica, V. 32, No. 1-2.
• Kapeller, Jacob and Stephan Pühringer (2010). The Internal Consistency of Perfect Competition, The Journal of Philosophical Economics, V. III, No. 2: pp. 134-152.

Steve Keen Aims At A Stationary Target

"Unlearning Economics" has been posting on Steve Keen's Debunking Economics: The Naked Emperor Dethroned? The second edition was published in 2011 and the first edition in 2001. As far as I can see, the major substantive changes in the second edition consist of:

• More on macroeconomics, especially so-called Dynamic Stochastic General Equilibrium (DSGE) models.
• More on Keen's own dynamic systems approach, building on Minsky, to macroeconomic modeling.
• Connecting up the intellectual bankruptcy of mainstream economics to the current global macroeconomic disaster

But I want to concentrate here on microeconomics.

A common mainstream response to Keen is to say that the cutting edge of mainstream researchers have transcended the issues Keen raises. At best, he is only attacking undergraduate teaching.

In the course of a decade, one might expect introductory teaching to have changed to incorporate some of this advanced research, at least if economics resembled many other academic disciplines. My sense, though, is that Keen had no need to update the sections on microeconomics, except to attempt other tactics in exposition, if he so chose. Am I correct?

Are mainstream economists more willing to teach General Equilibrium theory to undergraduates, including the proofs of the "near emptiness" of the theory? Do they teach that downward-sloping demand curves cannot be justified on the basis of individual utility maximization? Do they argue for downward-sloping demand curves on some other basis - perhaps because differences in characteristics among consumers balance out non-substitution effects in the aggregate (as in Werner Hildenband's research)? Has the absence of a chapter on game theory in Keen's book become more glaring, as it would be if David Kreps' textbook were more popular? Is the teaching of the theory of the perfectly competitive firm still vulnerable to Piero Sraffa's 1925 and 1926 papers? Is Robert Aumann's approach with a continuum of agents taught to undergraduates? Or, perhaps, teaching could become more focused on the empirical facts of behavioral economics, increasing returns to scale, markup pricing, and the structure of inter-industry flows and less focused on mistaken a priori neoclassical theory.

Mainstream economists are trained to be ignorant, including of the history of subject. This willful ignorance on history, as far as I know, has only become worse in the period between Keen's editions. Thus, if mainstream economics can ignore a criticism for about a decade, they can then relegate it to the (unstudied) history of thought. As I understand it, most of the arguments in Debunking Economics are decades old.

Will mainstream teaching in economics ever be worth taking seriously?

Models Building On Minsky

Some recent resources on Hyman Minsky:

• Gauti B. Eggertsson and Paul Krugman (2010) "Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach"
• Steve Keen (15 March 2011) "The Debt Krugman Would Rather Forget", Business Spectator.
• Steve Keen (2011) "A Monetary Minsky Model of the Great Moderation and Great Recession", Journal of Economic Behavior & Organization
• Thomas I. Palley (April 2010)"The Limits of Minsky's Financial Instability Hypothesis as an Explanation of the Crisis", Monthly Review, V. 61, Iss. 11.
• Thomas I. Palley (2011) "A Theory of Minsky Super-Cycles and Financial Crises", Contributions to Political Economy.
• Lance Taylor and Stephen A. O'Connell (1985) "A Minsky Crisis", Quarterly Journal of Economics, V. 100, Supplement: pp. 871-885.

With some work, one can find downloadable copies of the above papers containing the formal models. In the more popular paper above, Keen criticizes Krugman for retaining flawed assumptions of mainstream macroeconomics. Why should anyone care at this point how a Dynamic Stochastic General Equilibrium (DSGE) model can be tweaked? Palley's Monthly Review article is also deliberately designed to generate controversy. He argues that Minsky's approach needs to be supplemented by more structuralist explanations.

Reviews of Keen's Debunking Economics

I read some reviews as negative and some as positive. The negative reviews include both those who think neoclassical economics is basically inconsistent and incoherent (but think Keen fails to point out the errors well enough) and those who think otherwise. By the way, I argued with Keen about his presentation of the SMD theory before publication, even though I had never heard the label "Gorman form" then.

• Balak, Benjamin (2005). Eastern Economic Journal: 148-150
• Belenkiy, Ari (2005). Journal of Economic Behavior & Organization, V. 56: 129-139
• Laibman, David (2003). Review of Radical Political Economics (Summer): 351-353
• Misina, Miroslav (2005). Economic Journal (November): F419-F422
• Murphy, Robert P. and Gene Callaham (2003). Review of Austrian Economics, V. 16, N. 4: 381-384
• Myatt, Anthony(2004). Journal of Economic Education (Winter): 100-103
• Nesiba, Reynold F. (2006). Review of Radical Political Economics (Winter): 154-157
• Oleson, Ted (2003). Journal of Economic Issues: 228-231
• Quiggin, John (2002). (?): 233-235
• Whalen, Charles J. (2004). (?): 255-257

Textbooks For Teaching Non-Neoclassical Economics

Does an ideological or normative bias exist in mainstream teaching or practice? I think Gunnar Myrdal's The Political Element in the Development of Economic Theory is still worth reading on this topic. Much good stuff has been written on this topic since, too.

In my "Creating Two-Good Reswitching Examples", I list some textbooks for teaching the Cambridge Capital Controversy:

• S. Ahmad (1991). Capital in Economic Theory: Neo-classical, Cambridge, and Chaos, Edward Elgar
• C. Bidard (2004). Prices, Reproduction, Scarcity, Cambridge University Press
• E. Burmeister (1980). Capital Theory and Dynamics, Cambridge University Press
• R. M. Goodwin (1970). Elementary Economics from the Higher Standpoint, Cambridge University Press
• S. Keen (2001). Debunking Economics: The Naked Emperor of the Social Sciences Pluto Press
• H. D. Kurz and N. Salvadori (1995). Theory of Production: A Long-Period Analysis, Cambridge University Press
• L. L. Pasinetti (1977). Lectures on the Theory of Production, Columbia University Press
• J. Robinson and J. Eatwell (1973). Introduction to Modern Economics, McGraw-Hill
• V. Walsh and H. Gram (1980). Classical and Neoclassical Theory of General Equilibrium: Historical Origins and Mathematical Structure, Oxford University Press.
• J. E. Woods (1990). The Production of Commodities: An Introduction to Sraffa, Humanities Press International

These textbooks exhibit a range of rigor, level of mathematics, and assumptions about background. Burmeister's sympathies are clearly with the neoclassicals.

The above list reflects my focus on the CCC. But other focii are possible. Apparently David Krep's A Course in Microeconomic Theory is an introductory graduate text organized by game theory. In his competition, game theory is confined to selected chapters, instead of being an organizing principle.

I have seen references to some considerably less mainstream textbooks. Robin Hahnel's The ABC's of Political Economy: A Modern Approach and Hugh Stretton's Economics: A New Introduction are two I have seen some say nice things about.

There are more textbooks for Post Keynesians. A Marxist would have another list of textbooks. So a supply has been available for economists to teach something different. I suggest if the demand had been seen, even more textbooks would be forthcoming; one can find parts of ones put up here and there on the Web. David Colander is worth reading on the question of why mainstream economists do not alter their teaching, but I've already gone on long enough.

Response To Comments On Steve Keen's Work

Introduction

In comments on a previous post, Radek comments on some work of Steve Keen's. Since I've let something like a week go by, I thought I ought to raise this response to a post.

I respond more to people I disagree with. But I think I ought to note that, like DSquared, I respect Solow, while disagreeing with him. My favorite polemic from the Cambridge Capital Controversy is this:

“I have long since abandoned the illusion that participants in this debate actually communicate with each other. So I omit the standard polemical introduction, and get down to business at once.” –- Robert M. Solow (1962)

But back to Keen. What I appreciate most in Keen’s book is his attempt to convey to the introductory student and common reader that good reason exists to doubt (mainstream) economics, no matter how much (mainstream) economists attempt to blind one with “science”. Keen claims very little originality for most of what he has to say. As one can see, I have some disagreements with Keen’s attempts at popularization. But the discussion in this post only concerns two out of fourteen chapters in Keen’s book. And Radek does not even concede any virtues in those chapters.

Also, I can do without accusations that Keen is a “hack”, whether “a pretty skillful hack” or not; a “charlatan”; a liar; “dishonest and embarrassing”; “engages in” “dishonest rhetorical trick[s]”. For me, Guiness stout and Monty Python fall in the same category: things I’m still unsure what I think of. But I’m fairly sure abuse is not an argument.

Profit Not Maximized When Price Equal Marginal Revenue

Chapter 4, “Size Does Matter”, seems to be the most argued about chapter of Debunking Economics. It surprised me too.

Atomistic competition, in which one has a continuum of infinitesimal agents, is a standard assumption in economics. Keen and Standish (2006) point out that the assumption of atomistic competition is that one firm does not change its level of production in reaction to another firm's variation in production levels. Keen (2001) points out that Stigler shows that, under atomistic competition, the demand curve for a consumption good faced by the firm has the same slope as the demand curve for the market. I find Keen is not original in noting that atomistic competition is incompatible with the usual textbook U-shaped average cost curves:

"Of course, global increasing returns to scale (or more modestly, situations in which efficient scale is reached at a level of output which is noninfinitesimal relative to the total size of the market) remains a problem. Also, we do not deny the descriptive reality of the latter situation." -- Duffie and Sonnenschein (1989)

Radek ignores all this motivation for Keen’s simulations, and I find it difficult to argue with Keen’s claims. And they wreck havoc on mainstream introductory textbooks in microeconomics.

I have done work with simulations in quite different contexts. In my experience with certain researchers, they wanted to see their analytical arguments confirmed by both simulations, in which they could control the environment to which their arguments are applied, and practical applications. I think Radek should welcome my simulation. If he looks, he will see that I allow the user to vary the order in which firms make decisions. So I agree with Radek in that I think Keen can be challenged here. I also seem to recall an impression that step size matters to convergence in my simulation. I still think I would need to do further work to substantiate these worries.

The Sonnenschein-Mantel-Debreu Results

Keen brings up the SMD results in Chapter 2 of Debunking Economics. Duffie and Sonnenschein (1999) characterize these results as stating that "the class of excess demand functions generated by economies has no structure beyond Walras' law and homogeneity" (p. 574). They point out the implication that "the equilibrium price set may be an essentially arbitrary subset of the set of relative prices" (p. 574).

Radek states, "SMD is not about aggregating individual utilities in the sense that Keen's talking about." I find Keen to only be echoing the professional literature on this point. Think, for example, of Kirman’s (1992) analysis of representative agent models, which are widespread in New Classical Economics. Keen’s point is that Margaret Thatcher was wrong in asserting that “There is no such thing as society”. Would Radek accept Kirman’s claims, which I think are along the same lines:

"The problem seems to be embodied in what is an essential feature of a centuries-long tradition in economics, that of treating individuals as acting independently of each other...

If we look back briefly to the result that underlies the whole problem expressed here it is clear that in the standard framework we have too much freedom in constructing individuals. The basic artifact employed is to find individuals each of whose demand behavior is completely independent of the others... making individual behavior dependent or similar may open the way to obtaining meaningful restrictions...

If we are to progress further we may well be forced to theorise in terms of groups who have collectively coherent behaviour. Thus demand and expenditure functions if they are to be set against reality must be defined at some reasonably high level of aggregation. The idea that we should start at the level of the isolated individual is one which we may well have to abandon. There is no more misleading description in modern economics than the so-called microfoundations of macroeconomics which in fact describe the behaviour of the consumption or production sector by the behaviour of one individual or firm. If we aggregate over several individuals, such a model is unjustified...

It is clear that making assumptions on the distribution of agents' characteristics amounts, in some sense, to making assumptions about the organization of society...

In conclusion, then, it is worth repeating that recent theoretical work has shown how little the Walrasian model has to say about aggregate behavior. Economists therefore should not continue to make strong assertions about this behaviour based on so-called general equilibrium models which are, in reality, no more than special examples with no basis in economic theory as it stands."-- Alan Kirman (1989)

Radek comments:

So how 'huge' are SMD results - the fact that one may have multiple equilibria. Well, here I think there's often a good bit of intellectual dishonesty among critics of GE. On one hand they criticise GE for being 'unrealistic' on the other they wave SMD theorem as proof that GE is 'untenable' (again, whatever that means). But seriously, why should you expect the Real World to have a unique equilibrium? Particularly in the presence of wealth effect, which are the driving force behind SMD theorem, and the whole point of doing GE in the first place? Personally I think the possibility of multiple equilibria is a REALISTIC feature of general equilibrium theory and a point in favor of it rather than against it.

One would be in trouble if the theorem predicted a continuum of equilibria, or that the First Theorem no longer applied but that's not the case. One can still do local comperative statics and all them multiple equilibria are still Pareto efficient.

I find the above confused. Tony Lawson is the scholar to read when it comes to “realism” and Post Keynesianism. I don’t say every Post Keynesian agrees with him. But one who wants to engage Post Keynesian discussions of realism of assumptions must read at least some of Lawson. I don’t know what it means to say “the Real World” has multiple or unique equilibria. I think equilibria are properties of models, not characteristics of actually existing capitalist economies, independently of how they are described.

I don't care for Radek’s sort of abusive attack on people who say they are echoing the experts in a field, especially when the attackers do not cite any examples of who they are talking about. I think a good appreciation of the SMD results might require a historical perspective on what (some) economists were (and still are?) claiming about General Equilibrium and what the experts in the field now claim:

"It follows from the preceding observation that the Walrasian theory and the existence theorems do not tell us how to relate tastes, technology, and the distribution of wealth to a single set of relative values. Rather, they tell us that there is at least one vector (and possibly many more) of relative values compatible with the data of the model. In the absence of uniqueness, the comparative statics of how prices and allocations will change with a change in the parameter values is not a well-defined exercise. The finiteness result alluded to above may be of some help here, but what is really needed is a completion of the Walrasian theory that describes the particular choices that are made from the equilibrium set. Such a completion will almost surely require a theory that deals explicitly with the adjustment to equilibrium. If forces are not in balance, what changes will take place in order to bring them into balance?" -- Duffie and Sonnenschein (1989)

I suggested to Keen, prior to the publication of his book, that the assumptions that all agents have identical and homothetic utility functions are merely sufficient, not necessary, conditions to get well-behaved utility functions. On this logical point, I agree with Radek. But Keen has convinced me with his book and later work that, in practice, (mainstream) economists do widely adopt these assumptions in applied work, with little justification.

References

• Duffie, Darrell and Hugo Sonnenschein (1989). "Arrow and General Equilibrium Theory", Journal of Economic Literature, V. 27, N. 2 (June): 565-598.
• Keen, Steve (2001). Debunking Economics: The Naked Emperor of the Social Sciences, Zed Books.
• Keen, Steve and Russell Standish (2006). "Profit Maximization, Industry Structure, and Competition: A Critique of Neoclassical Theory", Physica A
• Kirman, Alan (1989). "The Intrinsic Limits of Modern Economic Theory: The Emperor has No Clothes", Economic Journal, V. 99, N. 395: 126-139.
• Kirman, Alan P. (1992). "Whom or What Does the Representative Individual Represent?" Journal of Economic Perspectives, V. 6, N. 2 (Spring): 117-136.
• Solow, Robert M. (1962). “Substitution and Fixed Proportions in the Theory of Capital”, Review of Economic Studies, V. 29, N. 3 (Jun): 207-218.

Keen And Ormerod, Econophysics, And The Distribution Of Income

This humble blog is all about documenting fallacies in mainstream economics. Very little of what I have to say is new, and some have tried to popularize some of these criticisms. I think, in particular of Paul Ormerod (1994) and Steve Keen (2001). Ormerod and Keen have some similarities. Both:

• Have written popular books (Ormerod 1994 and Keen 2001) explaining that neoclassical economics is incorrect
• Mention Lipsey and Lancaster's theory of the second best
• Emphasize that mainstream economists studying the theory of General Equilibrium have demonstrated the theoretical untenability of neoclassical economics
• Recommend an approach to economics based on the mathematics of complexity theory
• Publish original criticisms of mainstream economics first in their popular books (Ormerod 1999 and Keen 2001) and then later in a physics journal (e.g., Keen and Standish (2006) and Ormerod and Mounfield (2000))

They differ in that they express different opinions on Piero Sraffa in their popular books. Keen (2001) praises Sraffa, while Ormerod (1999) snarks.

I find that Ormerod and Keen have teamed up with two other authors for a recent paper (Gallegati et al. 2006). This paper contains an approving reference to Sraffa. A major theme of this paper is to question whether the evidence for power laws, in particular in the tails of certain distributions of certain economic variables, is as definite as seems to be claimed sometimes in the econophysics literature.

References

• Gallegati, Mauro, Steve Keen, Thomas Lux, and Paul Ormerod (2006). "Worrying Trends in Econophysics", Physica A
• Keen, Steve (2001). Debunking Economics: The Naked Emperor of the Social Sciences, Zed Books
• Keen, Steve and Russell Standish (2006). "Profit Maximization, Industry Structure, and Competition: A Critique of Neoclassical Theory", Physica A
• Ormerod, Paul (1994). The Death of Economics, London: Faber & Faber
• Ormerod, Paul (1999). Butterfly Economics: A New General Theory of Social and Economic Behavior, Pantheon
• Ormerod, Paul and Craig Mounfield (2000). "Random Matrix Theory and the Failure of Macro-Economic Forecasts", Physica A