With One Hand Tied Behind My Back

Some economists sometimes say that neoclassical economics will be abandoned when a better theory is available. And they use this as an excuse for not pursuing, say, heterodox economics.

I am tempted to respond that a better theory already exists, for example, some combination of Post Keynesian and institutional economics. But two properties of most varieties of heterodox economics make it difficult for this answer to register for mainstream economists. Before I get to to those properties, let me caveat my answer.

Economists have a number of applied fields. Is heterodox economics developed to such a state that one can say economists would (or should) know how it should impact their work in every applied field? I cannot say how my concerns would apply to, say, transport economics, although I know that work exists there that draws on behavioral economics. Anyways, I doubt that many applied economists are aware of or concerned with how there work fits better with some approaches in heterodox economics. Much applied work seems to me agnostic between paradigms. For example, would you say that most work applying linear programming is Sraffian, even though the historical origins of linear programming are entwined with John Von Neumann's Sraffa-like, classically inspired growth model? How about work with National Income and Product Accounts (NIPA), which, to me, fit comfortably with the classical focus on the generation, distribution, and use of the surplus? Furthermore, I know of some applied fields to which heterodox economists have contributed. I doubt that I can count Walter Isard as a heterodox economist, but I think of economic geography and regional analysis as compatible with Sraffian economics. Wassily Leontief, as far as I am concerned, was a heterodox economist, although, as far as I know, he never commented on the theoretical controversies in which I am interested. I am fairly sure that Bertram Schefold has work in energy economics inspired by Sraffian theory. Is not Amartya Sen's work on the capabilities approach a heterodox contribution to welfare economics? Given Paolo Sylos Labini's importance to the field, I suspect that many models exist in Industrial Organization (IO) that are compatible with a broad definition of Post Keynesianism. To conclude, the connection between applied fields and debates about heterodox economics are not clear to me.

Anyways, heterodox economists tend to emphasize a need for open systems models in economics. This emphasis is the first property of heterodox economics that I want to mention that makes it difficult for mainstream economists to accept the superiority of much heterodox work. Tony Lawson has provided lots of elaboration on the need for an open systems approach to studying human society. But I do not need to go into such philosophy. My favorite approach to price theory takes the distribution of income as given for the most abstract theory of the prices of commodities. Likewise, the composition of final uses is exogenous in Sraffa's theory. The structure of the theory is open to elaborations at lower levels of abstractions that include inputs from other social sciences than economics. Consumption might be explained by a substantive theory, in contrast to the empty formal theory of neoclassical utility-maximization.

Second, heterodox economists tend to be skeptical of the possibility of economic laws applying to all societies across all of human existence. By contrast, Lionel Robbins' definition of economics as the study of the allocation of scarce means among alternative uses is often claimed to be universal. There is nothing in the mainstream about capitalism or how social norms might differ among societies. Contrast, for example, with Luigi Pasinetti's work on structural dynamics, in which the theoretical structure builds in a place for variations in institutions. Or look at suggestions in Sraffa's book that taking one of wages or the rate of profits as the independent variable might be more appropriate at different times or places. Or look at the emphasis on conventions in Keynes' analysis of investment. I could go on.

So, by adopting theories appropriate for the problem domain, heterodox economists have developed theories that are superior to many orthodox theories. But, because of this very appropriateness, mainstream economists are socialized to fail to perceive this superiority.

Dominance of Financial Capital in the United States

Profits by Selected Industry as Percent of Total Profits in the United States

The data for the graph are taken from Use tables for the United States. I am thinking of trying my hand again at some empirical exploration of input-output tables. When graphs for such start looking like those I know how to generate from Java code, I will have begun to start to make some progress. I have found a tool, Apache POI, for Java programs to read Excel spreadsheets.

Need For Engagement With Heterodox Economists

Some brief observations:

• Simon Wren-Lewis is asked to define K. His answer: "It is normally K(t) = δ K(t - 1) + I(t)." In times past, Wren-Lewis has seemed like he genuinely was interested in what heterodox economists have to say. But, with that kind of answer, he really needs lots more study to get up to speed.
• Noah Smith tries to provide an overview of contemporary economics. Many groups of economists I pay attention to do not exist for Smith, and I doubt he knows much about even the recent history of his subject. What would he make of, for example, Philip Mirowski's Machine Dreams?
• Matthew Yglesias alerts his readers to the existence of the Cambridge Capital Controversy. For Yglesias, the central question is the origin of returns to capital and the validity of marginal productivity parables organized around the idea of relative scarcity. I think this is a good account, given how terse this is.

Components Of United States GDP

Table 1: Components, As Percentage Of GDP

I thought I'd expand on a recent graph. I was curious to see how state and federal government spending break down in the United States. To draw the graphs in this post I performed some aggregation from the data:

• Consumption: Listed as "Personal consumption expenditures".
• Investment: Combines "Private fixed investment" and "Changes in private inventories".
• Trade deficit: Combines "Exports of goods and services" and "Imports of goods and services".
• Federal Government: Combines "National defense: Consumption expenditures", "National defense: Gross investment", "Nondefense: Consumption expenditures", and "Nondefense: Gross investment".
• State Government: Combines "State and local government consumption expenditures" and "State and local government gross investment".

I suppose I could find a price index, and plot absolute amounts, rather than percentages of GDP. Then you could see, for example, that GDP in 2009 is actually lower than the 2008 value, as a result of the global crash. Does the breakdown of government spending into consumption and gross investment components reflect the influence of Robert Eisner?

Table 2: Selected Components, As Percentage Of GDP

Some Points Of Agreement

Consider:

• "...there is a crucial distinction between financial capital and capital goods."
• "Interest is not the return to physical capital."
• "Interest is not the 'Marginal Product of (physical) capital'."

These quotes are from Robert P. Murphy. (See here also.) I have written about Murphy before, including his take on Sraffa.

Paradigming Is Easy

Some publishers have made it easy to get an overview of currently existing paradigms in economics, including non-neoclassical paradigms:

• Modern Cambridge Economics: Each book is by an expert on the selected topic. (Previous mention here.)
• Schools of Thought in Economics: From Edward Elgar, each book is edited by an expert and consists of reprints of important papers from that school.
• International Library of Critical Writings in Economics: From Edward Elgar as well, each book is also an edited collection. Many of these are more on a field than on a school, but I like number 21, on the Post Keynesian theory of growth and distribution.
• M. E. Sharpe: I do not have a book series for this important publisher of heterodox economics, including the journal Challenge.

The books in the Edward Elgar series are probably too expensive for most individual purchases. Perhaps you can request some of interest from an academic library. Some of these books are more than a decade old, with articles in the collections going back even more decades. But, by looking at authors and journals, you can can get a hint of where to look for more contemporary work in a school of interest.

Compare and contrast Paul Krugman on this topic.

On r > g

I have not even started to read Thomas Piketty's Capital in the Twenty-First Century, but I have heard of Piketty as compared to Marx.

Whatever else Marx was, he was a very learned man. He read the works of virtually all political economists who came before him. And in his lengthy tomes, he would comment on them, not always fairly. He did not confine himself to ones that were politically influential among the elite. For example, consider Marx on the Ricardian socialists.

So if Piketty is like Marx, can I expect to find comments on the Cambridge equation, r = g/s_c? Can I expect to find something about the models of growth and distribution put forward by Richard Kahn, Nicholas Kaldor, Luigi Pasinetti, and Joan Robinson? (Joshua Gans has also noticed a parallelism between the work of Piketty and the Post Keynesian theory of distribution.) Or maybe the analogy is not complete.

Size of Government in USA

I thought that Krugman had a post about Paul Ryan stating, incorrectly, that Obama had increased the size of the government. And he wondered why conservatives make factual statements that can be easily shown to be wrong. But I cannot find such a post. I can find this one on Rand Paul making a different incorrect factual claim. I am fairly sure I am thinking of something more recent than this post about Rand Paul being confused in 2012.

(By the way, Paul Krugman is wrong about what heterodox economists believe about marginal productivity theory. If he reads this, though, I would rather read his comments about the empirical correlation between increased government size and increased equality.)

Estimating Probability of Extreme Events

Figure 1: Distribution for Mixture Distribution

1.0 Introduction

What is the probability that the Dow Jones Industrial Average (DJIA) will rise by at least 5% tomorrow? By 10%? Very few samples can be found in the data for a large enough rise, and, eventually, you will be asking about a rise beyond all historical experience. Some have argued that Extreme Value Theory can be applied to financial data to extrapolate these sorts of tail probabilities. In this post, I attempt to explain this theory. For purposes of exposition, I here disregard the possibility of such rises as being associated with states that might be impossible to foresee from the past history of the data-generating process.

2.0 A Random Sample from a Mixture Distribution

This exposition includes an example. I need a probability distribution in which tails differ from the portion of the distribution clustered around the center, in some sense. Consider a random variable X which can take on any real number. The probability distribution for this random variable is defined by the Cumulative Distribution Function (CDF). The CDF specifies the probability that a realization of the random variable is less than or equal to a given value:

F(x) = Pr(X ≤ x)

where:

• x is the argument at which the CDF is evaluated.
• F is the CDF.
• F(x) is the indicated probability, that is, the value of the CDF evaluated for the argument.

(Conventionally, uppercase letters toward the end of the alphabet denote random variables. The corresponding lowercase letter denotes a realization of that random variable resulting from the outcome of conducting the underlying experiment.)

To obtain a distribution with heavy tails, I consider a mixture distribution. (Mixture distributions are often used in the theory for robust statistics. I would appreciate a reference arguing that robust statistics and Extreme Value Theory are complementary, in some sense.) Suppose F₁ and F₂ are CDFs for Gaussian (also known as normal or bell shaped) distributions with possibly different means and standard deviations. And let p be a real number between zero and one. F is the CDF for a mixture distribution if it is defined as follows:

F(x) = p F₁(x) + (1 - p) F₂(x)

For definiteness, let the parameters for this distribution be as in Table 1. The two Gaussian distributions have equal means. The distribution with the 90% weight also has the smaller standard deviation. In other words, the distribution that is selected less frequently will have realizations that tend towards the tails of the overall mixture distribution.

Table 1: Parameters for a Mixture Distribution

Parameter	Value
Probability Variate from First Distribution	90%
First Gaussian Distribution
Mean	0.0
Standard Deviation	1.0
Second Gaussian Distribution
Mean	0.0
Standard Deviation	3.0

2.1 A Random Sample

Suppose X₁, X₂, ..., X_n are mutually stochastically independent random variables, each of which has the probability distribution with CDF F. Under these conditions, these random variables comprise a random sample. I wrote a computer program to generate a realization of such a random sample of size n. Table 2 shows some statistics for this realization. I use this realization of a random sample to illustrate the application of various statistical techniques below.

Table 2: Statistics for Synthesized Variates

	Value
Sample Size	500
Realizations from 1st Distribution	443
Realizations from 2nd Distribution	57
Sample Mean	-0.0086
Standard Deviation	1.3358
Minimum	-6.0125
Median	-0.0034
Maximum	9.932

2.2 Goodness of Fit

It is difficult to determine that a realization of the random sample is not from the distribution F₁. In other words, the existence of sample values, often in the tails, from F₂ is not readily apparent from a straightforward statistical test for the goodness-of-fit. Consider the order statistics found by sorting the random sample:

X₍₁₎ ≤ X₍₂₎ ≤ ... ≤ X_(n)

(By convention, a subscript for a random variable without parentheses denotes a random variable from a random sample. Parentheses denotes an order statistic.)

An empirical CDF can be constructed from the order statistics. The probability that a random variable from the distribution generating the random sample is less than or equal to x_(i) is estimated as i/n, the proportion of the sample less than or equal to the given order statistic. Figure 1, above, shows the empirical CDF for my realization of the random sample, as well as the CDFs for the two Gaussian distributions in the mixture distribution. Both Gaussian CDFs have a value of 1/2 for an argument of zero, since that is their mean. The Gaussian distribution with the smaller standard deviation has a CDF with a steeper slope around the mean, since more of its probability is clustered around zero. The empirical CDF, estimated from the data, is a step function, with equal size steps occurring at each realization of a random variable in the sample. One needs to sort the data to calculate the empirical CDF.

The maximum vertical distance between a theoretical distribution and an empirical CDF is known as the Kolmogorov-Smirnov statistic. Under the null hypothesis that the random sample is drawn from the theoretical distribution, the Kolmogorov-Smirnov statistic will be a small positive number. Table 3 shows the Kolmogorov-Smirnov statistics for the data. This statistic is not statistically significant for the first Gaussian distribution. The probability that one would observe such a large value for the Kolmogorov-Smirnov statistic for the second Gaussian distribution is less than 1%. Thus, one could conclude that this data was not generated from the second distribution, but (incorrectly) conclude that it was generated from the first.

Table 3: Goodness of Fit

	1st Gaussian Distribution	2nd Gaussian Distribution
Kolmogorov-Smirnov Statistic	0.0354	0.228
p Value	54.59%	0.00%

3.0 Distribution for the Tail

With the description of the data out of the way, tail probabilities can now be defined. I concentrate on the upper tail.

3.1 Definition of a Tail

The upper tail is defined in terms of the lower bound u for the tail and the tail probability q. These parameters are related like so:

q = Pr(X > u) = 1 - F(u)

The upper tail is defined as those values of the random variable such that the probability of exceeding such a value is less than the given parameter:

{x | Pr(X > x) < q}

In other words, the tail consists of values of the random variable that lie above the lower bound on the tail. It is sometimes convenient to define a new random variable, Y, for outcomes that lie in the tail:

Y = X - u

This new random variable is the distance from the lower bound of the tail, given that a realization of X lies in the tail. One could give a symmetrical definition of the lower tail and a corresponding random variable. Table 4 shows how many samples in my realization of the random sample, defined above, happen to come from the Gaussian distribution with the larger standard deviation, where, the parameter q is taken to be 10%.

Table 4: Variates in Tails and Center

	Value
Number in Lower Tail	18
Number in Center	23
Number in Upper Tail	16
Percentage of Lower Tail from 2nd Distribution	36.7%
Percentage of Center from 2nd Distribution	5.7%
Percentage of Upper Tail from 2nd Distribution	32.7%

For y > 0, the conditional probability that X exceeds any given value in the tail, given that X lies in the tail is:

Pr(X > y + u | X > u) = Pr[(X > y + u) and (X > u)]/Pr(X > u)

The above formula simply follows from the definition of conditional probability. The second clause in the "and" expression is redundant. So the above can be rewritten as:

Pr(X > y + u | X > u) = Pr(X > y + u)/Pr(X > u), y > 0

Let G(y) be the CDF for the distribution for the random variable Y. One can then rewrite the above formula as follows"

1 - G(y) = [1 - F(y + u)]/[1 - F(u)], y > 0

Substituting for the definition of the parameter q, one obtains:

F(y + u) = (1 - q) + q G(y), y > 0

Or:

F(x) = (1 - q) + q G(x - u), x > u

The above two expressions relate the CDFs for the distributions of the random variables X and Y.

3.2 Generalized Pareto Distribution

A theorem states that if X is a continuous random variable, the distribution of the tail is from a Generalized Pareto Distribution with the following CDF:

G(y) = 1 - [1 + (c/a)y]^-1/c

The parameter a is called the scale parameter, and it must be positive. The parameter c is the shape parameter. It can take on any real number. When the shape parameter is zero, the Generalized Pareto Distribution reduces, by a limit theorem, to the exponential distribution.

Below, I will need the following expression for the Probability Density Function (PDF) for the Generalized Pareto Distribution:

g(y, a, c) = (1/a)[1 + (c/a)y]^{-(1 + c)/c}

The PDF is the derivative of the CDF. For any set A to which a probability can be assigned, the probability that Y lies in A is the integral, over A, of the PDF for Y.

3.3 Parameter Estimates

The parameters defining the upper tail are easily estimated. Let r be an exogenously specified number of variates in the tail. The lower bound on the upper tail is estimated as:

u_estimate = X_{(n - r)}

The corresponding tail probability is estimated as:

q_estimate = r/n

Several methods exist for estimating the scale and shape parameters for the Generalized Pareto Distribution. I chose to apply the method of maximum likelihood. Since the random variables in a random sample are stochastically independent, their joint PDF is merely the product of the their individual PDFs. The log-likelihood function is the natural logarithm of the joint PDF, considered as a function of the parameters of the PDF.

ln g(a, c) = ln g(y₁, a, c) + ... ln g(y_r, a, c)

Maximum likelihood estimates are the values of the parameters that maximize the log-likelihood function for the observed realization of the random sample. I found these estimates by applying the Nelder-Mead algorithm to the additive inverse of the log-likelihood function. Table 5 shows estimates for the example.

Table 5: Estimates for Upper Tail Distribution

Parameter	Estimate
Tail Probability (q)	10%
Lower Bound on Tail (u)	1.368
Scale Parameter (a)	0.7332
Shape Parameter (c)	0.2144

The above has described how to estimate parameters for a distribution characterizing a tail of any continuous distribution. Given these estimates, one can calculate the conditional probability that Y lies above any value in the tail. Figure 2 plots this probability for the example. Notice that this probability is noticeably higher, for much of the tail, for the mixture distribution, as compared to the probability found from the Gaussian distribution with the smaller standard deviation in the mixture. And the Kolmogorov-Smirnov goodness-of-fit would not have led one to reject estimates from the first Gaussian distribution. But the estimates from Extreme Value Theory are closer to the higher (and correct) probabilities from the true theoretical distribution.

Figure 2: Tail Probabilities

4.0 Conclusion

This post has illustrated:

• A probability distribution in which the central part of the distribution's support tends to behave differently from the tails.
• The difficultly in rejecting the hypothesis that data is drawn from the distribution characterizing the central tendency of the data, with no account being taken of heavy tails.
• A method, applicable to any continuous random variable, for estimating a tail distribution.
• Such estimation yielding an appreciably larger estimate for a tail probability than the distribution characterizing the central tendency.

References

• J. B. Broadwater and R, Chellappa (2010). Adaptive Threshold Estimation via Extreme Value Theory, IEEE Transactions on Signal Processing, V. 58, No. 2 (Feb.): pp. 490-500.
• Damon Levine (2009). Modeling Tail Behavior with Extreme Value Theory, Risk Management Issue. 17.
• R. V. Hogg and A. T. Craig (1978). Introduction to Mathematical Statistics, Fourth edition, Macmillan.
• A. Ozturk, P. R. Chakravarthi, and D. D. Weiner (). On Determining the Radar Threshold for Non-Gaussian Process from Experimental Data, IEEE Transactions on Information Theory, V. 42, No. 4 (July): pp. 1310-1316.
• James Pickands III (1975). Statistical Inference Using Extreme Order Statistics, Annals of Statistics, V. 3, No. 1: pp. 119-131.

Illusions Generated By Markets Like Those Created By Language On Holiday

I have been reading a book, edited by Gavin Kitching and Nigel Pleasants, comparing and contrasting Ludwig Wittgenstein and Karl Marx. This is the later Wittgenstein of the Philosophical Investigations, not of the Tractatus. The authors of the papers from the conference generating this work do not seem too concerned with arguments about the differences between the young Marx and the mature Marx, albeit many quote a passage from the German Ideology about language. (I think this post is more disorganized than many others here.)

Anyways, I want to first consider a reading of Capital, consonant with the approach of Friedrich Engels and the Second International, but at variance with an analogy to Wittgenstein's later philosophy. One might think of the labor theory of value as a scientific approach revealing hidden forces and structures that are at a deeper level than observed empirical reality. Think about how, for example, physicists have an atomic theory that explains why tables are hard and water is wet. Even though a table may be seem solid, we know, if we accept science, that it is mostly empty space. Somewhere Bertrand Russell writes something like, "Naive realism leads to physics, and physics shows naive realism is wrong. Hence naive realism is false". Similarly, you may think purchases and sales on markets under capitalism are made between equals, freely contracting. But the science of Marxism reveals an underlying reality in which the source of profits is the exploitation of the workers.

Wittgenstein, in rejecting his early approach to language, rejects the idea of a decontextualized analysis of the sentences of our languages into an ultimate underlying uniform atomic structure which explains their meaning. Rather, in his later philosophy, he gathers togethers descriptions of the use of language, to dispel and dissolve the illusions characteristic of traditional philosophy. He is hostile to ideal of an ultimate essence for meaning, and points out the multifarious uses to which language is put. Some of his famous aphorisms include, "Nothing is hidden" and his explanation of the point of his philosophical investigations as "To show the fly the way out of the fly bottle". Some of his descriptions are not from actually existing societies, but from imagined primitive societies. Some of these imagined societies are described near the beginning of the Philosophical Investigations, much as in the first chapter of Piero Sraffa's Production of Commodities by Means of Commodities.

Can Marx be read in an analogous manner, as attempting to dispel illusions, while claiming that no hidden essence or foundation underlies capitalist economies? Such a reading, I think, will emphasize Marx's remarks on commodity fetishism and "real illusions" that come with non-reflective participation in a market economy. It also makes sense of Marx's literary style. Both Marx and Wittgenstein are attempting to encourage a fundamental change so that our form of life will not generate these illusions.

Perhaps such a reading is in tension with the view of Marx's account of exploitation as descriptive, not normative. What about Wittgenstein's saying that philosophy "leaves everything as it is"? How can one read Wittgenstein and Marx as pursuing complementary projects when Marx writes, "Philosophers have hitherto only interpreted the world in various ways; the point is to change it"? Various essays in this book address these issues. I guess what concerns me more is Marx's Hegelian style, quite different from Wittgenstein. (I rely on English translations.)

This book also alerted me to some issues in Wittgenstein interpretation. When Wittgenstein writes of a form of life, is he writing of human life in general (in contrast, say, to the form of life of a lion)? Or would different human cultures and societies have different forms of life? Does Wittgenstein encourage a political quietism since he does not provide an external standpoint outside of language to criticize rules? (I think the last objection draws lines more firm than is compatible with Wittgenstein's comments on family resemblances.)

I also have two new books to look up, Gellner (1959) and Winch (1963). Gellner sounds like an unscholarly polemic that yet was influential in turning philosophy away from the linguistic philosophy of the later Wittgenstein, J. L. Austen, and Gilbert Ryle. Winch seems to argue those studying society must use the terms that members of a culture use, and with the same understanding. So perhaps this is a Wittgensteinian argument that social science is not possible, or at least must lower its aims. But I have not read it yet.

References

• Ernest Gellner (1959). Words and Things: A Critical Account of Linguistic Philosophy and a Study in Ideology London: Gollancz.
• Gavin Kitching and Nigel Pleasants (editors) (2002). Marx and Wittgenstein: Knowledge, Morality and Politics, London: Routledge
• Peter Winch (1963). The Idea of a Social Science, London: Routledge and Kegan Paul.

Analytical TOC For Athreya

I finally finished Kartik Athreya's book, Big Ideas in Economics: A Nontechnical View. I have already offered two comments on it. I do not expect it to be successful. Do not look here for a discussion of the theory of the second best, the aggregation of production functions, the distinction between risk and uncertainty, or the problems with microeconomics (despite its point being that macroeconomics, as the author understands it, is applied microeconomics). Athreya does select and address some theoretical objections, such as the Sonnenschein-Debreu-Mantel theorem, related difficulties with using a representative agent, and the folk theorem in game theory. I was disappointed not to see an informed discussion of the relationship of steady state models, such as the Solow growth model, to very short run models such as the Arrow-Debreu model. On the other hand, you will find a lot of rationalization of assumptions on the ground that they are needed (useful?) to get definite conclusions, independent of any discussion of whether or not models with those models work empirically.

Anyways, I read the book on my Kindle. I found it difficult to keep the thread. So I have prepared the following analytical table of contents for my own use, if I should reread sections. I think Athreya could have gone through a couple more edits, reconsidering this structure. For example, maybe the book would have been more understandable with shorter and more chapters.

• Acknowledgements
• I. Introduction
• I.1 Why do Macroeconomists Think What They Think and Do What They Do?
• I.2 Whom Do I Want to Reach?
• I.3 Some Key Features
• I.4 Pictures, Talk, and Homework
• 1. The Modern Macroeconomic Approach and the Arrow-Debreu-McKenzie Model
• 1.1 Introduction
• 1.2 What is a Macroeconomic Model?
• 1.2.1 Macroeconomics as Hyperorganized Narrative with Hard-Nosed Data and Logic Checks
• 1.2.1.1 Ensuring Internal Consistency
• 1.2.1.2 informed Criticism
• 1.3 How Do Macroeconomists Account for the Facts?
• 1.3.1 How Macroeconomists Argue with Each Other (or, How to Argue with a Macroeconomist, if You Must!)
• 1.3.1.1 Step 1: They Tell Each Other Who Is in Their Model Economy, and What Those Participants Want to Do: Household Preferences and Firm Profit Maximization
• 1.3.1.2 Step 2: They Tell Each Other What Their Model's Participants Have: Endowments and Technology
• 1.3.1.3 Step 3: They Tell Each Other How Model Participants Can Interact: Trading Arrangements
• 1.3.1.4 Step 4: They Tell Each Other How Participants Will Interact: Equilibrium as Prediction
• 1.3.1.5 It Takes a Model to Beat a Model
• 1.4 Macroeconomic "Equilibrium": What It Does and Does Not Imply
• 1.5 Payoffs from the Standard Macroeconomic Model Building Recipe
• 1.5.1 Making Logical Errors Easier to Spot
• 1.5.2 Disciplining Claims about Causal Relationships
• 1.5.3 Better Policy Analysis: Welfare Economics
• 1.5.4 Better Policy Analysis: The "Lucas Critique"
• 1.5.4.1. All Models Are Susceptible to the Lucas Critique, but Some More Than Others
• 1.5.5 Making the Tent Bigger
• 1.6 The Benchmark Macroeconomic Model: Arrow-Debreu-McKenzie
• 1.6.1 Understanding the Basic ADM Structure Is a Must
• 1.6.2 ADM Terminology
• 1.6.2.1 Households: Preferences and Endowments
• 1.6.2.2 Firms
• 1.6.2.3 Profit Maximization
• 1.6.2.4 Markets and Prices
• 1.6.2.5 Pareto Efficiency and the Core
• 1.6.2.6 Don't Misunderstand Pareto Efficiency
• 1.6.3 The ADM Model: An Example and a Picture
• 1.7 Concluding Remarks
• 2. Prices, Efficiency, and Macroeconomics
• 2.1 Introduction
• 2.2 A Fanciful Macroeconomic Trading Institution: The Walrasian Clearinghouse
• 2.3 Why Is This Trading Process Interesting?
• 2.3.1 The First Welfare Theorem
• 2.3.2 Why Are Walrasian Outcomes So "Coordinated"? Some Intuitions
• 2.3.3 The Incentival Role of Prices
• 2.3.4 The Informational Role of Prices
• 2.3.4.1 Prices as Aggregators of Information
• 2.3.4.2 Prices as Conveyers of Information
• 2.4 Walrasian Prices Will Exist
• 2.4.1 Time and Uncertainty
• 2.4.2 Convexity and Existence
• 2.5 Decentralized Outcomes and the First Welfare Theorem
• 2.5.1 Decentralized Trade Seems to Generate "Workable" Outcomes
• 2.5.2 Decentralized Trade Seems to Centralize (and Locate Ownership) Sensibly
• 2.5.3 "ADM Minus Some Markets" Seems Like a Useful Description of the Real World
• 2.5.3.1 Externalities as Missing Markets
• 2.6 Should the Real World Look Like One in Which Most Trading Is Run Via a WCH, and If So, Why? Theoretical Foundations for Walrasian Equilibria
• 2.6.1 The Axiomatic or "Cooperative Game Theory" Approach
• 2.6.1.1 The Equivalence Principle
• 2.6.2 The Noncooperative Approach
• 2.6.2.1 Nash Equilibrium: The Most Important Kind of Equilibrium in Social Science
• 2.6.2.2 Why Look at "Nash" Outcomes? Because "Not Nash" Means "Not Likely"
• 2.6.2.3 What If Interactions Are Repeated and Not Anonymous
• 2.6.2.4 When Should Households and Firms Take Prices as Given?
• 2.6.2.5 Market Games
• 2.6.2.6 Summary of the Noncooperative Approach
• 2.6.3 The Experimental Approach
• 2.6.3.1 Markets as Calculators
• 2.6.3.2 Experiments, the Invention of New Trading Institutions, and Mechanism Design
• 2.7 The ADM Model Does Not Require "Perfect Information" to Deliver Pareto-Optimal Outcomes; It Requires a Complete Set of Walrasian Prices
• 2.7.1 The Interpretation of Prices: What's at Stake?
• 2.8 Some Real-World Complications
• 2.8.1 Walrasian Prices Are Sufficient, but Not Necessary
• 2.8.2 Costless Enforcement
• 2.8.3 Market Power
• 2.8.4 Imperfect Monitoring
• 2.8.4.1 The Myerson-Satterthwaite Theorem
• 2.8.4.2 The Revelation Principle
• 2.8.4.3 Further Reading
• 2.9 The Observational Implications of the ADM Model
• 2.9.1 Sonnenschein-Mantel-Debreu...
• 2.9.2 ...and Boldrin-Montrucchio
• 2.9.2.1 Does It Mean That "Anything Will Happen"? No
• 2.10 A Macro-Hippocratic Moment
• 2.11 Concluding Remarks
• 3. Macroeconomists, Efficiency, and Inequality
• 3.1 Economists, Efficiency, and Inequality
• 3.1.1 Decentralized Trading and Inequality
• 3.1.2 Economists' Preoccupation with "Efficiency"
• 3.1.3 Deadweight Loss from Taxation
• 3.2 The Second Welfare Theorem
• 3.2.1 The Welfare Theorems Inspire a Form of Central Planning!
• 3.2.2 A General Lesson of the Second Welfare Theorem: Taxes Can Hurt
• 3.2.3 Caveat 1: What's an "Initial" Endowment, Anyway?
• 3.2.4 Caveat 2: Knowledge and the Limits to Lump-Sum Redistribution
• 3.2.5 Caveat 3: Lump-Sum Redistribution Might Require Surprising People
• 3.2.6 The Second Welfare Theorem Does Not Require More Assumptions than the First Welfare Theorem
• 3.3 What's Right with Non-Lump Sum Taxes? Or, Sometimes Lump-Sum Taxes Are Bad for "Insurance"
• 3.3.1 Jargon Digression" "Ex-Ante" and "Ex-Post" Pareto Efficiency
• 3.3.2 Back to Lump-Sum Taxes Being Bad for Insurance...
• 3.3.3 Why Shouldn't I Trade Ex-Ante Efficiency for Equity?
• 3.3.3.1 Why Efficiency Is Important
• 3.4 A General Approach to Thinking about Allocations and Trading Institutions: Mechanism Design
• 3.4.1 Limits on Mechanisms
• 3.4.1.1 Implementing Social Outcomes: Gibbard-Satterthwaite and the Importance of the "Solution Concept"
• 3.4.1.2 Why Do Macroeconomists Care about Mechanism Design, and Why Should Policymakers?
• 3.5 Concluding Remarks
• 4. Macroeconomic Shortcuts
• 4.1 Introduction
• 4.1.1 Our Four Sin: Aggregation, Rationality, Equilibrium, and Mathematics
• 4.2 Macroeconomic Compromises
• 4.2.1 Aggregation
• 4.2.1.1 Aggregation of Producers
• 4.2.1.2 Aggregation of Consumers
• 4.2.1.3 Aggregation of Commodities
• 4.2.1.4 Aggregation and Modeling Tradeoffs
• 4.2.1.5 An Example: The Breeden-Lucas "Fruit Tree"
• 4.2.2 Rationality
• 4.2.2.1 No Rationality, No Utility Function
• 4.2.2.2 Bounded Rationality
• 4.2.2.3 Rational Expectations
• 4.2.2.4 Expected Utility
• 4.2.2.5 A Provisional Summary
• 4.2.3 Equilibrium Analysis
• 4.2.3.1 Steady States and Transitions
• 4.2.3.2 An Interesting Criticism of Steady-State Analysis
• 4.2.3.3 Equilibrium Analysis: A Provisional Summary
• 4.2.3.4 Race as an Equilibrium Outcome: The Work of Glenn Loury
• 4.2.4 Mathematics, Practicality, and Some Examples
• 4.2.4.1 Mathematics and Forecasting
• 4.2.4.2 Mathematics as a Language to Protect the Public from Economists
• 4.2.4.3 Example: The Continuum Assumption
• 4.2.4.4 Example: Infinitely Lived Households
• 4.2.4.5 Example: "Social Planning Problems"
• 4.3 Concluding Remarks
• 5. Benchmark Macroeconomic Models
• 5.1 ADM and the Real World
• 5.2 Time, Uncertainty, and the ADM Model
• 5.2.1 The Long Arm Attached to the Invisible hand
• 5.2.1.1 The Impossibility of Literal Arrow-Debreu Market Completeness
• 5.3 The Radner Version of the ADM Economy
• 5.3.1 A Summary of Radner Trading
• 5.3.2 Spot Markets and IOU Markets: Radner and How Macroeconomists Think about Market Dysfunction
• 5.3.2.1 Spots Are OK
• 5.3.2.2 IOUs, Maybe Not So Much?
• 5.3.2.3 Radner and the Real World: A Brief Recap
• 5.4 Many Important Macroeconomic Models Are Mainly Versions of Radner Economies
• 5.5 Macroeconomic Policy: A Brief General Discussion
• 5.5.1 What Is a Policy?
• 5.5.2 Two Questions to Ask before "Doing Policy"
• 5.5.2.1 Question 1: How Are the Preconditions for the First Welfare Theorem Violated?
• 5.5.2.2 Question 2: Why Do You Think You Can Do Better?
• 5.5.2.3 One Reason to Think You Can Do Better: Coordination Failure
• 5.5.3 Coordination Failure and Macroeconomics
• 5.6 Important Macroeconomic Models and Policy Implications
• 5.7 The Mother of All Walrasian Macroeconomic Models: Neoclassical Growth Models
• 5.7.1 Step 1: The Malthusian Growth Model: No Capital
• 5.7.2 Step 2: The Solow Growth Model: No Fixed Inputs
• 5.7.2.1 Labor-Saving Devices
• 5.7.2.2 Balanced-Growth Steady States
• 5.7.2.3 The Role Savings Rates Play in Living Standards
• 5.7.2.4 The Solow Model as a First Unified Model of Growth and Fluctuations
• 5.7.3 Step 3: The Modern Neoclassical Growth Model: Enter the Consumer
• 5.7.4 What Happens When There Is Uncertainty? The Stochastic Neoclassical Growth Modek
• 5.7.4.1 Deterministic and Stochastic Steady States
• 5.7.5 What Payoffs Do Stochastic Neoclassical Growth Models Offer Us?
• 5.7.5.1 A Step Toward a Unified Theory of Growth and Fluctuations
• 5.7.5.2 They Operationalize the ADM Model
• 5.7.5.3 Stochastic Neoclassical Growth Provides a Benchmark
• 5.7.6 The Influence of Neoclassical Growth Models on How We Think about Some Key Macroeconomic Issues
• 5.7.6.1 Macroeconomics Can Be Stable
• 5.7.6.2 Technological Progress is the Gift Horse
• 5.7.6.3 The Lives of Indian and American Barbers
• 5.7.6.4 Higher Tax Rates Mean Lower Income Levels, but May Not Lower Long-Run Growth Rates
• 5.7.6.5 The ADM Model Is Silent on Innovation
• 5.8 How Do Macroeconomic Models Provide Quantitative Information? Calibration and Estimation
• 5.8.1 Calibration and Estimation: Taking a Model Very (Too?) Seriously
• 5.9 The SGM and Keynesian Macroeconomics
• 5.9.1 Keynesian Economics and the SGM I: Coordination Failures
• 5.9.2 Keynesian Economics and the SGM II: Sticky Prices
• 5.9.2.1 Is Monopolistic Competition a UFO?
• 5.9.2.2 Tensions, Tensions
• 5.10 Less-Than-Perfect Worlds: The Standard Search Model, the Standard Incomplete Markets Model, and the Overlapping Generations Model
• 5.10.1 Who Knew?
• 5.10.2 No Representative Agent: Heterogeneity Galore
• 5.10.2.1 Equilibrium Doesn't Mean "Good": Redux
• 5.11 The Reality of Decentralized-Decentralized Trade: The Search Model
• 5.11.1 Optimal Decisions and Stationary Equilibria
• 5.11.2 What Kinds of Questions Can We Address with Search Models?
• 5.11.3 Keynesian Economics and the Search Model
• 5.11.3.1 Search Is Not Really about Searching
• 5.11.3.2 Search Models and Voluntary versus Involuntary Unemployment
• 5.11.3.3 What, Exactly, Is Being Traded? Walrasian Economics and the Importance of Defining the "Commodity Space"
• 5.12 The Reality of Missing Markets: The Standard Incomplete-Market Model
• 5.12.1 The Income Fluctuation Problem (IFP): The Lynchpin of Modern Macroeconomics
• 5.12.1.1 SIM Models: "IFPs in GE"
• 5.12.1.2 Stationary Equilibria
• 5.12.1.3 SIM as a Macroeconomic Model of Bounded Rationality
• 5.12.1.4 What Search and IM Models Give Us (I): Insurance vs. Incentives: The First Quantitative Pass
• 5.12.1.5 What Search and IM Models Give Us (II): Competitive Theories of Inequality
• 5.12.1.6 What Search and IM Models Give Us (III): Maybe "Competition" Isn't All That Great?
• 5.12.1.7 How Incomplete Are Decentralize Trading Arrangements?
• 5.12.1.8 It's the IOU Markets
• 5.13 The Reality of Life and Death: The Overlapping-Generations Model
• 5.13.1 Economists Get Precise about Policy, Inequality, and Intergenerational Conflict
• 5.14 Concluding Remarks
• 6. Macroeconomic Theory and Recent Events
• 6.1 Introduction
• 6.2 The Financial Crisis of 2007-2008: What Are the Questions?
• 6.2.1 The Facts: A Crisis Reading List
• 6.2.2 Radner and Financial Intermediation
• 6.2.3 What (Good) Are Financial Markets, and How Does the ADM Model Influence How Macroeconomists View Them?
• 6.3 Models for Question 1: Why Did Asset Prices Rise So Much?
• 6.3.1 Demand and Supply
• 6.3.2 Principal-Agent Conflicts
• 6.3.3 Financial Markets and the Importance of Beliefs
• 6.3.4 Differences of Opinion
• 6.3.5 Bubble Detection
• 6.3.5.1 What "Efficient Financial Markets" Means (Hint: It Does Not Mean Pareto Efficiency)
• 6.3.5.2 The EMH and "Random Walks"
• 6.4 Models for Question 2: Why Did Initial Changes Get Amplified
• 6.4.1 Debt
• 6.4.2 Models of Banks and Bank Runs
• 6.5 Models for Question 3: Why Has the Recovery Been So Slow?
• 6.5.1 Labor and Asset Market Search Models
• 6.6 Macroeconomics and the Financial Crisis of 2007-2008 Implications for Policy
• 6.6.1 (Try to End) "Too Big to Fail"
• 6.6.2 Asset Prices and Policy
• 6.6.2.1 The Great Price Diagnosis Dilemma for PolicyMakers
• 6.6.3 Spillovers and Ronald Coase
• 6.6.4 Ronald Coase and Macroeconomics
• 6.6.5 Dynamic Games
• 6.6.5.1 Things "off the Equilibrium Path" Can Matter for Things on It
• 6.6.5.2 The Limited Commitment of Benevolent Policymakers: Time Inconsistency
• 6.6.5.3 Consumer and Sovereign Debt
• 6.6.5.4 Ex-Ante versus Ex-Post Efficiency...Again
• 6.7 Macroeconomics and the Financial Crisis of 2007-2008: Navel Gazing and a Response to Those Gazing at Our Navels
• 6.7.1 Does Modern Macroeconomics Favor Laissez-Faire?
• 6.7.2 Where Did We Fail?
• 6.7.3 Criticism of DSGE Models
• 6.7.4 Reforming Macroeconomics
• 6.7.5 Policy: Some Perspective and a Caution
• 6.7.5.1 Global Policy Coordination
• 6.7.5.2 A Caution
• 6.8 What Should Macroeconomists Be Doing?
• Notes
• References
• Index

Philip Mirowski And Adolph Reed, Jr.: Separated At Birth?

I want to highlight the similarity in conclusions in Mirowski's recent book and Reed's controversial essay (see references below). Their understanding of the current conjuncture is fairly dispiriting. The right is winning in mass consciousness, despite their ideas being incoherent and vicious from an intellectual perspective. And their ideas extend over the entirety of the political spectrum, at least if one restricts oneself to what is seen to be practical. Arguments over how to make existing markets work better or to address current problems by constructing new markets, for example, accept the inevitability of capitalism.

Both Mirowski and Reed have something to say about what must be done by the left now. What is needed is a collective development of a leftist alternative. Those developing such an alternative need to be part of a group, like the Mont Pelerin Society was for the development of neoliberalism. And those developing this alternative, at least in their role in such a group, should not be overly concerned with the vagaries of this or that election in this or that country. This is a long term project, which, if successful, will spawn other groups over decades more concerned with implementation in specific times and places.

Are these authors correct in arguing the left does not currently have an inspiring vision to put before the public? You can talk about social democracy, but is that a way forward now? Are there powerful institutionalized groups working to improve our societies based on an architectonic view of what is possible? It seems to me more of a rearguard movement in advanced industrialized countries. And what about further left? I am aware of various statements of ideals - for example, Davidson and Davidson (1996), Rorty (1999)- but, without being built upon by a movement, these seem kind of idiosyncratic and quixotic to me.

An aside: If Mirowski is going to read literature produced by well-known writers who taught at Syracuse University, I wish he would mix some Raymond Carver in with the David Foster Wallace he has been reading.

References

• Greg Davidson and Paul Davidson (1996). Economics for a Civilized Society, M. E. Sharp. [I HAVEN'T READ THIS]
• Philip Mirowski (2013). Never Let a Serious Crisis Go to Waste: How Neoliberalism Survived the Financial Meltdown, Verso.
• Adolph Reed Jr. (2014). Nothing Left: The Long, Slow Surrender of American Liberals, Harper's (March).
• Richard Rorty (1999). Achieving Our Country: Leftist Thought in Twentieth-Century America.

Athreya Untrustworthy On History Of Thought

I continue to read Kartik Athreya's supposedly popular account of contemporary macroeconomics. Today I focus on the misleading presentation of the theory of economic growth.

Athreya presents the Solow-Swan Neoclassical Growth Model (NGM) as a contrast to Malthus' model of economic growth. He briefly alludes to Real Business Cycle (RBC) theory as the result of appending random shocks to the Solow-Swan model. He then goes on to discuss what he calls the Ramsey-Cass-Koopmans model. There are two problems here. (I bracket off the grouping of the Ramsey model of a central planning authority determining an optimal savings rate with models of household savings decisions.)

First, Solow developed his model in the context of many other economists also developing growth models. This setting is totally missing from Athreya's book. Neither "Harrod" nor "Domar" appear anywhere in the book. Yet Solow's work was a neoclassical response to the Harrod-Domar model. The Post Keynesian approach to steady-state growth, associated with such economists as Richard Kahn, Nicholas Kaldor, and Joan Robinson provided an alternative at the time. (I might also mention Michal Kalecki and Frank Hahn's doctoral thesis, if I recall correctly.) Maybe this approach is missing because Athreya is not aware of its existence.

Second, Athreya does not even get classical growth theory correct, as presented by Malthus or others. According to Athreya, Malthus' theory abstracts from the existence of capital. I guess income is supposedly distributed only in the form of wages and rents. Athreya then claims to consider the effects of a technological innovation, namely, the introduction of a vaccine in Malthus' theory. Supposedly, the effect is to lower the death rate, while leaving birth rates unchanged. That is, population increases. Since the quantity of land is fixed, the theory exhibts diminishing marginal returns to labor. So Athreya misrepresents Malthus as claiming that improved technology, while increasing total output, ultimately leads to lower average income per worker.

In the classical theory of value, the natural wage is given by habit and custom. Malthus, building on his predecessors, argued that transitory wages higher than the natural wage might lead to changes in habits, through what we now might call hysteresis. This effect would be to increase the natural rate of wages. At any rate, population was expected to increase when wages exceeded the natural wage. But, maybe, the classical economists emphasized more reactions to opportunities for jobs than reactions to wages. They accepted that unemployment could be persistent and expected lower and higher periods of unemployment to encourage increases and decreases of the rate of growth of population. Anyways, Athreya is right, at least, about the response to increased productivity being an initial increase in the population of workers.

But he is mistaken about the ultimate effect. Suppose the market wage falls below the natural wage, in a period in which the accumulation of capital has declined. Then the classical economists, such as Malthus, expected the rate of increase in population to fall. Emigration would increase, birth rates would fall, and workers would form families later in their lives. (It is unclear to me how the classical economists envisioned such mechanisms to kick in fast enough for their theories. At any rate, I can quote Ricardo suggesting that the stationary state was far away.) The ultimate effect of declining population would be for workers to obtain their natural wage, with the level of employment and distribution between wages, profits, and rent being consistent with technological possibilities after a change. That is, the ultimate effect, in Malthus' theory, of an improvement is not lower real wages. (I am here bracketing out any consideration of whether Malthus presented a stylized theory consistent with the empirical experience in the centuries prior to his time or overlooked the effects of the ongoing industrial revolution.)

I cannot recommend Athreya's book, either for the general reader curious about macroeconomics or for the advanced undergraduate or beginning graduate student. It is too misleading. The above is only one of many examples. I suppose some professional economists might find it of interest to catalog the misconceptions, mistakes, inconsistencies, tendentious statements, and occasional insights.

Update: I want to recall the comments of David Glasner, John Quiggin, Noah Smith, and Stephen Williamson.

References

• Kartik B, Athreya (2014). Big Ideas in Macroeconomics: A Nontechnical View, MIT Press.
• Nicholas Kaldor (1956). Alternative Theories of Distribution, Review of Economic Studies, V. XXIII: pp. 83-100.
• Antonella Stirati (1994). The Theory of Wages in Classical Economics: A Study of Adam Smith, David Ricardo and their Contemporaries, Edward Elgar,

Post Keynesianism Contrasted With Neoclassical Economics

The following is reproduced from "An Essay on Post-Keynesian Theory: A New Paradigm in Economics", Al Eichner and Jan Kregel's 1975 Journal of Economic Literature article. Of course, the table being a summary, all entries are highly stylized.

Aspect	Post Keynesian Theory	Neoclassical Theory
Dynamic properties	Assumes pronounced cyclical pattern on top of a clearly discernible growth path	Either no growth, or steady-state expansion with market mechanisms assumed to preclude any but a temporary deviation from that growth path
Explanation of how income is distributed	Institutional factors determine a historical division of income between residual and non-residual shareholders, with changes in that distribution depending on changes in the growth rate	The distribution of income explained solely by variable factor inputs and the marginal productivity of those variable factor inputs
Amount of information assumed to be available	Only the past is known, the future is uncertain	Complete foresight exists as to all possible events
Conditions that must be met before the analysis is considered complete	Discretionary income must be equal to discretionary expenditures	All markets cleared with supply equal to demand in each of those markets
Microeconomic base	Imperfect markets with significant monopolistic elements	Perfect markets with all micro units operating as price takers
Purpose of the theory	To explain the real world as observed empirically	To demonstrate the social optimality if the real world were to resemble the model

Daniel Defoe On Debt As Money

In this passage, Roxana is preparing to move from Paris to Amsterdam. She liquidates her possessions, and uses jewelry and bills of exchange as money to carry with her.

"I could not but approve all his measures, seeing they were so well contrived, and in so friendly a manner, for my benefit; and as he seemed to be so very sincere, I resolved to put my life in his hands. Immediately I went to my lodgings, and sent away Amy with such bundles as I had prepared for my travelling. I also sent several parcels of my fine[Pg 181] furniture to the merchant's house to be laid up for me, and bringing the key of the lodgings with me, I came back to his house. Here we finished our matters of money, and I delivered into his hands seven thousand eight hundred pistoles in bills and money, a copy of an assignment on the townhouse of Paris for four thousand pistoles, at three per cent. interest, attested, and a procuration for receiving the interest half-yearly; but the original I kept myself.

I could have trusted all I had with him, for he was perfectly honest, and had not the least view of doing me any wrong. Indeed, after it was so apparent that he had, as it were, saved my life, or at least saved me from being exposed and ruined—I say, after this, how could I doubt him in anything?

When I came to him, he had everything ready as I wanted, and as he had proposed. As to my money, he gave me first of all an accepted bill, payable at Rotterdam, for four thousand pistoles, and drawn from Genoa upon a merchant at Rotterdam, payable to a merchant at Paris, and endorsed by him to my merchant; this, he assured me, would be punctually paid; and so it was, to a day. The rest I had in other bills of exchange, drawn by himself upon other merchants in Holland. Having secured my jewels too, as well as I could, he sent me away the same[Pg 182] evening in a friend's coach, which he had procured for me, to St. Germain, and the next morning to Rouen. He also sent a servant of his own on horseback with me, who provided everything for me, and who carried his orders to the captain of the ship, which lay about three miles below Rouen, in the river, and by his directions I went immediately on board. The third day after I was on board the ship went away, and we were out at sea the next day after that; and thus I took my leave of France, and got clear of an ugly business, which, had it gone on, might have ruined me, and sent me back as naked to England as I was a little before I left it." -- Daniel Defoe, Roxana: The Fortunate Mistress (1724).

Defoe's novel, Robinson Crusoe, is more well-known among economists. For example, one can read Stephen Hymer's "Robinson Crusoe and the secret of primitive accumulation" (Monthly Review, 1971).

Gramsci: Laissez Faire As State Regulation

I am of the opinion that talk of more or less government intervention in markets is incoherent in, for example, the United States today. It is not as if some configuration of property rights, contract law independent of the state, corporations with limited liability, and markets of various types are all natural constructs, existing prior to all human interventions. I have gone on about this before. I might also note Philip Mirowski's view that sophisticated neoliberals recognize that a capitalist market order must be constructed; it does not come about naturally. I do not know that he would now think that all those in, for example, think tanks inhabiting the outer layers of the russian doll structures that neoliberals have build for propagandizing would recognize the role of government in constructing a market order.

Anyways, I have recently stumbled on Antonio Gramsci making a closely related point:

"The ideas of the Free Trade movement are based on a theoretical error whose practical origin is not hard to identify; they are based on a distinction between political society and civil society, which is made into and presented as an organic one, whereas in fact it is merely methodological. Thus it is asserted that economic activity belongs to civil society, and that the State must not intervene to regulate it. But since in actual reality civil society and State are one and the same, it must be made clear that laissez-faire too is a form of state 'regulation', introduced and maintained by legislative and coercive means. It is a deliberate policy, conscious of its own ends, and not the spontaneous, automatic expression of economic facts. Consequently, laissez-faire liberalism is a political programme, designed to change - in so far as it is victorious - a State's leading personnel, and to change the economic programme of the State itself - in other words the distribution of the national income." -- Antonio Gramsci, Prison Notebooks, "The Modern Prince", Some Theoretical and Practical Aspects of 'Economism'

Given the current conjuncture in, say, the United States, that bit about income distribution is of contemporary relevance. I think a study comparing and contrasting the ideas of Michel Foucault and Antonio Gramsci on how ideas become dominant in society would be interesting to read.

Elsewhere

• Greg Hill describes issues in getting into (Arrow-Debreu) equilibrium.
• I want to remember to sometime read Wolfgang Eichert's article, Long-period Positions in Multi-sectoral Cobb-Douglas Economies. The abstract sounds like an extension of two posts of mine.
• I also want to remember to sometime read Saverio Fratini's article Real Wicksell Effect, Demand for Capital and Stability.
• Robert Paul Wolff has posted a series critiquing game theory.
• Here is another article on rethinking economics.
• Unlearning Economics says the Cambridge Capital Controversy still matters.
• J. W. Mason is teaching international trade.

Update: On 6 February, completed series for R. P. Wolff, added an Unlearning Economics link, and added a link for J. W. Mason.

Economics Too Hard For Kartik Athreya

I have been trying to read Kartik Athreya's Big Ideas in Macroeconomics: A Nontechnical View. I find it quite dry. So far, it is all theory. (I guess some might quibble with that, given the overview of results from experimental economics.) There is no history of ideas and no context suggesting that those who might have developed these ideas were any more than disembodied consciousnesses. And no hint is given that whole groups of economists would find these views controversial. (Caveat: he does mention, for example, Ariel Rubinstein and Ricardo Caballero.) For Athreya, Paul Davidson, Wynne Godley, Alan Kirman, and Lance Taylor, for example, just do not exist.

I think Athreya might have misjudged his audience. He says that he is attempting to target two audiences:

• Advanced undergraduates considering graduate school and beginning graduate students.
• Popular readers with an interest in macroeconomics.

But the lack of any leavening from a presentation of details of theory will make this book a hard sell for the second audience. Maybe my opinion will change as I read further.

But I want to point out a display of ignorance of the logic of prices in general equilibrium:

"...notice there are likely to be many types of laborers involved in the production of barstools... Thers are also many possible input materials, and different possible production processes. Importantly, the myriad ways in which various inputs can be substituted for each other in barstool production is knowledge that can only be acquired through experience in the field.

In our W[alrasian] C[learing]H[ouse], each furniture maker will, at various prices, carefully consider all the ways in which inputs can be substituted for each other. If, for example, walnut is particularly expensive relative to oak, and oak can easily be substituted for walnut because it won't also necessitate the use of harder-tipped and more expensive saw blades, for instance, the oak will be used. In this way, the experience and almost-inevitably accumulated wisdom of those who have specialized in the production of any given product are brought to bear fully in the industry's use of inputs even though no firms are assumed to communicate with any others within the industry..." [emphasis in original]

As I pointed out many times, prices are not indices of relative scarcity, and neoclassical economists, such as Christopher Bliss, Frank Hahn, and Paul Samuelson have noted the logic of general equilibrium is not that of substitution. (Andreu Mas-Colell has an accessible overview of capital theory.) When will (some) mainstream economists accept their own logic?

Impact Of Piero Sraffa On Industrial Organization

1.0 Introduction

Piero Sraffa, with his 1926 Economic Journal article on the laws of returns, had a great impact on the emerging field of Industrial Organization (I/O). For the purposes of this post, Sraffa's paper can be said to have made two major contributions:

1. An internal critique of Marshall's theory of partial equilibrium, showing it holds only under the most specious conditions.
2. Suggestions for how to analyze the wide range of markets between perfect competition and monopoly.

The first contribution is still relevant today, given how the theory of the perfectly competitive firm is still presented in introductory textbooks. One might also argue that how the theories of imperfect and monopolistic competition were developed, they still are vulnerable to Sraffa's critique. In this post, however, I concentrate on a broad historical overview focused on the second contribution above. But Cameron Murray shows that some still find Sraffa's 1920s work of importance for contemporary theorizing about the theory of the firm.

I apologize for lacking references to recent secondary literature. I do not think that the thesis of this post is not well known among historians of economics or the authors of secondary literature.

2.0 Selected Quotes

Sraffa articulated the need for and possibility of theories of market forms between monopoly and perfect competition:

"...when we are supplied with theories in respect to the two extreme cases of monopoly and competition as part of the equipment required in order to undertake the study of the actual conditions in the different industries, we are warned that these generally do not fit exactly one or other of the categories, but will be found scattered along the intermediate zone, and that the nature of an industry will approximate more closely to the monopolist or the competitive system according to its particular circumstances, such as whether the number of autonomous undertakings in it is larger or smaller, or whether or not they are bound together by partial agreements, etc. We are thus led to believe that when production is in the hands of a large number of concerns entirely independent of one another as regards control, the conclusions proper to competition may be applied even if the market in which the goods are exchanged is not absolutely perfect, for its imperfections are in general constituted by frictions which may simply retard or slightly modify the effects of the active forces of competition, but which the latter ultimately succeed in substantially overcoming. This view appears to be fundamentally inadmissible. Many of the obstacles which break up that unity of the market which is the essential condition of competition are not of the nature of 'frictions,' but are themselves active forces which produce permanent and even cumulative effects. They are frequently, moreover, endowed with sufficient stability to enable them to be made the subject of analysis based on statical assumptions." -- p. 542

He stated some basic ideas developed in the theory of monopolistic competition:

"The causes of the preference shown by any group of buyers for a particular firm are of the most diverse nature, and may range from long custom, personal acquaintance, confidence in the quality of the product, proximity, knowledge of particular requirements and the possibility of obtaining credit, to the reputation of a trade-mark, or sign, or a name with high traditions, or to such special features of modelling or design in the product as-without constituting it a distinct commodity intended for the satisfaction of particular needs-have for their principal purpose that of distinguishing it from the products of other firms.

What these and the many other possible reasons for preference have in common is that they are expressed in a willingness (which may frequently be dictated by necessity) on the part of the group of buyers who constitute a firm's clientele to pay, if necessary, something extra in order to obtain the goods from a particular firm rather than from any other." -- p. 544

He described what could be seen as a forerunner of the theroy of kinked demand curves:

"...the forces which impel producers to raise prices are much more effective than those which impel them to reduce them; and this not merely owing to the fear which every seller has of spoiling his market, but mainly because an increase of profit secured by means of a cut in price is obtained at the cost of the competing firms, and consequently it impels them to take such defensive action as may jeopardise the greater profits secured; whereas an increase of profit obtained by means of a rise in prices not only does not injure competitors but brings them a positive gain, and it may therefore be regarded as having been more durably acquired. An undertaking, therefore, when confronted with the dual possibility of increasing its profits by raising its selling prices, or by reducing them, will generally adopt the first alternative unless the additional profits expected from the second are considerably greater." -- p. 548

Sraffa is also a forerunner of the theory of contestable markets, in which one analyzes the effects on existing firms of potential entrants into their markets.

"It should be noted that in the foregoing the disturbing influence exercised by the competition of new firms attracted to an industry the conditions of which permit of high monopolist profits has been neglected. This appeared justified, in the first place because the entrance of new-comers is frequently hindered by the heavy expenses necessary for setting up a connection in a trade in which the existing firms have an established goodwill - expenses which may often exceed the capital value of the profits obtainable; in the second place, this element can acquire importance only when the monopoly profits in a trade are considerably above the normal level of profits in the trade in general, which, however, does not prevent the prices from being determined up to that point in the manner which has been indicated."-- p. 549

I suppose I could also quote Sraffa's suggestion that developments along some of these lines would lead to models with determinate solutions. To summarize, you can see in this paper an outline of a program for the I/O field.

3.0 Impact on Economists Developing I/O

Sraffa was not a voice crying in the wilderness, ignored by economists of his day and thereafter. His paper was one contribution, among many in the 1920s, attempting to articulate the logical requirements for a theory of perfect competition. Sraffa was not even alone in expressing skepticism that one could confidently connect Marshall's theory to the empirical facts. I think of, for example, what has come to be known as the "empty economic boxes" debate.

Edward Chamberlin and Joan Robinson, with their 1933 books on, respectively, monopolistic and imperfect competition, is an example of simultaneous discovery in I/O. Richard Kahn provided Robinson quite a bit of help with her book and was also working on the theory of imperfect competition, if I recall correctly, in his thesis. Kahn and Robinson were directly inspired by Sraffa and interacted with him in Cambridge.

Joe S. Bain and Paolo Sylos Labini provide a later example of simultaneous discovery in I/O. They develop what has become known as "old" I/O, as opposed to more game-theoretic approaches. Sylos Labini, at least, thought of himself as following a Sraffian tradition inasmuch as he was attempting to develop I/O in keeping with a revival of classical political economy. But this observation takes me into Sraffa's later work and beyond the scope of this post.

Reference

• Franco Modigliani (1958). New Developments on the Oligopoly Front, Journal of Political Economy, V. 66, no. 3 (Jun.): pp. 215-232.
• Piero Sraffa (1926). The Laws of Returns under Competitive Conditions, Economic Journal, V. 36, no. 144 (Dec.): pp. 535-550.
• Paolo Sylos Labini (1995). Why the interpretation of the Cobb-Douglas production function must be radically changed, Structural Change and Economic Dynamics, V. 6, no. 4 (Dec.): pp. 485-504.

Dennis Robertson's "Wage Grumbles"

To simplify, the factors of production are land, labor, and capital. The marginal productivity of labor is the extra output produced by an infinitesimal increase in labor, holding the quantity of all other factors constant. What does it mean to hold the quantity of capital constant? Dennis Robertson thought about this:

"If ten men are to be set to dig a hole instead of nine, they will be furnished with ten cheaper spades instead of nine more expensive ones; or perhaps if there is no room for him to dig comfortably, the tenth man will be furnished with a bucket and sent to fetch beer for the other nine." -- Dennis Robertson (1931).

I do not know that I have ever read Robertson. But I have seen the above passage often quoted (e.g., in Miller 2000) or alluded to (e.g. in Harcourt 2014).

Anyways, here we see, in a micro-economic context, a constant quantity of capital, measured in numeraire units, with a variable form. The Cambridge Capital Controversy showed this notion to be untenable. And this quote is another demonstration that the CCC was about more than macroeconomic models with aggregate production functions, such as the Solow model of economic growth. We also see that, once, some did not find odd the idea of beer breaks.

References

• G. C. Harcourt (2014). Cambridge-Style Criticism of the Marginal Productivity Theory of Distribution, Proceedings of the American Economic Association. Philadelphia, PA (3-5 January).
• Richard A. Miller (2000). Ten Cheaper Spades: Production Theory and Cost Curves in the Short Run, Journal of Economic Education (Spring): pp. 119-130.
• Dennis W. Robertson (1931). Wage-grumbles, Economic Fragments. [I DON'T KNOW THAT I EVER READ THIS.]