Business As Sabotage

Over at Boing Boing, Dan Gillmor praises some comments of Thorstein Veblen on the media. (One of these days I might read Robert McChesney.) I did not recall the passage Gillmor quotes, but I was amused by the following passage from earlier in the same book:

"It was then still true, in great measure, that the undertaker was the owner of the industrial equipment, and that he kept an immediate oversight of the mechanical processes as well as of the pecuniary transactions in which his enterprise was engaged; and it was also true, with relatively infrequent exceptions, that an unsophisticated productive efficiency was the prime element of business success. A further feature of that precapitalistic business situation is that business, whether handicraft or trade, was customarily managed with a view to earning a livelihood rather than with a view to profits on investment...

...The economic welfare of the community at large is best served by a facile and uninterrupted interplay of the various processes which make up the industrial system at large; but the pecuniary interests of the business men in whose hands lies the discretion in the matter are not necessarily best served by an unbroken maintenance of the industrial balance. Especially is this true as regards those greater business men whose interests are very extensive. The pecuniary operations of these latter are of large scope, and their fortunes commonly are not permanently bound up with the smooth working of a given sub-process in the industrial system. Their fortunes are rather related to the larger conjunctures of the industrial system as a whole, the interstitial adjustments, or to conjunctures affecting large ramifications of the system. Nor is it at all uniformly to their interest to enhance the smooth working of the industrial system at large in so far as they are related to it. Gain may come to them from a given disturbance of the system whether the disturbance makes for heightened facility or for widespread hardship, very much as a speculator in grain futures may be either a bull or a bear. To the business man who aims at a differential gain arising out of interstitial adjustments or disturbances of the industrial system, it is not a material question whether his operations have an immediate furthering or hindering effect upon the system at large. The end is pecuniary gain, the means is disturbance of the industrial system, - except so far as the gain is sought by the old-fashioned method of permanent investment in some one industrial or commercial plant, a case which is for the present left on one side as not bearing on the point immediately in hand. The point immediately in question is the part which the business man plays in what are here called the interstitial adjustments of the industrial system; and so far as touches his transactions in this field it is, by and large, a matter of indifference to him whether his traffic affects the system advantageously or disastrously. His gains (or losses) are related to the magnitude of the disturbances that take place, rather than to their bearing upon the welfare of the community.

The outcome of this management of industrial affairs through pecuniary transactions, therefore, has been to dissociate the interests of those men who exercise the discretion from the interests of the community. This is true in a peculiar degree and increasingly since the fuller development of the machine industry has brought about a close-knit and wide-reaching articulation of industrial processes, and has at the same time given rise to a class of pecuniary experts whose business is the strategic management of the interstitial relations of the system. Broadly, this class of business men, in so far as they have no ulterior strategic ends to serve, have an interest in making the disturbances of the system large and frequent, since it is in the conjunctures of change that their gain emerges. Qualifications of this proposition may be needed, and it will be necessary to return to this point presently.

It is, as a business proposition, a matter of indifference to the man of large affairs whether the disturbances which his transactions set up in the industrial system help or hinder the system at large, except in so far as he has ulterior strategic ends to serve. But most of the modern captains of industry have such ulterior ends, and of the greater ones among them this is peculiarly true. Indeed, it is this work of far-reaching business strategy that gives them full title to the designation, 'Captains of Industry.' This large business strategy is the most admirable trait of the great business men who with force and insight swing the fortunes of civilized mankind. And due qualification is accordingly to be entered in the broad statement made above. The captain's strategy is commonly directed to gaining control of some large portion of the industrial system. When such control has been achieved, it may be to his interest to make and maintain business conditions which shall facilitate the smooth and efficient working of what has come under his control, in case he continues to hold a large interest in it as an investor; for, other things equal, the gains from what has come under his hands permanently in the way of industrial plant are greater the higher and more uninterrupted its industrial efficiency.

An appreciable portion of the larger transactions in railway and 'industrial' properties, e.g., are carried out with a view to the permanent ownership of the properties by the business men into whose hands they pass. But also in a large proportion of these transactions the business men's endeavors are directed to a temporary control of the properties in order to close out at an advance or to gain some indirect advantage; that is to say, the transactions have a strategic purpose. The business man aims to gain control of a given block of industrial equipment - as, e.g., given railway lines or iron mills that are strategically important - as a basis for further transactions out of which gain is expected. In such a case his efforts are directed, not to maintaining the permanent efficiency of the industrial equipment, but to influencing the tone of the market for the time being, the apprehensions of other large operators, or the transient faith of investors. His interest in the particular block of industrial equipment is, then, altogether transient, and while it lasts it is of a factitious character.

The exigencies of this business of interstitial disturbance decide that in the common run of cases the proximate aim of the business man is to upset or block the industrial process at some one or more points. His strategy is commonly directed against other business interests and his ends are commonly accomplished by the help of some form of pecuniary coercion. This is not uniformly true, but it seems to be true in appreciably more than half of the transactions in question. In general, transactions which aim to bring a coalition of industrial plants or processes under the control of a given business man are directed to making it difficult for the plants or processes in question to be carried on in severalty by their previous owners or managers. It is commonly a struggle between rival business men, and more often than not the outcome of the struggle depends on which side can inflict or endure the greater pecuniary damage. And pecuniary damage in such a case not uncommonly involves a setback to the industrial plants concerned and a derangement, more or less extensive, of the industrial system at large.

The work of the greater modern business men, in so far as they have to do with the ordering of the scheme of industrial life, is of this strategic character. The dispositions which they make are business transactions, 'deals,' as they are called in the business jargon borrowed from gaming slang. These do not always involve coercion of the opposing interests; it is not always necessary to 'put a man in a hole' before he is willing to 'come in on' a 'deal.' It may often be that the several parties whose business interests touch one another will each see his interest in reaching an amicable and speedy arrangement; but the interval that elapses between the time when a given 'deal' is seen to be advantageous to one of the parties concerned and the time when the terms are finally arranged is commonly occupied with business manoeuvres on both or all sides, intended to 'bring the others to terms.' In so playing for position and endeavoring to secure the largest advantage possible, the manager of such a campaign of reorganization not infrequently aims to 'freeze out' a rival or to put a rival's industrial enterprise under suspicion of insolvency and 'unsound methods,' at the same time that he 'puts up a bluff' and manages his own concern with a view to a transient effect on the opinions of the business community. Where these endeavors occur, directed to a transient derangement of a rival's business or to a transient, perhaps specious, exhibition of industrial capacity and earning power on the part of one's own concern, they are commonly detrimental to the industrial system at large; they act temporarily to lower the aggregate serviceability of the comprehensive industrial process within which their effects run, and to make the livelihood and the peace of mind of those involved in these industries more precarious than they would be in the absence of such disturbances. If one is to believe any appreciable proportion of what passes current as information on this head, in print and by word of mouth, business men whose work is not simply routine constantly give some attention to manoeuvring of this kind and to the discovery of new opportunities for putting their competitors at a disadvantage. This seems to apply in a peculiar degree, if not chiefly, to those classes of business men whose operations have to do with railways and the class of securities called 'industrials.' Taking the industrial process as a whole, it is safe to say that at no time is it free from derangements of this character in any of the main branches of modern industry. This chronic state of perturbation is incident to the management of industry by business methods and is unavoidable under existing conditions. So soon as the machine industry had developed to large proportions, it became unavoidable, in the nature of the case, that the business men in whose hands lies the conduct of affairs should play at cross-purposes and endeavor to derange industry. But chronic perturbation is so much a matter of course and prevails with so rare interruptions, that, being the normal state of affairs, it does not attract particular notice." -- Thorstein Veblen (1904). The Theory of Business Enterprise, Chapter 3.

CCC Not Exclusively About Aggregate Theory

I thought I might point out what some others say the Cambridge Capital Controversy is about:

"It is also worth noting that Samuelson...assesses the relevance of capital reversing mainly in terms of the beehavior of the interest rate consequent upon a change in saving behavior: a decrease in current consumption may entail a new steady-state equilibrium in which the interest rate is higher rather than lower than initially. This was indeed unexpected in conventional theory, but its ramifications are rather more serious than Samuelson lets on. The conventional relation between consumption and the interest rate emerges from the operation of the substitution mechanisms that underlie the downward-sloping factor demand functions of the marginalist theory; it is the latter distribution theory that capital reversing undermines." -- Gary Mongiovi, 2002. "Classics and Moderns: Sraffa's Legacy in Economics", Metroeconomica, V. 53, N. 3: 223-241.

"...one must conclude that at present there is no defensible neoclassical theory (in the sense of explanation) of prices and distribution. The onus is on the neoclassicals to show that this is not so. Unless and until they succeed, it seems reasonable to turn to different, non-neoclassical approaches to value and distribution (and employment and growth)." -- Fabio Petri, 1999. "Professor Hahn on the 'neo-Ricardian' Criticism of Neoclassical Economics", In Value, Distribution and Capital: Essays in Honour of Pierangelo Garegnani, Routledge.

"After the stirring, contentious debate over the theory of capital generated by the discovery of the phenomenon of re-switching in the 1960s, one has surprisingly witnessed, in the economic literature, within the course of only a few years, the sudden, one might even say abrupt, disappearance of all discussions on such themes.

The phases through which this state of affairs has come about are themselves an interesting phenomenon, from the view point of the history of economic science, and deserve careful consideration, even at the cost of a brief digression.

The first reaction to the discovery of re-switching was one of uneasy fastidiousness. The intuitive conjecture prevailed that it should be an odd, weird, bizarre or rare case of no empirical relevance whatsoever. The economists who nevertheless originally had to admit it did so with instinctive reluctance, as it clashed with their inherited way of thinking. They used a variety of terms for it, ranging from 'paradoxical' and 'perverse' to 'exceptional', 'inconvenient' and 'anomalous'; a case that 'intuition suggests is unrealistic', and so on (see the numerous quotations in Pasinetti 1966, p. 515, and also Pasinetti 1978). Charles Ferguson, as reported above, was more explicit and candid. He reasserted his instinctive confidence in the neoclassical production function, but admitted that his trust was 'a statement of faith'.

There followed a second phase in which there was a painstaking search for specifying the conditions that could be sufficient to exclude the re-switching phenomenon (on the subject see, for example, Franklin Fisher 1971, Sato 1974, Burmeister 1980). There was moreover a substantial effort to re-interpret the rate of interest as at least expressing the rate of return for society as a whole, when the economic system was changing the proportions between two equally profitable techniques (Solow 1963 and 1967). However, all these efforts did not lead very far. On the one hand the conditions that would be needed in order to avoid the re-switching of techniques proved to be so extremely restrictive as to leave no reasonable possibility of relying on them. On the other hand, in a critique of Solow's attempt to revive Irving Fisher's concept of the 'rate of return', Pasinetti investigated a general discontinuity property of the conception of spectrum of techniques, showing that the vicinity, even an infinitesimal vicinity, of any two techniques on the scale of variation of the rate of profits does not entail at all any vicinity of such techniques (as marginal productivity theory would require) on the scale of variation of their degree of capital-intensity (capital/output, or capital/labour ratios). Capital-intensity might in fact remain quite far apart for the two techniques involved (Pasinetti, 1969). These discontinuity properties have been analysed in detail by J. Barkley Rosser Jr. (1991, ch. 8: 'Discontinuity and Capital Theory'). Thus, new analytical investigation could bring no help for the traditional views; quite the contrary.

Yet there finally came a third very curious phase, which should appear rather strange, given its weak theoretical and empirical underpinning, but which was greeted with relief by the theorists of mainstream economics. The essence of this third phase can be summed up with the following proposition: the criticisms of the traditional theory of capital raised by the phenomenon of re-switching (and consequent reverse capital-deepening) are valid, but only with reference to the neoclassical model conceived in aggregate terms. They do not apply to the neoclassical case of the general economic equilibrium model, conceived in disaggregated terms and based on the behaviour of individuals maximising inter-temporal functions of profits and of utility.

This proposition actually has no objective foundation: phenomena of non-convexity, re-switchings of techniques and badly-behaved production functions, to take an expression that has been widely used ('behaving badly' meaning simply that they behave in a way as not to obey the assumptions of neoclassical economics), are not ­ as has been amply demonstrated ­ a consequence or a characteristic of any particular process of 'aggregation'. They may occur at any time and in any context, aggregated or disaggregated. Various authors have continued to demonstrate this point (e.g. Kurz 1987, Schefold 1997, Garegnani 1998, and others). But so things go. The contrary conviction had taken root and has continued to spread. Above all, the proposition cited above has been trundled out again and again, with no proof, but simply referring back to other sources, which in turn are either insufficient or inconsistent.

The principal one of these sources is represented by an incredibly polemical and dogmatic paper by Frank Hahn (1982), explicitly intended to heap discredit on those economists whom he calls 'the Neo-Ricardians'. With undeniable rhetorical and dialectical skill, Hahn shifted the bases of the whole debate. He admits, without mincing words, that the entire version of neoclassical theory of capital and income distribution, based on aggregate production functions (basically, the whole neoclassical stream of thought descending from Böhm-Bawerk, Wicksell and John Bates Clark) has to be scrapped as inconsistent and incorrect. He then goes on to argue that the correct and relevant version of the neoclassical theory is not that of Böhm-Bawerk, Wicksell and Clark, and not even that of Marshall, but rather the theory that stems from the Walrasian scheme of general economic equilibrium; a scheme which in its modern version is represented by the Arrow-Debreu formulation (Arrow and Debreu 1954, Debreu 1959, Arrow-Hahn, 1971). In this version, the scheme appears as a very general one. Although, in its essential terms, the scheme is a pure exchange model (i.e. a scheme of given resources, which the 'agents' exchange among themselves on the basis of the postulate of maximisation of utility), it can also be reinterpreted in inter-temporal terms, by associating with each resource a quantity index and a time index. In this version, the phenomenon of production becomes a phenomenon of inter-temporal exchange. Thus a framework can be traced out containing a whole range of heterogeneous capital goods. At any given moment of time, the postulates of maximisation (of utility and of profit) by the 'agents' (consumers and entrepreneurs) lead the system to positions of 'temporary equilibrium', generating an overall system of prices for all resources, present and future.

According to Hahn, this framework also includes Sraffa's model as a very special case; namely, as the case where the original heterogeneous goods in the given initial set are exactly in those proportions that generate a uniform rate of profits. But, in general, the 'equilibrium prices' generated by the system will imply rates of interest (and of profit, taken to coincide with the rates of interest) differing from any one (heterogeneous) capital good to another. This does not matter in the Walrasian model à la Arrow-Debreu, given that this model is a price determining model (a point which will be taken up again in the following section). Indeed, the non-uniformity of interest rates is proudly pointed out as a sign of the generality of the model. Hahn admits that the framework might show cases and problems of lack of uniqueness and/or lack of stability of the solutions. However, Hahn claims that the scheme should be immune to the criticisms prompted by the re-switching phenomenon.

But how? The point is precisely here. According to Hahn, in a system with manifold production techniques, equality would still hold between the return on each capital good and the derivative of its production with respect to its input, namely the 'marginal productivities' (in physical terms), although no causal relation could ever be asserted, since all the solutions emerge from a system of simultaneous equations. Hahn admits that there might, of course, be some 'non-convexities' and 'badly-behaved' production functions, in other words that cases of re-switching might occur. So Hahn admits cases of re-switching after all! But here is the ruse: while admitting such cases, Hahn relegates them to the category of difficulties concerning the zones of 'instability'. Now, zones of instability of the system can always occur, in models with heterogeneous capital goods, even in the case of perfectly convex and well-behaved production functions. Indeed, Hahn himself had demonstrated precisely this in an earlier article of his (Hahn 1966) ­ an article, it is to be it noted, written as a critique of dominant theory. Here is therefore how the confusion has been generated ­ a confusion between two different phenomena, namely: a) instabilities, that can in general arise in all neoclassical models with heterogeneous capital goods, and b) the particular phenomenon of re-switching, which ­ by being re-classified as generating instability (a characteristic which is not incorrect, since, among other things, re-switching also generates instability in the capital goods market) is restrictively associated (and confused) with the case previously considered by Hahn.

The paradoxical outcome has been that, instead of taking up Hahn's first finding (1966), which is critical and negative with reference to all the multi-sector models of neoclassical theory, mainstream literature has used Hahn's second article (1982) to assert that the difficulties connected with instability were already well-known.

Conclusion: re-switching had nothing new to tell us. As if the difficulties, when they are already known could, by this very fact, acquire a justification for being ignored, no matter whether they crop up in a different context, where they are reiterated and extended! Surprisingly enough, however, this is precisely what has happened.

Hahn has certainly been very careful not to stress his previous findings ­ strictly logical and negative. Instead, he has adopted the familiar expedient of saying that, of course, there are difficulties; of course these difficulties call for further research; hopefully further research will settle them in the future.

And here we finally come to the non sequitur of the conclusion: the 'Neo-Ricardians' could safely be ignored.

Mainstream economists could not have asked for better. The effect has been to give re-switching the air of an obsession vexing others, and to induce dominant economic theorists not to talk of it any more. The debate soon flagged; in the major economics journal it has been forgotten.

But something even more interesting and intriguing has happened. After only a few years, even the admissions initially made no longer found any mention. Aggregate production functions have made their untroubled re-appearance in the macroeconomic textbooks, without the slightest hint as to their earlier (recognised) logical inconsistencies. It has taken only a few years for them to reappear in papers published in the major journals of dominant economic theory, which at the same time have begun systematically to reject all articles dealing with re-switching as unpublishable. The same authors, who had for two decades been asserting the need to scrap the aggregate neoclassical production functions are now using them quite normally. The typical economics student entering university from the 1980s onwards has heard nothing of the re-switching difficulties involved in the neoclassical theory of capital and income distribution.

It is as if the debate on the choice of techniques had never taken place. Amnesia on such a vast scale can only be explained by more appropriate terms, such as 'suppression' or 'repression' or 'removal'. This is, perhaps, one of the most interesting examples of that process described by Kuhn (1962), through which dominant 'normal' science suppresses, and thus ignores, the cases of contradiction and anomaly it bears within." -- Luigi L. Pasinetti, "Critique of the Neoclassical Theory of Growth and Distribution", 200?

A Manhattan Project For Economics?

Last December, Mike Brown, Stuart Kauffman, Zoe-Vonna Palmrose, and Lee Smolin discussed "Can Science Help Solve the Economic Crisis?" They suggest that what we need now is an economics Manhattan project. And by the way, neoclassical economics is not completely correct. (The Edge seems like an interesting place, whatever you think of this article.)

I vaguely know something about two of these authors. I read Stuart Kauffman's At Home in the Universe a number of years ago. I had previously read something about the Santa Fe Institute, including some of Brian Arthur's papers. But the idea of mathematical biology, with an emphasis on cross-disciplinary work from computer science was new to me.

I have been struggling through Peter Woit's Not Even Wrong: The Failure of String Theory and the Search for Unity in Physical Law for a month or so now. The algebra is tough going for me. Maybe I would have been better off with Lee Smolin's book on the same topic. And I have Smolin's paper "Time and Symmetry in Models of Economic Markets" to read. Barkley Rosser, Jr., suggests that Smolin should read some more economics, but it seems to me Smolin is quite modest about the potential of his work. I think Rosser and Smolin and his colleague approach some harmony in the comments in that thread.

Hat Tip: New York Times

The First Thing We Do, Let's Kill All The Lawyers

Paul Samuelson seems to be aware of the possibility of hostile, sometimes politically-motivated, readings of works in economics:

"Piero's was a subtle mind, which had thought long and hard on these (mathematical) relationships. His pen writes as if a lawyer were at hand to ensure that no vulnerable sentence appears. I honour him for that, and with my own students felt obligated to point out the subtelty of the text..." -- Paul A. Samuelson (2000) "Sraffa's Hits and Misses", in Critical Essays on Piero Sraffa's Legacy in Economics (ed. by Heinz D. Kurz), Cambridge University Press

"For some reason that I have no understanding of, the virulence of the attack on Tarshis was of a higher order of magnitude than on my book, but there were plenty of attacks on my book, and there was a lot of work done by people. Also I wrote carefully and lawyer-like so that there were a lot of complaints that Samuelson was playing peek-a-boo with the Commies. The whole thing was a sad scene that did not reflect well on conservative business pressuring of colleges."-- Paul A. Samuelson (quoted in David Colander and Harry Landreth, "Political Influence on the Textbook Keynesian Revolution: God, Man, and Laurie Tarshis at Yale")

Some Links

• "A Progressive Program for Economic Recovery & Financial Reconstruction" from the Universiy of Massachusetts Amherst's Political Economy Research Institute (PERI), the New School's Schwartz Center for Economic Policy Analysis (CEPA), and others
• "Capitalism Beyond the Crisis", by Amartya Sen, in The New York Review of Books
• "Ivory Tower Unswayed by Crashing Economy", Patricia Cohen, New York Times, 4 March 2009
• "Sold Out: How Wall Street and Washington Betrayed America"

Paul Lewis On Unproven Justifications For Flexible Labor Markets

Many who do not understand economics, such as many mainstream economists working at the OECD, the IMF, the World Bank, and other powerful institutions, think less unemployment would result from more "flexible" labor markets. Flexibility is a code-word for eliminating unions, lowering the real value of minimum wages, and otherwise decreasing standards in labor markets. I have pointed out some reasons why this push for labor market flexibility is theoretically and empirically unjustified.

There is more to Paul Lewis' recent paper than this echo of my favorite argument:

"One rationalisation of F[lexible] L[abour] M[arkets] rests upon neoclassical economic theory, in particular M[arginal] P[roductivity] T[heory]. A key feature is optimisation of the quantity of each factor employed so that its price equals its marginal productivity. To fit with the trade and technology hypotheses this neoclassical model must contain a minimum of two homogeneous categories of labour - low and high skilled - and two types of 'capital' - advanced high-skill complementary and low-skill complementary equipment.¹...

...What results from these labour market conditions at a macro level is the natural rate of unemployment, or N[on]-A[ccelerating] I[nflation] R[ate] of U[nemployment] as it has come to be known. This is a long-run equilibrium, a consequence of supply and demand in the labour market, in this case largely constituted by the market for the low-skilled. It is consistent with firms having zero net profit,³ which corresponds with a 'warranted wage' for labour (Blanchard, 2006, p. 13).

¹ I consider the arguments for F[lexible] L[abour] M[arkets] rest upon the following neoclassical assumptions. (i) Capital refers to the physical means of production, which has to be homogeneous in its inherent productive features, (ii) it is quantifiable independently of its price, which allows it to be optimised in production. This characterisation of capital was shown to be nothing more than a 'neoclassical parable' as Samuelson put it, with no grounding in reality (see Blaug, 1997; Hodgson, 1997; Hunt, 2002). However, this shortcoming has not prevented its continued use as a foundation of mainstream microeconomics.

³ A condition of perfect competition in the product markets. The outcome of zero profits in equilibrium is a further example of the inability of M[arginal] P[roductivity] T[heory] to model common features of real economies." -- Paul Lewis, "(How) Do Flexible Labour Markets Really Work? The Role of Profitability in Influencing Unemployment, Cambridge Journal of Economics, V. 33 (2009): pp. 51-77

No Need For Greed Or Hunger, A Brotherhood Of Man

Last month, I compared and contrasted "socialism" and "social democracy". A discussion on Crooked Timber inspired me here.

I now find John King has a working paper, "Socialist Democratic and Socialist Policies", intended for publication in the International Encyclopedia of Public Policy. I haven't fully absorbed this, but I see King goes back before Eduard Bernstein and his Marxist revisionism.

Freeing Oneself From The Ideas Of Some Academic Scribbler Of A Few Years Back

I have just begun reading James Galbraith's The Predator State. I like this passage:

"What, then, is a reality-based person to do? Many people appear to believe that the best they can do under the circumstances is to hedge and qualify, at the margins. That is, they can aver that the market may be imperfect, that under certain conditions it may fail, that it might function better given the aid of fuller information or certain constraints on behavior. And this position, deeply rooted in academic economics and therefore at least somewhat defensible on the public stage, has become the 'liberal' position in debates over markets, linked to the slogan 'making markets work.'

The problem with this compromise is that it depends on a misreading of the academic economics on which it is based. The underlying idea appears to be that markets exist but sometimes have problems: a bit of monopoly power, some kinks in the flow of information, a few side effects, maybe a little difficulty predicting the future. But in fact, the modern currents of academic economics are far more devastating than that. Each of the problems just mentioned is not incidental; rather they are pervasive. Taken together, they raise serious doubts about the idea that markets can work at all. To state that again: taken together, they form an overwhelming critique of the very concept of the market.

In the purest version of the theory that underlies the conservative version of the perfect market, economic man is a machine to whom whimsy and evolution are unknown. In practice, man is inconsistent; changeable; sometimes, though not consistently, irrational; his judgments biased and distorted and influenced by his peers. Modern behavioral economics has begun - but only begun - to notice this, seeking by experimental methods to show whether the actual behavior of presumptively competent people corresponds to the predictions of the rationalist theory. The findings, associated with the Nobel Prize-winning work of the Princeton psychologist Daniel Kahneman, are that they are not. Ordinary, intelligent people appear consistently unwilling, or unable, to calculate the consequences of their decisions in a manner predicted by the view that they are responding purely to the market. Instead, they act as social beings, concerned about their standing with their peers, about the fairness of the deal they are being offered, and other matters quite irrelevant to the utility of the object or money on offer. These are remarkably subversive findings, for they suggest that even if there were no monopoly, no externalities, perfect information, and perfect foresight, markets composed of real people would still not perform as the conservative vision requires.

But of course there are easier ways to reach the same conclusions, and behavioral economics is of interest mainly because it speaks to market-obsessed academics from within all the mind-boggling restrictions that they habitually impose on their analyses in order to make the problems appear capable of solution. The real world is a different place altogether." -- James K. Galbraith, The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too, Free Press (2008): pp. 21 -22

I'm not sure that Galbraith contains much of that spontaneous wit that his father generally put in in about the fifth draft.

A Plague of Economists

What do economists think about Keynesian ideas, such as deficit spending in the midst of a great depression? Oliver Staley and Michael McKee report, "[James] Tobin's stamp is on the $787 billion stimulus signed by President Barack Obama, former students and colleagues say. His philosophies are influencing Austan Goolsbee, a former Tobin student advising Obama, and Ben S. Bernanke, head of the Federal Reserve. Unlike Friedman, Tobin provides guidance for today’s problems, said Paul Krugman, a Princeton University economist." Furthermore, "Bernanke cited Tobin’s 1969 essay on monetary theory in a 2004 paper discussing options available to the Federal Reserve for stimulating the economy when interest rates approach zero."

So economists are for it.

On the other hand, Will Wilkinson interviews Edward Prescott and Edmund Phelps. The idiot savant Edward Prescott says, "Stimulus is not part of the language of economics... There is an old, discarded theory that's been tried and failed spectacularly, which is where that language of stimulus comes from".

So economists are against it.

The Poverty of Economic Philosophy

Steve Keen brings to our attention a couple of attacks, based on the ongoing global economic crisis, on mainstream academic economics:

• A workshop report from David Colander, Hans Föllmer, Armin Haas, Michael Goldberg, Katarina Juselius, Alan Kirman, Thomas Lux, and Brigitte Sloth
• Anatole Kaletsky's editorial in a newspaper down under, I guess.

Davidson Writes A Letter

This is from last Sunday's (22 February) New York Times:

Paul D. Ryan repeats the tired idea that when the Federal Reserve prints money for the government to spend on economic recovery, the result will be inflation because "it is a situation in which too few goods are being chased by too much money." This is based on a false assumption that the output of the country will not increase when government lets contracts to business to produce more goods and services that will improve the productivity and health of our country.

If there is significant unemployment and idle capacity in the private sector (and who can deny there is?), then this deficit spending will not cause inflation. Rather, the "printed" money spent on a recovery plan creates profit opportunities that induce private enterprise to hire and produce more goods. Then there will be many more goods for this money to chase and no inflation need occur.
Paul Davidson
Boynton Beach, Fla, Feb 14, 2009
The writer is editor of The Journal of Post Keynesian Economics

Another Reswitching Example

1.0 Introduction
I have previously presented examples of reswitching and capital reversing. These phenomena were discovered as part of the Cambridge Capital Controversy, and you will occasionally see commentators bring up the CCC on various blogs. This post presents another example. This example has a different structure than my favorite models. In this example, not all commodities are produced with the aid of commodities. Some capital goods not explicitly shown are produced directly with unassisted labor.

2.0 Some Theory And An Example
Consider a firm choosing among a set of techniques for producing a given commodity. Each technique, as in Table 1, exhibits Constant Returns to Scale (CRS) and can be represented as a series of dated labor inputs. The first element in this series is the amount of labor that must be applied in the technique during the current production cycle to produce one unit of the commodity. The second element is the amount of labor that must be applied one cycle ago to produce the capital goods required for use by the first labor input in the series. And so on. This representation of a technique is known as a flow-input, point-output model.

Table 1: The Technology

Year Before Output	Labor Hired for Each Technique
	Alpha	Beta
0	33 Person-Years	0 Person-Years
1	0 Person-Years	52 Person-Years
2	20 Person-Years	0 Person-Years

Consider the the cost of producing a unit of output with a given technique, where the calculation of the cost is performed at the end of the year in which the output becomes available. The cost is the sum of the cost of the labor inputs over previous years, with the cost of each labor input including an interest charge:

L₀ w + L₁ w (1 + r) + L₂ w (1 + r)² + ... + L_n w (1 + r)ⁿ + ...

where w is the wage for a unit of labor, r is the rate of profits, and (L₀, L₁, L₂, ...) is the series of dated labor inputs representing the technique. The wage is paid at the end of the year for the labor expended during that year.

The best rate of profits (also known as the interest rate) available to the firm should be used in finding the cost of producing a unit of output with each technique. Since the only use of financial capital available to the firm here is to produce with one or another of the techniques of production, the best rate of profits is the rate of profits obtainable with cost-minimizing techniques. The following algorithm traverses the techniques to find the rate of profits associated with cost-minimizing techniques:

1. Choose a technique.
2. For the given wage w, find the rate of profits r that, when used to cost up the labor inputs, equates that cost to the price of a unit of the produced commodity.
3. Cost up the labor inuts for all techniques with this wage and rate of profits.
4. Choose a technique with the minimum of the costs found in Step 3.
5. If the technique for which the rate of profits was obtained in Step 2 can be selected in Step 4, stop. You have found a cost-minimizing technique and the rate of profits.
6. Else, go to Step 2 and repeat with the newly selected technique.

Figures 1, 2, and 3 illustrate the application of the algorithm to the example. Figure 1 shows the wage-rate of profits curves associated with each technique. In flow-input, point-output models, these curves never cross the axis for the rate of profits. Instead, the curves approach it asymptotically. Points at which such curves intersect are called switch points. The "perverse" or "paradoxical" switch point is at a wage of 1/78 units of output per person year and a rate of profits of 50%. The higher-wage switch point is at a wage of 5/286 units of output per person-year and a rate of profits of 10%. A switch point is called "paradoxical" merely because it illustrates behavior contradicting mistaken and outdated neoclassical beliefs. The algorithm can be considerably simplified:

Theorem: Consider a technology specified as a choice among techniques, where each technique is represented by a flow-input, point-output model. Let the outer envelope of the wage-rate of profits curves for each technique be constructed by finding the maximum rate of profits for each wage over all wage-rate of profits curves. For each point on the outer envelope, a technique in which the technique’s corresponding wage-rate of profits curve contains that point is selected by the above algorithm as a cost-minimizing technique at that wage.

Figure 1: Rate of Profits by Technique

The theorem is easily applied to the example. By the theorem, the alpha technique is cost-minimizing for wages between the switch points. The beta technique is cost-minimizing for wages below 1/78 units of output per person-year and between wages of 5/286 and the maximum wage of 1/52 units of output per person-year.

Now to show that the algorithm yields the same answers. Suppose one starts by choosing the alpha technique at Step 1. The rate of profits sought in Step 2 is read off the wage-rate of profits curve for the alpha technique in Figure 1, given the wage. The costs found in Step 3 are shown in Figure 2. Figure 1 shows that the alpha technique is, indeed, cost minimizing for intermediate wages, that is, between the switch points. If the wage is either too low or too high, the beta technique is selected in Step 4, as shown in Figure 2. According to Step 6, the flow of control in the algorithm then goes to Step 2 with the beta technique selected. Figure 3 shows the costs of the techniques using the rate of profits for the beta technique. Here too, the algorithm concludes with the same answer as suggested by the theorem.

Figure 2: Cost of Techniques at Alpha Rate of Profits

Figure 3: Cost of Techniques at Beta Rate of Profit

3.0 Conclusion
Once the cost-minimizing technique has been determined, one can consider how much labor firms will want to hire per unit output at any given wage. Figure 4, which is based on the assumption of a stationary-state output, illustrates this calculation for the example. If a firm is operating the alpha technique, for example, to produce an unchanged output over the next three years, workers producing consumption goods available at the end of the current year, producing capital goods to be used to produce consumption goods available at the end of the next year, and producing capital goods to be used to produce capital goods available at the end of the next year will all be working side-by-side. That is, 53 workers will be employed per unit output under the alpha technique for a stationary state. As the graph shows, around the switch point at the lower wage, a higher wage is associated with a cost-minimizing technique in which firms want to employ more workers for a given stationary-state output.

Figure 4: Labor Intensity of Cheapest Technique

So much for the theory that wages and employment are determined by the intersection of well-behaved supply and demand curves in the labor market.

The Undermining Social Democratic Downhill Slide...

"[Michael] Harrington was a 'democratic socialist', not a social democrat. Whereas social democracy endorsed the welfare state, democratic socialism expanded proletarian decision-making into every corner of society, including the workplace, thereby reversing capitalist priorites. In America, democratic socialism meant taking the New Deal beyond its first two stages [1930s and 1960s?]. By empowering workers, a 'Third New Deal' would complete the process begun in 1929, when control of key economic investments was passed from unfettered boardrooms to a capitalist-controlled welfare state." -- Robert A. Gorman, Michael Harrington: Speaking American, Routledge (1995)

Two Crises Of Economic Theory

The American Economic Association held their annual meeting in New Orleans in 1971. At the invitation of John Kenneth Galbraith, the AEA president that year, Joan Robinson delivered the keynote Ely address. She identified "The Second Crisis of Economic Theory".

The first crisis occurred in the 1930s. Economists had no theory, at the time, to guide policy for addressing the dramatic drop in the volume of output and the increase in unemployment. John Maynard Keynes, as well as Michal Kalecki, developed the theory to address this crisis.

As I recall, the second crisis of economic theory relates to the mix of goods being produced, even when the volume is such that more-or-less full employment is being achieved. Many of her time did not think the balance correct. Conspicuous consumption, positional goods, and the means of destruction are produced in abundance. But as for the production of amenities useful for modern life typically provided by government (e.g., public transportation) - not so much. Mainstream economic theory does not provide a perspective for a thorough-going improvement on what comes out of more-or-less capitalist markets.

Consider the context of Robinson's Ely lecture. Although she had already developed a theory of stagflation, she couldn't have known how poor western economies would perform over the next decades. So at the time of her lecture, the second crisis of economic theory might have been more readily apparent than the first.

It seems to me that both crises are evident today. The world's economic problems are not only how to get people back to work during this worldwide global downturn. We also need to reorient the world's economy to operate with more sustainable and renewable energy resources, encourage the production of more public goods in many economies, decrease the workweek, etc.

Reference

• Joan Robinson (1972) "The Second Crisis of Economic Theory", American Economic Review, Papers and Proceedings, V. 62 (May): 1-10

Empirical Evidence On Minimum Wages

A theme of this blog is that it is illogical to explain wages and employment by the interaction of well-behaved demand and supply curves in the labor market, even under assumptions of perfect competition, no information asymmetries, etc. Since orthodox teaching on the subject is simply incorrect, David Card's empirical results on minimum wages did not astonish me.

For those interested in these results, I notice that researchers at Berkeley have extended them. So this paper goes on my long list of ones to read some day:

"We use policy discontinuities at state borders to identify the effects of minimum wages on earnings and employment in restaurants and other low-wage sectors. Our approach generalizes the case study method by considering all local differences in minimum wage policies between 1990 and 2006. We compare all contiguous county pairs in the U.S. that straddle a state border and find no adverse employment effects. We show that traditional approaches that do not account for local economic conditions tend to produce spurious negative effects due to spatial heterogeneities in employment trends that are unrelated to minimum wage policies. Our findings are robust to allowing for long term effects of minimum wage changes." -- Amdrajit Dube, T. Wiliam Lester, and Michael Reich "Minimum Wage Effects Across State Borders: Estimates Using Contiguous Counties", working paper (2008)

In Honor Of The Day

Today is the bicentennial of Darwin's birth.

I think of evolutionary economics as equivalent to (old) institutional economics.

Clarence Ayres was one prominent institutionalist economist, maybe the most prominent of his generation. He ended up at the University of Texas at Austin and helped develop the Texas school of institutional economics. (James Galbraith is currently at UT.) Ayres most well known book is probably The Theory of Economic Progress, which I have not read. I have read The Divine Right of Capital, in which I found some echoes of Joan Robinson's capital critique, even though it precedes the relevant portions of her work.

But I want to point out that Ayres also wrote Huxley, a 1932 biography of Thomas Huxley, also known as "Darwin's bulldog". In 1860 Huxley debated Bishop Samuel Wilberforce:

"Turning to Huxley he inquired with a charming show of solicitude whether the scientist supposed himself to be descended from an ape on the side of his grandmother or his grandfather... And then [Huxley] delivered his famous counterstroke, the upshot of which is that ancestor apes are preferable to bishops."

Infinite Are The Arguments Of Mages

The following letter comes after five interchanges of letters between Keynes and Hayek and a summary letter by Keynes. Keynes was trying to get at what definitions of saving and investment Hayek was using, what Hayek meant by "forced saving", and why Hayek thought a constant proportion of the money in circulation must be saved to keep the capital stock at the same level. The date of this letter is 29 March 1932, and it is reprinted in The Collected Works of F. A. Hayek: Volume 9: Contra Keynes and Cambridge: Essays, Correspondence (edited by Bruce Caldwell, Chicago University Press, 1995):

Dear Hayek,

I will certainly reserve you space in this June [Economic] Journal for a reply to Sraffa. But let it be no longer than it need be. It is the trouble of controversy - from an editor's point of view - that it is without end. Your MS should reach me not later than May 1.

Having been much occupied in other directions, I have not yet studied your Economica article as closely as I shall. But, unless it be dealt with in isolation from the main issue, I doubt if I shall return to the charge in Economica. I am trying to re-shape and improve my central position, and that is probably a better way to spend one's time than in controversy.

Yours sincerely
J. M. Keynes

Economists As Creationists Who Have Never Heard Of Evolution

I found this quote amusing:

"One of Brad DeLong’s commentators compares what’s going on to the discovery that some eminent biologists are creationists, but it’s actually worse than that: it’s like discovering that some eminent biologists have never heard of the theory of evolution and the concept of natural selection." -- Paul Krugman

I am in agreement with, for instance, Krugman and DeLong that the U.S.A. government currently needs to spend a lot on a stimulus package. But I wondered if such more-or-less liberal economists acknowledge other controversies in economics. Have they heard factor prices (like wages) cannot necessarily be explained by the interaction of well-behaved supply and demand curves in factor markets, even under ideal assumptions of perfect competition, flexible prices, perfect information, etc? I don't know whether I want to put much emphasis on Brad DeLong's failure to note such in this post about immigration.

Simple And Expanded Reproduction

1.0 Introduction
This is a repost. I've switched templates, and the new one interferes with the layout of the mathematics in the previous version. I've made a few minor changes here and there.

This post presents a model in which a capitalist economy smoothly reproduces itself. The purpose of such a model is not to predict that capitalist economies will converge to some such path as illustrated in the model. Rather, the model provides a basis for the analysis of where things can go wrong.

This sort of model has a long history. My exposition is close to Marx (1956), with the difference that Marx sets out the conditions of simple and expanded production in terms of labor values, not in terms of prices of production. Rosa Luxemburg (1951) and Michal Kalecki (1969) used Marx's department break-down to develop a Keynes-like model of the long run and the short run. Shigeto Tsuru (1942) apparently exposed this model to english-speaking academics when few were looking at Marx's analysis. Paul Samuelson (1957) thought this model of interest. Joan Robinson (1962) drew on these ideas, among others, in her models of metallic ages. Goodwin's generalization (1949) of Keynes to a multisectorial model and Pasinetti's (1981, 1993) analyses of vertically integrated sectors also seem to me to bear family resemblances to this model. Doubtless, my references could be extended in many directions.

Table 1: Definition of Variables

Variable	Definition
a01	The person-years of labor hired per unit output (e.g., ton steel) in the first sector.
a02	The person-years of labor hired per unit output (e.g., bushel corn) in the second sector.
a11	The capital goods (measured in tons) used up per unit output in the first (steel-producing) sector.
a01	The capital goods (measured in tons) used up per unit output in the second (corn-producing) sector.
p1	The price of a unit output in the first sector.
p2	The price of a unit output in the second sector.
r	The rate of profits.
s	The savings rate out of profits.
w	The wage, that is, the price of hiring a person-year.
X1	The number of units (ton steel) produced in the first sector.
X2	The number of units produced (bushels corn) in the second sector.
g	The rate of growth.

2.0 Two Departments
This model considers a capitalist economy with no government and no foreign trade. The outputs of this economy are grouped into two great departments. In the first department, capitalists direct workers to produce means of production (also known as capital goods) with the means of production in that department. In the second department, the workers are directed to produce means of consumption (also known as consumption goods) with the means of production in that department.

For ease of exposition, I make certain additional simplifying assumptions. The workers consume all of their wages. Only the capitalists save, and they save only in the case of expanded reproduction. All capital is circulating capital. That is, there is no fixed capital, such as long-lived machinery. In other words, all capital goods are totally used up each year in producing the yearly output. No technological innovations are introduced.

I think introducing technological innovations and fixed capital makes the possibility of smooth reproduction more incredible. A government can be introduced as a third department, or perhaps by dividing government output among the two departments shown. Foreign trade introduces the possibility of correcting imbalances in domestic demand from outside the domestic economy. But then one could recast the model as of the world economy.

3.0 Prices
A necessary condition for smooth reproduction of a competitive capitalist economy is that the same rate of profit be made in all departments. Otherwise, some capitalists are finding that the expectations on which investments were made are being unfulfilled. They would want to have contracted some departments and expanded others. I also impose the condition that spot prices remain stationary. The following equations express these conditions:

(a₁₁ p₁)(1 + r) + a₀₁ w = p₁

(a₁₂ p₁)(1 + r) + a₀₂ w = p₂

I suppose one could put time indices on the prices in the above equations, thereby defining a dynamic system for prices. Suppose distribution and the ratios of physical quantity flows remain unchanged year after year. Then the steady-state prices expressed in the above equations (without time indices) would be a limit point of the dynamic process so defined. It is this caveat, I think, that allows me to ignore that constant prices are, perhaps, not a necessary condition for smooth reproduction.

Table 2: Value of Outputs by Department and Distribution

Department	Capital	Wages	Profits
Capital Goods	a11 X1 p1	a01 X1 w	a11 X1 p1 r
Consumption Commodities	a12 X2 p1	a02 X2 w	a12 X2 p1 r

4.0 In Balance
4.1 Simple Reproduction
The economy is in simple reproduction when it is replicated on the same scale year after year. A necessary condition for an economy in simple reproduction is that the production of capital goods each year be equal to the capital goods used up each year. In the model shown here, the value of the capital goods used up each year must equal the value of the output of the first department:

a₁₁ X₁ p₁ + a₁₂ X₂ p₁ = (a₁₁ X₁ p₁)(1 + r) + a₀₁ X₁ w

The above equation can be simplified:

a₁₂ X₂ p₁ = a₀₁ X₁ w + a₁₁ X₁ p₁ r

The above is easily summarized in words. It states that the value of capital goods demanded from the second department matches the demand for consumption goods from the first department. In a sense, this equation is a generalization of Keynes' idea of effective demand. The condition that all workers looking for a job are able to find one at the going wage is a separate condition, not stated here. This model generalizes Keynes' theory, in some sense, to the long-run.

An alternate method of deriving the last equation is available. Start from the equation of the value of total demand for consumption goods and the value of the output of the department producing consumption goods. This condition, when simplified, yields the same equation.

4.2 Expanded Reproduction
The economy experiences expanded reproduction when it consistently expands each year. In this case, the demand for capital goods from the second department includes the savings of the capitalists receiving profits from that department. Likewise, the demand for consumption goods from the first department excludes the savings of the capitalists in that department. Observing these qualifications, it is easy to mathematically express the condition that the demand for capital goods from the second department match the demand for consumption goods from the first department:

a₁₂ X₂ p₁ + s a₁₂ X₂ p₁ r = a₀₁ X₁ w + (1 - s) a₁₁ X₁ p₁ r

Or:

a₁₂ X₂ p₁(1 + s r) = a₀₁ X₁ w + (1 - s) a₁₁ X₁ p₁ r

Focus on the left-hand side of the above equation. Is it apparent that the rate of growth of the value of the capital goods in the second department is the product of the capitalists' saving propensity and the rate of profit? In expanded reproduction, under these simplifying assumptions, both departments and their components all grow at the same rate. In other words, the rate of profit along a warranted growth path is the quotient of the rate of growth and the saving propensity of the capitalists.

r = g/s

This is the famous Cambridge equation typically arising in a Post Keynesian theory of distribution, especially in, say, Luigi Pasinetti's version.

5.0 Conclusion
In the model, capitalists independently decide on what department to enter, and how much to produce in that department. A collective result of those decisions is the total output of each department. For those decisions to be validated, the value of consumer goods demanded by workers and capitalists in the department producing capital goods must match the value of capital goods demanded by the capitalists in the department producing consumption goods.

The model is silent on how such an equality can come about. Supply and demand seems like an inadequate answer to me.

References

• Richard M. Goodwin (1949). "The Multiplier as Matrix", Economic Journal, V. 59, N. 236 (Dec.): 537-555
• M. Kalecki (1969). Theory of Economic Dynamics: An Essay on Cyclical and Long-Run Changes in Capitalist Economy, Second Edition, Augustus M. Kelly
• Rosa Luxemburg (1951). The Accumulation of Capital (Trans. by Agnes Schwarzschild), Yale University Press
• Karl Marx (1956). Capital, Volume 2, Progress Publishers
• Luigi L. Pasinetti (1981). Structural Change and Economic Growth: A Theoretical Essay on the Dynamics of the Wealth of Nations, Cambridge University Press
• Luigi L. Pasinetti (1993). Structural Economic Dynamics: A Theory of the Economic Consequences of Human Learning, Cambridge University Press
• Joan Robinson (1962). Essays in the Theory of Economic Growth, Macmillan
• Paul A. Samuelson (1957). "Wages and Interest: A Modern Dissection of Marxian Economic Models", American Economic Review, V. 47 (Dec.): 884-912
• Shigeto Tsuru (1942). "On Reproduction Schemes", Appendix A in Paul Sweezy's The Theory of Capitalist Development, Monthly Review Press [This reference I haven't read]

Leijonhufvud's Corridor

The ideas of a number of economists have been cited in popular accounts of the current economic crisis.

Some have been calling this a "Minsky moment" and have been exploring the Post Keynesian economist Hyman Minsky. In building on this trend, Michael Perelman sees connections to Marx's views on fictious capital. I have pointed out Hugh Townshend basically describing (in 1937) the housing crisis as part of his account of

Another popular interpretation points to erroneous Austrian Business Cycle Theory. For some reason - probably political, although I'm willing to accept ignorance also - very few who go on about the ABCT bring up the Austrian concept of the "secondary depression". Yet this epicycle would seem to be precisely relevant as the crisis becomes a general downturn, instead of being more restricted to financial institutions.

Another interesting idea, although one I am not sure I agree with, is Axel Leijonhufvud's corridor. Leijonhufvud became famous for arguing "Keynesians" had misinterpretated Keynes. As I understand it, his interpretation is closely related to that offered by Robert Clower in his 1965 paper, "The Keynesian Counter-Revolution: A Theoretical Appraisal". Clower argues that households, in making consumption and savings decisions, are constrained by realized income, not by the income they would receive at a point of full-employment equilibrium. Clower and Leijonhufvud end up with thinking of Keynes as describing a disequilibrium. I think Keynes claimed to have described an equilibrium that could be consistent with the presence of involuntary unemployment.

I think Leijonhufvud developed his notion of the corridor later. The corridor constitutes time paths near enough to full employment. If the economy falls outside the corridor, agents no longer have well-developed norms and expectations about what happens that are mutually consistent and likely to quickly lead the economy back to full employment.

Influence Of Government Size On Income Distribution

I have been reading Philip A. Klein's Economics Confronts the Economy (Edward Elgar, 2006). He presents data in two tables that I thought, when combined, suggest relationships. So I drew the regression lines below. The data on income distribution is from 1998. Total government expenditures as a percentage of GDP is from 1999. Government expenditures include, for example state and local spending in the United States. The graphed data are for the United States, and, in order of decreasing percentage of government spending as a percentage of Gross Domestic Product, Sweden, Denmark, Belgium, Finland, France, Austria, Italy, Netherlands, Norway, Canada, Germany, New Zealand, the United Kingdom, Spain, Ireland, Australia, and Japan. Apparently, in advanced industrial democracies, as government spending directs a greater percentage of resources, the poorest have relatively more income and the richest have relatively less. One can see why the richest would like lackeys to fight the latter tendency.

Figure 1: Share of Income in Lowest 10% Among Developed Economies

Figure 2: Share of Income in Highest 10% Among Developed Economies

I haven't finished Klein's book, but I think I'll note two points I find of interest. He argues that when economists advocate for positive analysis of existing economies, they implicitly accept the status quo. This is a value judgement that could be contested. Secondly, when economists limit normative theory to Pareto-improving recommendations, they restrict themselves from commenting on such matters as income distribution and the quality of life of the vast population. (Moving along one of the regression lines probably makes some worse off.)

A Brouhaha

Some mainstream economics have been pointing out other well-known economists are simply incompetent. Among those doing the pointing are Paul Krugman and Brad DeLong. Robert Waldmann provides some background. (I'm not sure if this is Waldmann.) Mark Thoma comments. I think Uwe Reinhardt's post somehow fits in this grouping. Matthew Yglesias opts for believing the economists being pointed at are deliberately misleading, instead of merely stupid.

I was amused at the ignorance exhibited by a self identifed "UMN Econ Student" in the comments to Waldmann's post:

"The short of it, and this is coming from a Minnesota Econ PhD student, is that we try hard not to bullshit people by hiding our assumptions, no matter how ridiculous you may find them."

A canonical freshwater macroeconomic model is not merely a General Equilibrium model with perfect competition, perfect information, etc. It will also have a single representative agent and, in each period, a single homogeneous produced good that can be used either as a consumption good or as a capital good. What special-case assumptions on technology and preferences would one like to impose in a multi-good multi-agent model such that such a model behaves like a one agent, one good model? Economists have no answer.

The above posts are a selection. It is only in the comments that anybody points out that both saltwater and freshwater economists totally ignore Post Keynesians. I like this comment by A. Senderowicz.

Update: Somehow I missed Daniel's overview. Neil Sinhababu, at Ezra Klein's blog, has noticed this contretemps.

Samuelson Jests

I might as well document some jibes Kevin Quinn finds amusing. These are from two different articles from two different periods:

"I have dealt with Karl Marx the economist, not Marx the philosopher of history and revolution. A minor Post-Ricardian, Marx was an autodidact cut off in his lifetime from competent criticism and stimulus."-- Paul A. Samuelson (1957) "Wages and Interest: A Modern Dissection of Marxian Economic Models", American Economic Review, V. 47 (Dec.): pp. 884-912

"The 'transformation algorithm' is precisely of the following form: 'contemplate two alternative and discordant systems. Write down one. Now transform by taking an eraser and rubbing it out. Then fill in the other one. Voila! You have completed your transformation algorithm.'" -- Paul A. Samuelson (1971) "Understanding the Marxian Notion of Exploitation: A Summary of the So-Called Transformation Problem Between Marxian Values and Competitive Prices", Journal of Economic Literature, V. 9, N. 2 (June): pp. 399-431

"The truth has now been laid bare. Stripped of logical complication and confusion, anybody's method of solving the famous transformation problem is seen to involve returning from the unnecessary detour taken in Volume I's analysis of values. As I have cited in my mathematical paper, such a 'transformation' is precisely like that in which an eraser is used to rub out an earlier entry, after which we make a new start to end up with the properly calculated entry." -- Paul A. Samuelson (1971) "Understanding the Marxian Notion of Exploitation: A Summary of the So-Called Transformation Problem Between Marxian Values and Competitive Prices", Journal of Economic Literature, V. 9, N. 2 (June): pp. 399-431

Samuelson refers to:

• Paul A. Samuelson (1970) "The 'Transformation' from Marxian 'Values' to Competitive 'Prices': A Process of Rejection and Replacement", Proceedings of the National Academy of Sciences, 67(1) (Sept.): pp. 423-425.

As far as I know, no economist responded to Samuelson’s paper in the 1950s. He had reaction in the 1970s. The JEL published replies by Abba Lerner and Michio Morishima; an editorial comment by Mark Perlman; an analysis by Martin Brofenbrenner of submitted but unpublished reactions by Gordon Bjornson, Jean Cartelier, Bruno Jossa, David Laibman, Paul Massick, and Murray Wolfson; a paper on Marx by William Baumol; and responses by Samuelson, including an interchange with Joan Robinson. I suggest the difference in the number of reactions has something to do with events in non-academia. Perhaps the sixties had some impact on the algebra in which some economists were interested.

Krugman Correct

More than a decade ago, Paul Krugman characterized Austrian Business Cycle Theory (ABCT) as "The hangover theory":

"It is the idea that slumps are the price we pay for booms, that the suffering the economy experiences during a recession is a necessary punishment for the excesses of the previous expansion"

The other day, Steven Horwitz, one of the leading advocates of ABCT offered the following analogy for economics:

"the mistake is drinking too much and being hungover is the correction."

(Steven Horwitz is the secretary and webmaster for the Society of the Development of Austrian Economics and manages to get letters to the editor published in the Watertown Daily Times. Myself, I read the Lowville Journal & Republican if I want to know who is growing the largest pumpkin and who has been visited over the weekend by their children away at college.) I think my critique of ABCT goes more into the nuts and bolts of the theory.

Elsewhere, Krugman adopts a Post Keynesian point:

"I should also point out this, in [Robert] Barro’s article:

'John Maynard Keynes thought that the problem lay with wages and prices that were stuck at excessive levels. But this problem could be readily fixed by expansionary monetary policy, enough of which will mean that wages and prices do not have to fall.'

Is it too much to ask that someone criticizing Keynes actually, you know, read Keynes — at least enough to know that he devoted a whole chapter to explaining why a fall in wages would not expand employment?"

Hart and Zingales, Stupid or Dishonest?

On 3 December 2008, Oliver Hart and Luigi Zingales wrote on the funny pages of the Wall Street Journal:

"This year will be remembered not just for one of the worst financial crises in American history, but also as the moment when economists abandoned their principles. There used to be a consensus that selective intervention in the economy was bad."

What kind of principle of economics is this that tells us what policy should be?

It is obviously untrue that any such consensus existed. Corporations for which their owners have limited liability could not be founded without a selective government intervention in the economy. Any legal protection for Intellectual Property, such as any non-zero period for copyrights and patents, is a selective government intervention. The existence of the Federal Reserve is a selective government intervention. Furthermore, economists have had no consensus for decades on claims that monetary policy is ineffective or that the monetary authorities should conform to the Cassels/Friedman rule of growing the money supply at a constant rate. Bankruptcy law, including its recent tweaking against the interests of debtors, is a selective government intervention. Hart and Zingales demonstrate, with the balderdash in their first paragraph, that they have not given a serious moment's thought to the theory of the firm, industrial organization, or macroeconomics.

What has been demonstrated is, in general, orthodox economists are willing to serve as lackeys to the malefactors of great wealth. (I could pick many more examples.) What effect on elite opinion does this willingness of supposed academic experts to teach nonsense in the news organs of the affluent have, do you think?

A Theory of the Rate of Change in Exchange Rates

1.0 Introduction
I created this model by thinking about what would happen if no basic commodity existed, and yet no commodity could be produced with unassisted labor alone. That is, suppose (seed) corn can be used to produce corn, and rice can be used to produce rice. But corn does not enter either directly or indirectly into the production of rice. Nor does rice enter either directly or indirectly into the production of corn.

The mathematical problem posed by these thoughts can be set out in a model of two countries trading. I end up with an explanation of relative rates of currency appreciation across countries by the interaction of technology and the distribution of income - class struggle, if you will - in each country. I think this model illustrates that non-mainstream ways of thinking about economics can suggest new models and new insights.

I don't claim originality for this model. I was re-reading Samuelson (1957) to confirm my impression that that is where Samuelson describes Marx as "a minor Post-Ricardian". (I'm fairly sure Samuelson sets out his eraser algorithm in his 1971 JEL article.) I did not recall that Samuelson had set out a Marxist scheme of reproduction in his 1957 paper, albeit with a poor supply and demand interpretation. Anyways, I stopped at this passage:

"Without going into the social relations of the past or future, any economist... can evisage a case where Industry III [luxuries] alone, by virtue of having a₃ = 0 and b₃ < 1 will determine its own-rate of profit by itself, and he will realize that if this new r differs from that of (11) what must give is not bourgeois economic theory or the capitalistic institutional economy but rather the assumption of stationary relative prices." -- Paul A. Samuelson (1957)

This quote jostled my memory of a Joan Robinson review of Sraffa's book. I also dimly recall Keynes' 1923 analysis of arbitrage in forward trades in international currency markets and expected rates of inflation. I'd have to review whether one of the papers collected in Steedman (1979) sets out something like this model. I don't recall any conclusion as simple as the one I obtain, but I think there must be something like this in older Marxist models.

2.0 The Model
Consider two countries, each producing one of two commodities, corn and rice. The commodity produced in each country is a basic good in that country's economy. Assume no migration of labor is possible between the countries. Hence, wages can vary across economies. Assume, however, that no barriers to international flows of (financial) capital have been erected. Thus, a tendency exists for the same rate of profits to arise across countries, where financial outlays and revenues are calculated in some common abstract unit of account.

Without loss of generality, assume the price of corn is always one dollar per unit. The price of rice is one yen per unit. And the exchange rate at the start of the year is one yen per dollar.

These assumptions allow one to formulate equations for the prices of production in a common unit of account, for example, dollars. In the corn-producing country, prices of production satisfy the following equation:

a_c,c (1 + r) + a_0,c w_c = 1

where

• a_c,c is the amount of corn needed as input per unit corn produced
• a_0,c is the person-years labor needed as input per unit corn produced
• w_c is the wage in units corn in the corn-producing country
• r is the rate of profits

I here follow Sraffa's approach of regarding the wage as being paid at the end of the cycle of production. Given the assumptions, both sides of the above equation can be considered as being expressed in terms of dollars per unit corn produced. The rate of profits shows how many dollars are returned for each dollar invested.

The remaining equation specifying the model relates the revenues, in terms of dollars per unit rice produced, to costs in the rice-producing country. That equation is:

a_r,r (1 + r) + a_0,r w_r/p = 1/p

where

• a_r,r is the amount of rice needed as input per unit rice produced
• a_0,r is the person-years labor needed as input per unit rice produced
• w_r is the wage in units rice in the rice-producing country
• p is the exchange rate of yens per dollar at the end of the year

The above equations express the idea that the capitalists are indifferent between investing their dollars in producing corn in the corn-producing country or producing rice in the rice-producing country.

One can easily solve the above equations for the exchange rate at the end of the year:

p = [(1 - a_0,r w_r)/a_r,r]/[(1 - a_0,c w_c)/a_c,c]

The left-hand side of the above equation is ratio of the exchange rate at the end of the year to the exchange rate at the start of the year. The right-hand side is the quotient of two ratios, each ratio characterizing one of the two countries. These are the ratios of the net product remaining after compensating the workers for their labor power to the outlay needed to produce that surplus.

3.0 Conclusion
This model suggests that the smaller the rate of surplus value the capitalists are able to extract from the workers in a given country, the stronger their currency tends to become.

Update: I originally had the conclusion incorrect.

References

• John Maynard Keynes (1923) A Tract on Monetary Reform
• Paul A. Samuelson (1957) "Wages and Interest: A Modern Dissection of Marxian Economic Models", American Economic Review, V. 47, N. 6 (December): pp. 884-912
• Paul A. Samuelson (1971) "Understanding the Marxian Notion of Exploitation: A Summary of the So-Called 'Transformation Problem' Between Marxian Values and Competitive Prices", Journal of Economic Literature, V. 9, N. 2: pp. 399-431.
• Ian Steedman (editor) (1979) Fundamental Issues in Trade Theory, Macmillan

Samuelson on Hayek

Barkley Rosser, Jr., has published a piece by Samuelson on Hayek in the current issue of The Journal of Organization and Behavior, as well as an article, by Andrew Farrant and Edward McPhail, about a dispute between Hayek and Samuelson. I here record some thoughts by Samuelson in justifying his tone in an earlier article on Sraffa:

"If a scholar in his ninth decade is to record his considered opinions on an important topic, it had better be a matter not of when but of now... Dr. Samuel Johnson said that being hung in the morning greatly clarifies the mind. Nonsense. It is more likely to paralyze coherent thought. True though that as the days grow shorter, one does dispense with nice diplomancies and ancient jockeyings for victory." -- Paul A. Samuelson, "Sraffa's Hits and Misses", in Critical Essays on Piero Sraffa's Legacy in Economics (edited by Heinz D. Kurz), Cambridge University Press (2000)

Anyway, a number of bloggers have reacted. I noticed Tyler Cowen, Brad DeLong, Peter T. Leeson, Mark Thoma, and Barkley Rosser himself.

The comments sections for these posts is of varying length. I'm in the one on Rosser's co-blog. In discussing Hayek's contribution to the socialist calculation debate on Thoma's blog, Rosser brings up Jean-François Revel's The Totalitarian Temptation. I haven't read this book in decades. I'd have to reread it to see if Revel predicted the fall of the Soviet Union.

I also want to point out Chris Dillow's comments on Keynes' anti-semitism. I don't think much about Sraffa being of Jewish descent; Sraffa angered Mussolini directly anyways, what with his reporting on Italian banking in the December 1922 issue of the Guardian and Sraffa's support for Gramsci. I had known about Keynes' support of Sraffa, including intervention with the British government to obtain his release from internment. Dillow points to documentation of more broad-based support of Keynes for Jewish refugees. (I've previously linked to some other post on that month's discussion on that list.)

Economists Without Ethics

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

School Rankings

I have been reading Philip A. Klein's Economics Confronts the Economy, which I purchased in the Strand, several weeks ago. This 2006 book is an institutionalist critique of mainstream economics. At one point, Klein wants to establish that mainstream economists at the best schools are, for the most part, no longer taught, for example, the history of economic thought. He provides the following list of schools:

1. University of Chicago
2. Harvard
3. MIT
4. Princeton
5. Stanford
6. Norwestern
7. Yale
8. University of Pennsylvania
9. University of California at Berkeley
10. University of California at Los Angeles
11. University of Wisconsin
12. Columbia
13. University of Rochester
14. Cornell
15. University of Minnesota
16. University of Michigan

I don't know the basis of Klein's ranking. If one were to ask me which schools in the U.S. are considered the most prestigious among mainstream economists, I might have named seven from this list. Maybe Northwestern is higher than I expect, and Columbia is lower. I suppose one could offer further quibbles

Does Depression, V. 2, Require Economists To Reconsider Theory?

Jeff Madrick reports little sign of the consideration of this question at the AEA/ASSA conference last week. Yves Smith comments on this question, and points us to a paper by Daron Acemoglu. I have yet to read Acemoglu's paper. Steve Keen makes a case for such reconsideration. (I wrote this post before reading this particular bit from Keen.) Peter Boettke asserts current events cannot challenge laissez faire economic policy because laissez faire has yet to be tried.

Hicks Invents Arrow-Debreu Model Of Intertemporal Equilibrium

"It is possible, at the other extreme, to conceive of an economy in which, for a considerable period ahead, everything was fixed up in advance. If all goods were bought and sold forward, not only would current demands and supplies be matched, but also planned demand and supplies. In such a 'Futures Economy' ... plans would be co-ordinated; and, for practical purposes, expectations would be co-ordinated too. (The price which would govern a firm's planned output for a particular future week would be the futures price, and not its own individual price-expectation.)" -- J. R. Hicks, Value and Capital: An Inquiry into Some Fundamental Principles of Economic Theory, Second edition, Oxford University Press, p. 136

Hat tip to Pierangelo Garegnani.

A Troll Is A Trail

"[Miss Ingram] entered into a discourse on botany with the gentle Mrs. Dent. It seemed Mrs. Dent had not studied that science: though, as she said, she liked flowers, 'especially wild ones;' Miss Ingram had, and she ran over its vocabulary with an air. I presently perceived she was (what is vernacularly termed) trailing Mrs. Dent; that is, playing on her ignorance--her trail might be clever, but it was decidedly not good-natured." -- Charlotte Bronte, Jane Eyre, Chapter 17

The Meaning Of A Word Is Its Use In The Language

The economy is never in equilibrium, or so many heterodox economists say. Being a Joan Robinson fan, I'm likely to agree. To understand the implications of the idea, and the use and abuse of equilibrium analysis, one must understand what economists mean by "equilibrium".

Tyler Cowen and Richard Fink provide an example of abuse, that is, a confusion about the implications of the economy not being in equilibrium. In the following passage, Cowen and Fink explicitly put aside income effects, false prices, strategic behavior, etc.:

"all that the Rothbard-Mises analysis implies is that there is a tendency towards equilibrium in a world with frozen data. Of course, this implies little or nothing about whether there is a tendency towards equilibrium in a world where the data are not frozen. All that [Evenly Rotating Economy] theorists are saying is that, if we freeze the disequilibrating forces, then the equilibrating forces will prevail. But on this basis we may likewise assert a tendency towards disequilibrium. By allowing the data to change just as it does in the real world, and 'freezing' all individual learning, we can demonstrate that the economy would degenerate into a series of successively less-coordinated states of disequilibrium. However, this would clearly be an illegitimate proof of a real world tendency towards disequilibrium..." -- Tyler Cowen and Richard Fink, "Inconsistent Equilibrium Constructs: The Evenly Rotating Economy of Mises and Rothbard", m V. 75, N. 4 (Sep. 1985): 866-869

(Hat tip to Matthew Mueller.) If there were a tendency, with frozen data, towards a ERE, the time path of the ERE corresponding to the data at each moment of time would show the tendency of the economy as a function of time. This is not the only point at which Cowen and Fink are confused.

What economists mean by equilibrium is not a simple question. Economists use the word "equilibrium" in many ways. The number of such ways has proliferated with the development of game theory. In this post, I compare and contrast only two uses of the word "equilibrium". And I think I don't fully explicate even these two uses.

The economy can be said to be in equilibrium when the following two conditions are met:

• The quantity supplied equals the quantity demanded of all commodities with positive prices
• The quantity supplied does not fall below the quantity demanded of all goods with zero prices.

This definition is specific to a particular neoclassical theory (or model).

Another definition comes out of the mathematical abstraction of a dynamical system. A dynamical system specifies how state variables change at any momement of time as a function of the location in state space. For example, a system of differential equations can define a dynamical system:

dx(t)/dt = f(x(t))

A limit point is a location, x, in the state space such that that location does not change with respect to time as function of the system dynamics. In other words, f(x) is zero at a limit point. Certain loci, other than the set of limit points, are of interest in dynamical systems. I am thinking specifically of limit cycles, strange attractors, and non-wandering sets. Consider a model of the economy as a dynamical system. The economy is in equilibrium, by a dynamical systems definition, when it is at a limit point.

The definition of equilibrium as equating supply and demand can be read as a special case of the definition of equilibrium as a limit point in a dynamical system. The tâtonnement process is a model of a type of dynamical system. Equilibrium, in the sense of a limit point in this system, is equilibrium in the sense of no excess demand for goods.

But Keynes can be read as suggesting the dynamical system definition of equilibrium need not equate supply and demand, particularly in the labor market. That is, Keynes' view of the possibility of the existence of an equilibrium with unemployment is more general and points to a non-neoclassical theory of prices.

Debauched By Economics

The following is a letter Sraffa sent to Robinson in 1936:

King's College, Cambridge
27.10.36

Dear Joan

Many thanks for your letter – it is a valuable addition to my museum and I shall hang it next to an extract from Sidgwick where, after lecturing Ricardo on how meaningless it is to talk of a quantity of labour, goes on cheerfully himself to talk of quantities of utility.

If one measures labour and land by heads or acres the result has a definite meaning, subject to a margin of error: the margin is wide, but it is a question of degree. On the other hand if you measure capital in tons the result is purely and simply nonsense. How many tons is, e.g., a railway tunnel?

If you are not convinced, try it on someone who has not been debauched by economics. Tell your gardener that a farmer employs 10 men – will he not have a pretty accurate idea of the quantities of land and labour? Now tell him that he employs 500 tons of capital, and he will think you are dotty – (not more so, however, than Sidgwick or Marshall).

Yours
P.S.

This Is Not A...

...mural by Diego Rivera. This mural, from which Figure 1 is a detail, replaced one by Diego Rivera. John D. Rockefeller, Jr., was displeased by the commie imagery in Rivera's mural.

Figure 1: Detail Of Jose Maria Sert's American Progress at Rockefeller Center

I also had a chance to see a cubist painting by Rivera, at the Musuem Of Modern Art. In general, I am not a fan of cubism.

Figure 2: Diego Rivera Painting at MOMA

I deliberately did not stay in New York City over new year's eve.