Neoclassical economics

I came across this really helpful paper on the underlying premises which are common to all neoclassical theories of economics. The authors attempt to lay bare the unquestioned assumptions, and to show why they arose, and why they are unacknowledged. In doing so they show why it is necessary to reconnect this set of axioms with a wider intellectual discourse, and also why there is fierce resistance to doing that. I think this is very well worth while reading.

www.paecon.net/PAEReview/issue38/ArnspergerVaroufakis38.htm

The paper touches on many of the things which I have been trying to think about in this section and more widely. The authors propose three fundamental assumptions which form the foundation of the neoliberal world view: what I have been calling their "theory of human nature".

1. Individualism
2. Instrumentality
3. Equilibration (which is a horrible word, but means the tendency to reach and maintain a state of equilibrium, as discussed in other threads)

In reading this paper it occurred to me that it is very useful to think about whether we actually accept those propositions as a fair description of how things work, which is the authors' point: and also to think about why they have such power in debate (which they also mention). There are clear links with the "anti philosophy" tendency so common in scientism: and also to the intrinsic necessity of some such set of assumptions if economics is to wear scientific clothes (also previously discussed)

The recognition that these positions need not be crude, and are therefore not easily displaced by simple characterisation is to me an important insight. But the circularity of the more sophisticated versions is nicely described and this paper forms a good starting point for thought

I came across a paper by someone called Tony Lawson which I thought was interesting. It is a pdf file and so I am not able to link it, since I don't know how. But I will say something about his analysis because I think he elaborates a number of things I have been thinking about in quite an interesting way

Mr Lawson points to the failure of neoclassical economics to describe and predict real world outcomes. He says this is now widely acknowledged within the economics profession and that a great deal of soul searching is going on within academia because of the financial crash and its implications for the subject.

He goes on to consider the "heterdox" (which is the name for those economists who do not accept the neoclassical position) criticism which is often based on charges of ideology: a position I have also taken. According to Mr Lawson those criticisms can be boiled down to two different strands. In the first the neoclassical economists are said to be "swimming in their water", that is they are unable to see and to question the assumptions of capitalism.Those assumptions are therefore taken as read and the enterprise begins from that base. The other strand is that the economists are in fact aware of those premises and are actively promoting and defending the status quo. Mr Lawson does not accept either of those propositions and he lays the failure elsewhere.

What he is essentially saying, if I have understood him correctly, is that the ideology which underpins the failure of economics is the "scientism" I have referred to before. He asserts that the true problem is reliance on mathematical modelling and he goes further: from his point of view the models are not even intended to describe the real world: they are an exercise in themselves. According to his analysis both the neoclassicist and the heterdox economists are convinced that the maths is essential and their point of difference is which model. He suggests that the answer is "no model", and that other ways of approaching the subject are required. I agree with that. It does not just apply to economics it applies to the whole of so-called social science, and I need not rehearse an argument I have made many times before in this thread.

I agree with Mr Lawson so far: but where I part company with him is the "Werner von Braun" element in his analysis. From his point of view mainstream economics is irrelevant to policy and real world behaviour: he goes so far as to say that it is that very irrelevance which has allowed it to continue because, he says, it does not challenge any political position. That being so nobody bothers to challenge or to attack its funding.

From my point of view that is not true. However unengaged some academic economists might be; however much they may concentrate on gettng sunlight out of cucumbers, the fact remains that neoclassical models are used to justify particular political positions. It is also true that the "revolving door", and the corruption of academia through private sector funding and through lucrative "consultancies" in both corporations and in government, makes his case unsustainable. At least that is how I see it.

Further to this critique of neoclassical economic theory, this is a rather savage indictment of the field.

http://thewildpeak.wordpress.com/2012/07/26/887/

This author's proposition is that in the days of Smith and Ricardo and Hume etc, all economists were "political economists". They were practical people who were concerned with the real world, and they were aware of the consequences of our economic decision making on people's lives. Thus you get Adam Smith warning about the dangers of unfettered power for the wealthy etc.

As other authors have noted, that changed, and economics. along with other studies of humanity (and indeed most of us in the western world) became bedazzled by the success of the natural sciences. The scientific method is phenomenally useful for somethings: in its ideal form it is a very good way of approaching any problem which can me made amenable to its methods, and its range is greater than we could have suspected when it was being developed. But it is not unlimited, and overgeneralisation has become part of the problem. Most of the so called social sciences have made very little progress in the last century: and I believe that is because they are trying to ape the means and success of hard science in fields where that is not helpful or even appropriate.

Like Mr Lawson, the author linked here sees the genesis of the problem in that shift from "political economy" to an economics limited to science and maths. But he goes rather further: for this author charges that, in seeking to follow a scientific method, economics adopted a conception of economic activity which was based on Newtonian physics. Newtonian physics does not even work in large parts of physics, though it is very useful in some areas. But it has this crucial feature: we are all familiar with the notion of "modelling" and we know that this is a process whereby we exclude a number of real world features so that we can study the thing we are interested in. So, for example, we assume that there is no friction when we want to consider the interactions of force and mass. That is handy and produces useful insights: but it depends on being right about two things: first you have to know what is relevant to what you propose to study: and second, your ideal model must yield falsifiable predictions in the real world. Those interact: if the predictions do not pass the real world test your model is wrong and you must revisit the hypothesis. That is the central feature of hard science, at least according to Popper. That is what is missing from all of the social sciences: nothing is ever comprehensively disproved and abandoned, because the other essential: the "crucial experiment" is not available: it is either unethical, or the phenomena studied are too complex for identification and control of all the variables. That may not always be true: we may develop a mathematics capable of handling the complexities: but we do not have it yet and I am apt to think we never will. I think we need a new (or old) paradigm.

Be that as it may the important point about this article is his identification of much of the neoclassical theory with newtonian mechanics: because it does seem to have many features of that system, not least the notion of "equilibration" mentioned in the OP. As important is his observation that in adopting that approach economics has done something never seen in real world physics: it has taken time and space out of the picture, in the same way as friction is removed when we derive the law F=MA. I have mentioned in an earlier post that we can only ignore things when we know when and how they are relevant; else our predictions will be wrong. For many practical purposes we can ignore the difference between mass and weight, for example: but only because we know both exist, and we know when the distinction matters.

According to this author there are economists who recognise this: but they are not mainstream and they are not the ones influencing policy.

For examples of the kind of thinking which arises from these assumptions one need look no further than the IMF. I have been reading about "safe assets" and that is a topic which has interesting ramifications in itself. But here I just want to show the sort of language which serves to confirm those of us who are not economists in the view that it is all too complicated. So I am using the summary of their paper about safe assets as illustration of what I think is the problem. This is the document

www.imf.org/external/pubs/ft/gfsr/2012/01/pdf/c3.pdf

In the first paragraph it states that


What are we to make of this? It appears to say that sovereign debt was in the past presumed to be a risk free investment. That is interesting in itself: because the question then arises why they are a source of profit for the private investor. Vninect has questioned the idea that these people deserve their rewards because they are "risk takers": but if their money goes into a completely risk free instrument, there can be no possible justification for those rewards, can there? What the investor is doing is putting his money in the bank, effectively. When I put money in the bank I get some interest, and that is because the bank, in theory, uses my money (which is a loan to the bank) to make other loans to other people, and it charges higher interest than it pays me: that is where the profit comes from. What I do not do, is trade my bank book in order to make more money than the interest I get from the bank. How could I? As I see it, if I have surplus money I can put it into investment vehicles, which are risky but possibly profitable, if I guess right: or I can put it into the bank to keep it safe. I will get less but I will get certainty. Assuming the banks are safe, that is a trade off we are all familiar with, surely?

If I have enough surplus and I can lend to the bank for a long time I get more interest: that is because it is more use to the bank in terms of their own lending. That is sort of peculiar as well, because short term borrowing often costs more than long term borrowing. If we still think of money as somehow a commodity, then my long term deposit goes out to a long term borrower (say on a mortgage) and the return is relatively low: but the bank still makes a profit presumably, so the interest on my money is still lower than the bank gets from the mortgage it has advanced: and it gets that income for a long time. It can't lose because the mortgage is a secured asset, and so this part of the banking system is, or should be, the basis for seeing them as safe in the first place. If they take my long term deposit and lend it out for short periods unsecured (say on a credit card) they take the risk of losing some of it: but they charge enormous interest and make sure that covers the normal rate of default. That is the banker's skill.

So how does it come about that something which is equivalent to putting money in the bank becomes a source of profit? Well it is used as collateral. If I have put my money into a deposit account which only yields the higher rate of interest because I have promised to leave it there for 10 years, it might happen that I was wrong when I decided I did not need that money for 10 years: something might happen so that I do need it. If I close the account I will typically lose money (if I can do it at all): but someone else will lend me money because I have that account, and I will probably lose less if I do it that way. What I cannot do is sell my deposit account: because it is tied to me. Government bonds are not like that: they are not issued to individuals, they are redeemable by anyone. So they can be sold. If you sell them in those circumstances you save the interest on the loan you would otherwise take out: and forego the interest you were getting. Probably makes sense for you. But note that the bond is not now collateral. So what is it?

The paper says that "safe assets" wear a number of hats


That is one definition of money, as it happens: so the bonds become money at least in some circumstances.

You then have to consider why people buy and sell money: it is a strange concept, however you look at it. For you and I, we do it if we are going on holiday to a place where the money is different from our own: we buy dolllars in exchange for pounds, if we are going to america, for example. We lose on the transaction: always. If the rate of exchange is stable there is still commission for the person who makes the swop for us: and that is understandable. Stable exchange rates are a central aim of the IMF but of course those rates do vary from day to day: that is reported every day in the financial media. For you and I it means that sometimes when we go on holiday our holiday is cheap: sometimes expensive. That is really our only direct contact with this: but it is a source of profit for currency market traders, who can make millions buying cheap and selling dear.

One of the things which occurs to me about this is that the introduction of the euro reduced the scope for such profits: there were fewer currencies and so fewer opportunities to speculate in and on those currencies. There is a long history of such speculation and they have had profound effects on the real world: forced exit from the ERM was one example in the UK. One can argue that this was not pure speculation but just the actions of smart individuals who understood the realities of national economies and forced governments to face up to those realities: and that is a commonly told story. Or you can take the view that already markets were more powerful than national governments and that they made the weather: it was a self fulfilling prophecy in that view: and not a risk at all. That presupposes that the markets have more wealth than governments and that some individuals or corporations can use enough of that wealth to force an outcome: given that about half of the wealthiest bodies in the world are now corporations and not governments, that is at least plausible.

So I wondered about the fact that since the introduction of the euro,the focus has shifted from currency to sovereign debt. It seems to me that this is just more of the same. Money was not a "safe asset" before and profit was to be made because of that. In the euro that opportunity is gone, but it has been seized back through shifting the same process to government bonds.

When speculators attacked currencies they targetted one at a time: again it can be argued that this was based on a real appreciation of economic realities for the country involved and in that sense was not primarily focussed on profit at the expense of the people: that was just a side effect. I don't believe that, really. The reason I don't is that I cannot see any reason for the current attacks on sovereigns: as noted before, there is no real evidence that the problems we face are a consequence of government debt: at least not in the case of Spain or Italy. The problem is the banks, and so it would seem more logical for the markets to attack them. Bank borrowing costs should be through the roof: and indeed the LIBOR scandal is partly due to the fact that banks would not lend to each other at any price: so that seems to have some validity. Yet the cry is that this is a liquidity problem, not a solvency problem: and so sovereigns have lent very cheap money to the banks through taking over their debts; or through buying back bonds already issued (QE). This is because they are too big to fail. But with the debt transferred to the sovereigns it now appears that countries are not "too big to fail". And in all of this fortunes are made through the charging of ever increasing interest on government debt.

Which brings me back to the language in the summary linked.

Note this bold assertion


As we see, the billiard ball theory is alive and well in the IMF. But think about that. We are talking about the safety of assets here: in what universe is safety a function of supply and demand? A thing is either safe or it is not, surely? Perhaps what they mean is that the amount we are prepared to pay for safety is limited: that is true. We could probably make every car on the road a lot safer than it is: but it would cost a lot. So we trade off safety and price in many areas. Vninect has also talked about this in the context of crash helmets in ice hockey. And as he noted, regulation is required to reach a reasonable outcome. And there is nothing wrong with that at all. But for the IMF such regulation is called "market distortion". It is true that in the saner parts of the economic world it is acknowledged that "market distortion" can be a good thing: but in neoclassical economics it is a boo word.

It is quite interesting to note that the ratings agencies are not seen as a market distorter: they are merely objectively reporting the risk attached to various assets, in this narrative. That they did not accurately assess that risk and in fact were heavily involved in the crash for that very reason does not change this perception in any way. They were wrong and their ratings caused assets to be overpriced: but that is not "market distortion" apparently: and we are to continue to accept their judgements despite this abject failure. But when, in face of the consequences of that market failure to accurately price risk, we decide to demand more security or collateral for a given risk, that is market distortion. Excuse me if I tend to feel I am through the looking glass again. The market quite clearly did not "price risk efficiently": that is why we are where we are. Certainly there was some regulation so it can be said the market was not perfectly free: but the failure to price risk efficiently was inversely correlated with the level of regulation, so far as I can see. Correlation is not by definition causal: but it often is, as it happens. It would be folly to assume that it is not in this case: yet that is precisely what this piece implies.

And so we come to the conclusion of the piece: which is that better regulation, in the form of a demand for better collateral for the risks, will cause instability of itself. This is because there is a shortage of safe assets. And that is because the market and the ratings agenies say so. Assets previously seen as risk free are not: and so the supply has reduced. Regulation will increase the demand: so the price will go up. Apparently, in this case, that is not to be allowed. They say


And in face of that horror they recommend that


This is like saying that the trade off between the safety of bikes and the price of bikes cannot be altered too quickly: and if it is a matter of marginal adjustment you can see the point. It conveniently ignores the fact that these particular bikes do not occasionally suffer a brake failure: rather they frequently cause nuclear explosions in ordinary use. What do you think policy response should be?

As always with the IMF their recommended longer term solutions involve more austerity for the ordinary people; and more privatisation

But they are doomed to failure if they believe their own nonsense: because what they say they are trying to achieve is


That is bucking the market which they tell us cannot be done. in another part of the forest.

http://mainlymacro.blogspot.co.uk/2012/08/...s-bad-name.html

This is a blog post from Simon Wren Lewis, who is an academic economist. According to him, two very famous economists have prepared a paper for Mitt Romney's american presidential campaign and they have apparently deliberately misled people in their discussion of the effect of "stimulus" in that country.

There can be no more damning indictment of economists, and it further confirms my view that there is no actual content to what passes for this "discipline".

If you want to see the kind of thing that economists get up to I have seen no better example than this

ftp://147.52.239.100/students/master/macro...0%281972%29.pdf

It is a paper from a neoclassical economist and it a reasonable illustration of how they go about their business. The phrase "mental masturbation" comes to mind.

It is obvious that in constructing a model one must simplify. It is equally obvious that to exclude everything that doesn't suit you is cheating. That is what this paper does. It is the epitomy of working backwards from a conclusion, so far as I can tell. And this kind of thing underpins real policy choices made in the real world.

I know it is tempting: but no, don't shoot yourself. It will suffice to ensure that nobody with any real power listens to such stuff: and unemployment for the perpetrator should swiftly follow on the basis of some "utility" function which we can no doubt derive ......