A code of ethics doesn’t go far enough

I am travelling for most of this week with a very disrupted working routine – in between commitments. So this blog is shorter than usual and also somewhat unfinished in its conception. But the topic is the current call for the American Economic Association to introduce a code of ethical conduct for professional economists in the light of revelations in recent years about the abominable behaviour that many (academic) economists have displayed where they provide expert opinion in public in their guise as an independent economist but at the same time are being paid stipends of one form or another by corporations who would be affected by policy changes that the economists are talking about. This is usually in the context of such economists calling for more extensive deregulation. My view is that a more serious challenge to my profession has to be made. A code of conduct is fine but when the whole carcass of the profession is corrupted and rotten something more comprehensive is required – a major rethink about how we teach economics – nothing short of a scientific revolution is required. The whole body of mainstream economics needs to be trashed.

In October 2010, two academics from the University of Massachusetts released a working paper – Financial Economists, Financial Interests and Dark Corners of the Meltdown: It’s Time to set Ethical Standards for the Economics Profession – a long title for an important issue.

The paper:

… reviews the connections between academia, private financial institutions and public institutions of nineteen academic economists who are members of groups who have put forth proposals on financial reform … [and] … addresses the potential conflict of interest that exists when academic economists take on dual roles as both experts in the media concerning topics such as financial regulation while also having affiliations with private financial institutions such as firms, rating agencies, stock exchanges and private banks …

The context is clearly about the “role economists’ have played in the run-up to the financial crisis of 2007-2010”.

The authors ask – “Why did the vast majority of economists fail to foresee the financial crisis despite numerous signs all around them?” The three plausible explanations are:

1. Mainstream economic theory is bereft of any capacity to understand the way the monetary economy operates and the likelihood of crisis – in the words of the authors – “economists depended too much on abstract models that do not allow for bubbles and crisis”.

2. Mainstream economists are “blinded by ideology” – the “Great Moderation” banter – Please read my blog – The Great Moderation myth – for more discussion on this point. It is obvious that there is a religious belief in the efficasy of the private market and its alleged (not!) self-regulating properties.

3. Mainstream economists “faced a conflict of interest” and had “perverse incentives not to recognize the crisis”.

All three of these claims are true and apply differentially to the profession at different levels of seniority (and influence). The third explanation clearly applies to the senior figures who take rewards from large financial corporations while at the same time urging governments to deregulate (in favour of the same corporations) because economic theory tells us that is best.

They are never exposed because the more junior members of the profession are besotted by the first explanation – they are indoctrinated to accept a style of reasoning – called the “economic way of thinking” – which has no relationship to how the system actually works. Their models are stylisations of another world where the types of dysfunction we have just observed are absent (and impossible). Many of their models are internally inconsistent (for example, all those that deal with income distribution and production) and none really stack up against empirical realities.

Mainstream economics is also a religion. The presumption is that market allocation by private agents unfettered by government rules and regulations is optimal. Everyone is better off! They might sometimes fail but in those cases the solution is always to make them freer – because the failure is typically ascribed to being due to government meddling. There is no real notion of a collective in mainstream economics.

The paper lists some of the more obvious examples where top government officials in the US have had very lucrative connections with Wall Street. They cite two Treasury officials who were being paid by investment banks (one received $US3 million plus from the Wall Street bank while their pay at the Treasury was $US162,900 per annum.

They site the well-known case of Lawrence Summers who received $US5.2 million from various hedge fund interests while acting as the Director of the White House’s National Economic Council.

The authors found that 70 per cent of economists they examined had “positions with private financial firms”. They found that very rarely did these economists identify their financial firm affiliation in their writings or media commentary.

They cite an example of one Stanford academic who was part of an influential public panel on the financial crisis and was answering questions about ratings agencies without disclosing that he was in fact on the board of Moody’s. This affiliation was subsequently teased out of him.

It is interesting though that the authors did not find any major difference between the attitudes towards financial regulation of those who did have affiliations with financial firms and those who were not affiliated. Which suggests that the problem is more basic – the core of the egg is rotten – Explanations 1 and 2 above.

You also might like to read this New York Times article (December 31 , 2009) – Lessons Learned but Not Applied – by Simon Johnson who

There is also an interesting 2010 movie Inside Job by Charles Ferguson which presented a forensic account of the way in which economists use their academic affiliations to garner credibility while discussing matters relating to financial regulation etc while at the same time being paid by the corporations being regulated.

The movie especially brings out the “choice moments of triumphalism” by leading lights in economics and policy making – this is the Great Moderation boasts – where we were all pressured into believing that government out, investment bank in was best for all of us. The reality is that the advice that economists gave government (many while in the pay of the private corporations) has underpinned a massive disaster – more costly than any of the so-called inefficiencies that protective regulation might have caused.

Recall that when the then chief economist of the IMF raised some concerns about the way the financial markets were heading (in 2005) Larry Summers rudely called him a “luddite”. The exchange came at the 2005 Federal Reserve meetings at Jackson Hole. In reply to a paper by the IMF official, Summers said:

I speak as a repentant, brief Tobin tax advocate, and someone who has learned a great deal about the subject, like Don Kohn, from Alan Greenspan, and someone who finds the basic, slightly Luddite premise of this paper to be largely misguided.

Inside Job clearly hasn’t much time for my profession (and I am in accord with that view). The movie clearly demonstrates how economists are corrupted by payments in various guises.

Anyway, the upshot of all of this is that there has been a letter signed by around 300 economists has been sent to the American Economic Association (which is holding its annual meeting this week in Denver) demanding that the association adopt a code of ethics which would require its members to disclose these conflicts of interest.

There was an article in the New York Times this week (December 30, 2010) – Academic Economists to Consider Ethics Code – which reported on this topic and was followed up by another article (January 4, 2011) – Letter Calls on Economists to Adopt Code of Ethics.

You can read the letter HERE. It is signed by a very solid group many of whom I know personally and am friends with several.

I agree with the tenet of the letter such that the American Economic Association should:

… adopt a code of ethics that requires disclosure of potential conflicts of interest that can arise between economists’ roles as economic experts and as paid consultants, principals or agents for private firms. As the economics profession serves a prominent role in economic policy, the public’s confidence in the integrity of the profession will, in part, depend on how the issue of potential conflicts of interest is addressed.

I agree that:

Economists should maintain the highest degree of integrity in their professional work and avoid conflicts of interest and the appearance of conflict. Moreover, economists should disclose relevant sources of financial support and relevant personal or professional relationships that may have the appearance or potential for a conflict of interest in public speeches and writing, as well as in academic publications.

But in saying that I wonder how far the signatories want the AEA to go?

In my view it is a conflict of interest to claim that one is participating in a science which has empirical content and then totally ignore the fact that the main body of theory categorically failed to account for the largest event in some 80 years is a breach of the “degree of integrity in their professional work”.

Teaching erroneous concepts such as the money multiplier to innocent students day-in and day-out when it is quite obviously the case that the monetary system does not operate in this way is a breach of the “degree of integrity in their professional work”.

I especially liked this response to the letter by Robert E. Lucas, Jnr of the University of Chicago – who is clearly not impressed by the proposal:

What disciplines economics, like any science, is whether your work can be replicated. It either stands up or it doesn’t. Your motivations and whatnot are secondary.”

Economics is not a science in the way that it can conduct controlled experiments and replicate results. Inasmuch as there is an empirical check on the prognostications of the mainstream economics program then it has failed dismally.

Any coherent body of work – such as macroeconomics – should have been able to articulate a major crisis in its field. The evidence is clear. Mainstream macroeconomics thought the business cycle was dead. They had “triumphed”. The depth of the crisis is the measure of how badly the mainstream theory has failed.

Interestingly, when Lucas gave his 2003 presidential address to the American Economic Association, Lucas made one of the classic statements:

My thesis in this lecture is that macroeconomics in this original sense has succeeded: Its central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades. There remain important gains in welfare from better fiscal policies, but I argue that these are gains from providing people with better incentives to work and to save, not from better fine tuning of spending flows. Taking U.S. performance over the past 50 years as a benchmark, the potential for welfare gains from better long-run, supply side policies exceeds by far the potential from further improvements in short-run demand management.

Yes, the business cycle is dead. Long live the business cycle.

When I read the letter I thought of two points immediately and I will expand on these in future blogs because they are significant and not well understood.

First, modern mainstream economic theory (new Keynesian, etc) is still strongly based on the neoclassical theory that emerged in the second half of the C19th. At that time, Marxism was growing in influence and the message was getting through to workers that profits were the reward for ownership of capital not a contribution to production.

It is clear that we could go to the share registry one night and alter all the company ownerships by changing names on certificates and the distribution of income would radically alter without anyone doing more or less work. The capacity of owners of capital to take the surplus labour of the workers – for nothing – was then the central story. It was patently unfair and increasingly violent protests were threatening the capacity of capital to maintain their “unproductive” hegemony over the vast bulk of the population.

Clearly a solution was needed. Enter marginal productivity theory (which I will write about in more detail when I come to deal with the Capital Controversies of the 1960s).

Marginal productivity theory – in a nutshell – claims that each “factor of production” produces a marginal product and competition ensures that at the margin that factor receives a payment (wage, interest, profit) exactly equal to that marginal product or contribution. A marginal product is the extra production that is forthcoming from adding an extra unit of the factor of production.

Two things emerged. Labour was no longer considered a special productive input – but just one “factor” of production along with the other inanimate factors. This depersonalisation of workers attempted to downplay issues of control and supervision which were designed to ensure the workers didn’t go home once they had produced enough for their own wage and while they were working they were working hard.

More significantly, marginal productivity theory held out that unlike the claims of Marxists, competitive capitalism was a fair system because it rewarded productive input in proportion to the contribution of that input to final output. What could be fairer than that? Profits were now constructed as just another return to effort rather than a misbegotten worker rip-off. Profits and wages – all in proportion to input and contribution.

In his famous book – The Distribution of Wealth (1999) Clark outlined the marginal productivity theory of distribution. He wrote in relation to labour that (page 16):

All labor is directly paid for; its compensation is the market value of its product …

And later (page 71) he wrote:

It is the purpose of this work to show that the distribution of the income of society is controlled by a natural law, and that this law, if it worked without friction, would give to every agent of production the amount of wealth which that agent creates

A major writer in this period was the American John Bates Clark. In 1891 – Distribution as Determined by a Law of Rent, Quarterly of Economics, 5: 313 – Clark wrote the following (which is representative):

With extreme brevity we have stated a law that is as comprehensive as anything in economics. We have not referred to the obstacles that the law encounters in practice, nor have we made an attempt to measure the deviations from the theoretical standard that the actual distribution of the social income reveals … It, in fact, identifies production with distribution, and shows that what a social class gets is, under natural law, what it contributes to the general output of industry …

So the class analysis of Marx was gone and instead capitalism was considered to be a system that maximised the outcomes of free exchange between equals – workers, capital, landowners – they were all alike. They brought their inputs to the market and freely traded exchange values (which reflected use values) and received what they contributed.

The inequality in the exchange relationships that Marx had identified – labour power is exchanged but labour is used – was suppressed.

Juxtapose that construction with that portrayed so strongly by Marx in Capital Volume 1, Chapter 6, The Buying and Selling of Labour-Power. Here he is talking about the chimera of freedom that capitalism portends – the exchange level of reality where workers appear to freely exchange labour in return for a wage. But once you go beyond that superficiality we learn about the essence of capitalism.

Marx wrote that:

This sphere that we are deserting, within whose boundaries the sale and purchase of labour-power goes on, is in fact a very Eden of the innate rights of man. There alone rule Freedom, Equality, Property and Bentham. Freedom, because both buyer and seller of a commodity, say of labour-power, are constrained only by their own free will. They contract as free agents, and the agreement they come to, is but the form in which they give legal expression to their common will. Equality, because each enters into relation with the other, as with a simple owner of commodities, and they exchange equivalent for equivalent. Property, because each disposes only of what is his own. And Bentham, because each looks only to himself. The only force that brings them together and puts them in relation with each other, is the selfishness, the gain and the private interests of each. Each looks to himself only, and no one troubles himself about the rest, and just because they do so, do they all, in accordance with the pre-established harmony of things, or under the auspices of an all-shrewd providence, work together to their mutual advantage, for the common weal and in the interest of all.

On leaving this sphere of simple circulation or of exchange of commodities, which furnishes the “Free-trader Vulgaris” with his views and ideas, and with the standard by which he judges a society based on capital and wages, we think we can perceive a change in the physiognomy of our dramatis personae. He, who before was the money-owner, now strides in front as capitalist; the possessor of labour-power follows as his labourer. The one with an air of importance, smirking, intent on business; the other, timid and holding back, like one who is bringing his own hide to market and has nothing to expect but – a hiding.

I always like reading that section of Capital … the “one with an air of importance” … “the other, timid .. nothing to expect but – a hiding”.

Who paid John Bates Clark? He was an academic at Columbia University but received funding from leading industrialists of the day who were concerned with the growing threat of a Marxist-inspired trade union movement. So the mainstream profession has always been conflicted – although I would just say “bought”.

Thorstein Veblen wrote in 1908 that Clark was an apologist for capitalism (‘Professor Clark’s Economics’, Quarterly Journal of Economics, 22(2), 147-195).

Clark also opposed minimum wages (see his 1913 article – ‘The Minimum Wage’, Atlantic Monthly 112: 289-97) calling them “risky” (page 297) and “inhumane” (page 297) if they were set above the marginal product. He also opposed public employment for those who were not able to get work in the private sector saying it “would depart from all American precedents” (page 294)

The point is that marginal productivity theory is still used to defend various policy positions mostly associated with extensive labour market deregulation. Policies implemented in its name have led to the wage share contracting significantly in many advanced economies and real income being distributed to profits. The rise of the financial services industry has used that redistribution to create all the “products” we have seen explode in recent year yet the inventors have rarely suffered the losses.

Marginal productivity theory was also demolished in the Cambridge debates which I will come back to. It is not good enough to resort to general equilibrium versions. They are all internally inconsistent. The theory should not be taught in any decent university. But it is still the centrepiece of mainstream production and distribution theory and underpins explanations of unemployment (as voluntary or temporary) and wage determination.

Economists who teach this stuff as if it is a serious representation of the world we live in are in my view do not uphold a high degree of integrity in their professional work.

Previously, in these blogs – I feel good knowing there are libraries full of books and Education – a vehicle for class division – I mentioned the work of Bowles and Gintis – specifically their 1976 book – Schooling in Capitalist America.

In that book, several propositions were advanced including:

… that schools prepare people for adult work rules, by socializing people to function well, and without complaint, in the hierarchical structure of the modern corporation …

that parental economic status is passed on to children in part by means of unequal educational opportunity, but that the economic advantages of the offspring of higher social status families go considerably beyond the superior education they receive …

the evolution of the modern school system is not accounted for by the gradual perfection of a democratic or pedagogical ideal. Rather, it was the product of a series of conflicts arising through the transformation of the social organization of work and the distribution of its rewards. In this process, the interests of the owners of the leading businesses tended to predominate but were rarely uncontested.

In the context of today’s blog, their work shows how the influences of capital and industry pervade the educational system and shape the way we teach and learn.

Economics departments are classic places where the dominant view is promoted and dissent is rarely possible – because it is hard to get a job if you deviate from the norm. Some of us were fortunate to get through the control processes – but there are very few senior progressive (heterodox) economists in universities anywhere.

So this process ensures that students are successfully indoctrinated to believe that because the government faces a budget constraint tough choices have to be made and that public activity is inherently inefficient whereas private activity is optimal. And all the rest of the lies that goes with this “education”.

The questions that should be asked – like – who gains a better access to real income if this policy is adopted are rarely asked because the mainstream agenda is about promoting an income distribution that is anti-worker but making out that the distribution is “fair”.

Conclusion

I think a call for a code of ethics should be broadened for a major closure of economics programs around the world and a new approach to the study of economics built around Modern Monetary Theory (MMT) at the macro level and interdisciplinary approaches at the micro level incorporating sociology, psychology, anthropology, and a more reasoned view of firm-based operations in the context of a class-based economy – where workers want to work less and be paid more and bosses want them to do the opposite.

That is all I can write today as I have to catch a plane and then will be tied up with commitments for the rest of the day until late.

Accordingly, that is enough for today!