Options for Europe – Part 91

The title is my current working title for a book I am finalising over the next few months on the Eurozone. If all goes well (and it should) it will be published in both Italian and English by very well-known publishers. The publication date for the Italian edition is tentatively late April to early May 2014.

You can access the entire sequence of blogs in this series through the – Euro book Category.

I cannot guarantee the sequence of daily additions will make sense overall because at times I will go back and fill in bits (that I needed library access or whatever for). But you should be able to pick up the thread over time although the full edited version will only be available in the final book (obviously).

Part III – Options for Europe

[FINAL TASKS – INTRODUCTION AND ADDING SOME BITS TO A FEW CHAPTERS – MINOR EDITS]

Chapter 1 – Introduction

[I AM STILL THINKING ABOUT THE BEST WAY TO START THE BOOK – THE FOLLOWING IS ONE APPROACH WHICH GOES FROM SETTING A GENERAL CONTEXT THEN PLACING THE SPECIFIC EUROPEAN PROBLEMS WITHIN IT. THE ALTERNATIVE IS THAT I START TO IMMEDIATELY DOCUMENT THE EUROPEAN PROBLEM AND THEN STEP BACK TO PUT IT IN CONTEXT. I CURRENTLY PREFER THIS APPROACH BUT WILL DECIDE LATER IN THE WEEK WHICH WAY I GO – COMMENTS APPRECIATED THROUGH THE WEEK OF-COURSE]

[NEW MATERIAL TODAY]

Chapter 1 – Introduction

“Nations with a common currency never went to war against each other. A common currency is more than the money you pay with … No more war – that was the first message.”

“ich wie ein Diktator, siehe Euro” (I was like a dictator about the euro).

Helmut Kohl, Former German Chancellor (in Jens Peter Paul, Bilanz einer gescheiterten Kommunikation, 2010)

“The finance ministers did not want to see anything disagreeable which they would be forced to deal with … a combination of the stubbornness of the Germanic idea of monetary control and the absence of a clear vision from all the other countries”

Jacques Delors, Former President of the European Commission
December 2, 2011

“We bouwen op drijfzand” (We are building on quicksand)

André Szász, Former director of the De Nederlandsche Bank
1998

======================

Joseph Altman is an American biologist specialising in neurobiology who is credited with discovering adult neurogenesis in the 1960s. This is the idea that adult brains can create new neurons, a proposition that was denied by contemporary thought at the time. It wasn’t until the phenomenon was ‘rediscovered’ by another scientist (Elizabeth Gould in 1999) that the proposition became fashionable. Neurogenesis is now one of the most significant areas in neuroscience. Why were Altman’s discoveries ignored for almost 30 years? Charles Gross wrote in 2008 that “the dogma of ‘no new neurons’ was universally held and vigorously defended by the most powerful and leading primate developmental anatomist of his time” (Gross, 2008: 331).

Two things are important about this information for the purposes of understanding the enduring crisis within Europe’s Economic and Monetary Union (EMU). First, academic disciplines (such as, neurobiologists, economists etc) work within organised ‘paradigms’, which Thomas Kuhn identified as “universally recognized scientific achievements that, for a time, provide model problems and solutions for a community of practitioners” (Kuhn, 1996: X). Typically, the body of knowledge that defines the paradigm are “recounted … by science textbooks, elementary and advanced” (Kuhn, 1962: 10). Kuhn challenged the notion that ‘scientific’ activity is a linear process, whereby scholars add new empirically supported facts to the knowledge base to replace previously accepted notions. Rather, Kuhn said that dominant viewpoints persist until they are confronted with insurmountable anomalies, whereupon a revolution (paradigm shift) occurs. The new paradigm exposes the old theories as inapplicable, introduces new concepts, asks new questions and provides students with a new way of thinking with a new language and explanatory metaphors. Once supplanted, the old theories are no longer considered valid knowledge. Kuhn also noted that there is a sort of mob rule among practitioners within a dominant paradigm and they vehemently hold on to their views even in the face of logical or empirical anomaly. Those who propose new ways of thinking are initially vilified by the group. Altam’s work represented the potential for a paradigm shift and was resisted by the mob until change became ineluctable.

Fellow philosopher of science, Imre Lakatos extended Kuhn’s notion of a scientific community by introducing the concept of a ‘research programme’, which consisted of a hard core (theories that define the paradigm), auxilliary assumptions (the ‘protective belt’) and methodological rules or heuristics (Lakatos, 1970). The hard-core is akin to a religious belief in that it is never subjected to empirical scrutiny by the group and is protected by the heuristic. It defines what the group stands for. The positive heuristic defines the day-to-day research activities, the questions that are permitted to be explored, and the methods that are acceptable. It is permissible to challenge some of the auxiliary hypotheses, which in themselves, plausible or not, provide no threat to the core theories. The core is protected by the negative heuristic, which essentially bans certain questions from being asked and forms of enquiry or evidence being admitted even when strong contrary evidence is produced. One might think of this as denial. For a time, a research program maintains dominance because it adds content, which are considered new advances in knowledge and are of interest to the group. At some point a research program may become degenerative in that its content diminishes in the face of increasing empirical anomaly – that is, the theory no longer is considered to be an adequate explanation of what people see. But a degenerating research program can maintain its hold on a professional group for an extended period such is the resistance to change among those within it.

Just before the Global Financial Crisis (GFC) revealed its worst, Olivier Blanchard, the chief economist at the International Monetary Fund (IMF), reviewing the understanding that macroeconomists had of the real world, claimed that the “state of macro is good” (Blanchard, 2008: 2). He asserted that a “largely common vision has emerged” (p.5) in macroeconomics, with a “convergence in methodology” (p.3) such that research articles in macroeconomics “look very similar to each other in structure, and very different from the way they did thirty years ago” (p.21). They now follow “strict, haiku-like, rules” (p.26). He also noted that the dominant ‘New Keynesian’ approach in macroeconomics had “become a workhorse for policy and welfare analysis” (p.8) because it is “simple, analytically convenient … [and] … reduces a complex reality to a few simple equations” (p.9). It didn’t seem to matter to these economists that in the “basic NK model is that there is no unemployment” (p.12), such that all fluctuations in measured joblessness are characterised largely by workers choosing whether or not to work as part of a so-called optimal choice between work and leisure.

The mainstream macroeconomists, who have an abiding faith in the ability of the self-regulated market to deliver optimal outcomes – which we will refer to as the neo-liberal approach, had declared some years before the crisis, with an arrogance common to the discipline, that the business cycle is dead. That is, the large swings in macroeconomic performance (recessions and mass unemployment and boom and inflation) that had dominated the attention of economic policy makers in the Post World War II period and led to fiscal policy (the manipulation of taxation and government spending) being the primary tool governments used to maintain full employment and price stability, were now being denied. University of Chicago professor Robert Lucas Jnr gave an extraordinary address to the American Economic Association in 2003 where he claimed “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” (Lucas, 2003: 1). A year later, the then US Federal Reserve Bank Governor, Ben Bernanke claimed that as a result of the policy shift away from governments attempting to manage total spending in the economy by varying fiscal policy settings in favour of using monetary policy (interest rate setting by central banks) to concentrate purely on price stability and the pursuit of fiscal surpluses, the world was enjoying the Great Moderation (Bernanke, 2004). Allegedly, damaging recessions were a thing of the past and low inflation and steady growth were now the norm. The public was led to believe that these mainstream economists had triumphed over the old interventionists who had over-regulated the economy, sucked the enterprise out of private enterprise, allowed trade unions to become too powerful, and bred generations of indolent and unmotivated individuals who only aspired to live on income support payments. The business cycle was dead and economic policy should now concentrate on deregulating labour and financial markets and reducing income support payments to reduce the subsidy to unemployment so that the ‘market’ can work even more efficiently. This was denial writ large. Paul Krugman (2009) said these alleged “successes” defined a self-styled “golden era for the profession”. The worst economic crisis in 80 years was building while these economists waxed lyrical in their own world of self-aggrandisement and self congratulation.

This view of economics dominates the academy, which then feeds into the domain of policy making. The mainstream paradigm in economics was blind “to the very possibility of catastrophic failures in a market economy” (Krugman, 2009) and its policy prescriptions, based on an unjustified belief in the efficiency of that economy, created the circumstances that would lead to the crisis. In every way, mainstream economics is a degenerating research program. Krugman (2009) said that the “the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth.” However, as Kuhn noted practitioners within such a program grimly hang on to their theoretical core despite failure to explain real world events. A degenerative research program maintains its hegemony in a number of ways, including control of teaching programs in universities; control of the hiring process within the Academy; control of key publication outlets; control of major research funding bodies; and a dominance in the linkages between the Academy, business and government. Much of the control is implicit and accomplished through networks to get around external oversight such as, anti-discrimination legislation. The late economist Jack Barbash discussed the way in which the economics profession protects its belief system from criticism and avoids, as far as possible, addressing real world problems. He notes that there is “no formally coercive apparatus” but “the equivalent of an ‘old-boy’ network” in operation (Barbash, 1982: 51). Advantages (publications, research grants, promotions etc) accrue to those who conform to the rules. Socialisation begins in one’s student days where the masters of the paradigm control the curriculum; the grading systems; and who gets postgraduate scholarships to pursue doctoral studies. The indoctrination intensifies when one enters the postgraduate stages. In economics, the graduate student learns that “rigor is more important than substance” and “method is more important than result” (p.52). Remember those haiku-like rules that govern an economics paper’s chance of publication success.

The American institutional economist David Gordon (1972) wrote that whenever the mainstream economics paradigm is confronted with empirical evidence that appears to refute its basic predictions it creates an exception by way of response to the anomaly and continues on as if nothing had happened. As a result, the mainstream macroeconomics textbooks, which students are forced to use, contain very little that is useful for an understanding of how the real world actually works. Students are given false accounts of how the financial sector including banking works; are taught a number of myths about the impact of the government on the private markets; and, above all, are taught that if markets are left to their own devices, the outcomes will be superior to those that involve regulation or government oversight. As the gap between theory and outcome have become obvious to all, it is easy to cast those who hang onto the mainstream theoretical propositions as cult worshippers who have lost all ‘scientific’ credibility.

More insidious is that neo-liberal economics privileges the interests of capital. To understand why there is so much resistance to abandoning the failed economic theories we need to understand that the mainstream economics paradigm is much more than a set of theories that economics professors indoctrinate their students with. Blyth (2013: 100) notes that these mainstream economic theories “enshrine different distributions of wealth and power and are power resources for actors whose claims to authority and income depend upon their credibility”, which explains, in part, why there was such resistance to abandoning them, even though it was clear that they were bereft of any evidential standing. Historically, the body of theory that now represents neo-liberal economics was first developed in the late C19th as an antidote against the rising influence of Marxism, particularly in Europe. The message was getting through to workers that profits were the reward for ownership of capital not a reward for any contribution to production. 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 hegemony over the vast bulk of the population. Clearly a solution was needed. Economists were recruited by industrialists to develop theory that made it look like competitive capitalism was a fair system because it rewarded productive input in proportion to the contribution of that input to final output. Later this was refined as attacks on government policy aimed at redistributing national income. All the time, the interests of those who own or serve capital were being advanced at the expense of the less advantaged.

Which leads us to the second reason why the Altmann case is of interest to anyone seeking to understand why the EMU is in such a mess. These communities of scholars develop a dominant culture, which provides its members which a sense of belonging and joint purpose but also renders them oblivious and hostile to new and superior ways of thinking. These communities develop what Irving Janis identified in 1972 to be ‘Groupthink’, which drives the ‘mob-rule’ that maintains discipline within paradigms. Groupthink is a “mode of thinking people engage in when they are deeply involved in a cohesive in-group, when the members striving for unanimity override their motivation to realistically appraise alternative courses of action” (Janus, 1982: 9) and “requires each member to avoid raising controversial issues” (Janis, 1982: 12). It has also been defined as “a pattern of thought characterized by self-deception, forced manufacture of consent, and conformity to group values and ethics” (Merriam-Webster on-line dictionary). Groupthink becomes apparent to the outside world when there is a crisis or in Janis’s words a ‘fiasco’. The GFC was certainly that.

In 2011, the IMF’s Independent Evaluation Office (IEO) released a report on the Institution’s performance in the lead up to the Global Financial Crisis (IEO, 2011), which was a scathing assessment of the Washington-based organisation that has been a central player in the euro-zone crisis. The IEO said that “(w)arning member countries about risks to the global economy and the buildup of vulnerabilities in their own economies is arguably the most important purpose of IMF surveillance” (IEO, 2011, vii). However, the External Evaluation Report commented on the ideological biases at the IMF and determined that the IMF failed to give adequate warning of the impending GFC because it was “hindered by a high degree of groupthink” (p.17), which, among other things suppressed “contrarian views” where an “insular culture also played a big role’ (p.17). The report said that “(a)nalytical weaknesses were at the core of some of the IMF’s most evident shortcomings in surveillance” (p.17) as a result of “the tendency among homogeneous, cohesive groups to consider issues only within a certain paradigm and not challenge its basic premises” (p.17). Significantly, they concluded that the:

The prevailing view among IMF staff – a cohesive group of macroeconomists – was that market discipline and self-regulation would be sufficient to stave off serious problems in financial institutions. They also believed that crises were unlikely to happen in advanced economies, where ‘sophisticated’ financial markets could thrive safely with minimal regulation of a large and growing portion of the financial system (p.17).

The External Evaluation Report says that “IMF economists tended to hold in highest regard” (p.18) models proven to be inadequate (so-called Dynamic Stochastic General Equilibrium models). Willem Buiter (2009) described these economic models as useless “self-referential, inward-looking distractions at best”, which “excludes everything relevant to the pursuit of financial stability”.

Economist Robert Schiller (2008), who says Groupthink tells us why “panels of experts could make colossal mistakes”, implicates the US Federal Reserve (and central banks in general) in this self-censoring behaviour where “mavericks” are put under intense pressure if they question the “group consensus”. Ryan Grim (2009) concluded after a detailed investigation that “The Federal Reserve, through its extensive network of consultants, visiting scholars, alumni and staff economists, so thoroughly dominates the field of economics that real criticism of the central bank has become a career liability for members of the profession.” Not only does the US Federal Reserve fund a huge amount of non-staff economic consultancies but also “keeps many of the influential editors of prominent academic journals on its payroll” (Grim, 2009). By controlling what gets published in the key journals, the bank also influences the career trajectory of economists, and thus suppresses independent research that might be critical of the way the central bank operates. The US Federal Reserve has an “intolerance for dissent”, something that well-known economist Alan Blinder found out quickly, when he joined the the bank as a vice chairman. He lasted around 18 months after “a lot of senior staff … were pissed off … [because he was] … not playing by the customs that they were accustomed to” (Grim, 2009). His sin? He asked too many questions and challenged to many assumptions. Even a moderate critic of the bank, Paul Krugman, reported that he was “blackballed from the Fed summer conference at Jackson Hole … ever since I criticized” Governor Alan Greenspan (Democracy Now, 2007).

[WILL FINISH INTRODUCTION OVER THE NEXT FEW DAYS – THEN EDITING AND CLEANING UP TO DO. NORMAL TRANSMISSION WILL RESUME NEXT WEEK]

Additional references

This list will be progressively compiled.

Barbash, J. (1982) ‘The Guilds of Academe’, Challenge, 25(1), March-April, 50-54.

Blanchard, O. (2008) ‘The State of Macro’, NBER Working Paper No. 14259, National Bureau of Economic Research, August.

Democracy Now (2007) ‘The Conscience of a Liberal: New York Times Columnist Paul Krugman on Healthcare, Tax Cuts, Social Security, the Mortgage Crisis and Alan Greenspan’, October 17, 2007. http://www.democracynow.org/2007/10/17/the_conscience_of_a_liberal_new

Independent Evaluation Office (IEO) (2011) ‘ IMF Performance in the Run-Up to the Financial and Economic Crisis: IMF Surveillance in 2004-07’, Washington, International Monetary Fund. http://www.ieo-imf.org/ieo/files/completedevaluations/Crisis-%20Main%20Report%20(without%20Moises%20Signature).pdf

Janis, I.L. (1972) Victims of Groupthink, New York, Houghton Mifflin.

Janis, I.L. (1982) Groupthink: Psychological Studies of Policy Decisions and Fiascoes, Second Edition, New York, Houghton Mifflin.

Goodacre, H. (2014) ‘Economics Departments have fallen behind’, Financial Times, May 23, 2014. http://www.ft.com/intl/cms/s/0/c32a888a-dc38-11e3-8511-00144feabdc0.html

Gordon, D.M. (1972) Theories of poverty and underemployment, Lexington, Mass: Heath, Lexington Books.

Grim, R. (2009) ‘Priceless: How the Federal Reserve Bought the Economics Profession’, Huffington Post, May 13, 2009. http://www.huffingtonpost.com/2009/09/07/priceless-how-the-federal_n_278805.html

Gross, C.C. (2008) ‘Three before their time: neuroscientists whose ideas were ignored by their contemporaries’, Experimental Brain Research, 192(3), January, 321-34. http://www.ncbi.nlm.nih.gov/pubmed/18641979

Kazin, M. (2006) A Godly Hero: The Life of William Jennings Bryan, New York, Alfred A. Knopf.

Krugman, P. (2009) ‘How Did Economists Get It So Wrong?’, New York Times, September 2, 2009. http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html

Kuhn, T.S. (1996) The Structure of Scientific Revolutions, Third Edition, Chicago, The University of Chicago Press.

Lakatos, I. (1970) ‘Falsification and the Methodology of Scientific Research Programmes’, in Lakatos, I. and Musgrave, A. (eds.) (1990) Criticism and the Growth of Knowledge, Cambridge, Cambridge University Press, 91-195.

Schiller, R.J. (2008) ‘Challenging the Crowd in Whispers, Not Shouts ‘, New York Times, November 2, 2008. http://www.nytimes.com/2008/11/02/business/02view.html

(c) Copyright 2014 Bill Mitchell. All Rights Reserved.