Do not learn economics from a newspaper

Last weekend, the senior economics writer for the Sydney Morning Herald became a salesman. He has been seemingly recruited voluntarily into the marketing campaign for Mankiw’s economics textbooks which dominate the world supply. In his textbook the Principles of Economics, which is just palpable indoctrination, students are introduced at the outset to the 10 Principles of Economics. These principles resemble the hard sell you get from a salesperson who knows their product will not stand scrutiny but wants the commission nonetheless. But Gittins, knowing his power to influence the economic thinking among his readership, presents the principles as if they are all you need to know to understand economics. What a total con that is.

In the December 26, 2009 edition of the Sydney Morning Herald, Gittins wrote – Life’s trade-offs in 10 easy principles. He opened his article in this way:

Here’s a never-to-be-repeated holiday special: all you need to know about economics in 10 easy steps. They come courtesy of the best-selling introductory economics textbook by Gregory Mankiw of Harvard University (with Joshua Gans and Stephen King co-authors of the Australian edition).

One hopes that most people were too obsessed with the start of the Boxing Day test cricket match or the Sydney to Hobart Yacht race or with other diversions to have read this rubbish.

The Principles of Economics (PoE) are the exemplar of neo-classical micro and macroeconomic thinking. For the unitiated the method is to start with a few basic assertions – rationality, maximisation, competition, efficiency, perfect foresight and some more – and then everything else is deduced to be true if it follows the logic of these assertions. The assertions are rarely confronted with empirical scrutiny and when they are they typically are found wanting.

As an example, people are assumed to maximise their utility which is unobserved and is then expressed as real income. So then you ask what real income is and the answer is everything. So it becomes an absurd tautology because everything one does can be interpreted as maximising real income even if it describes the junkie lying in a gutter groaning for their next hit. So the proposition that we maximise utility is self-evidently true by construction. Of-course this has no meaningful content at all but that never gets in the way of the mainstream economist.

As Gittins points out the “four principles of individual decision making” are presented first. The principles are presented without noting that they are highly controversial. There is no controversy in the PoE – they are just catechism. So students who are engaging in the epistemological foray into economics are never given a hint that there is a strong evidence-based literature out there which shows that the PoE are just assertions. Matters of faith.

Who says these are the Principles? How was that decided? When? What correspondence with reality exists? So the statement are akin to statements like “this car is the most sophisticated available”. It might be but some other car salesman will have a different view.

Gittins says:

Economics is about the trade-offs people – and societies – have to make, and about helping people improve the trade-offs they’re making. One common trade-off society faces is between efficiency and equity. Efficiency in the allocation of resources means society getting the most it can from its scarce resources. Equity means the benefits from those resources are distributed fairly among the members of society. Often, the things we could do to make the cake bigger (efficiency) make the slices of the cake more unequal (equity) and vice versa.

So for us poor souls that have sat through this nonsense we are told that economics is about the allocation of scarce resources among competing ends and we are always being confronted with making tough choices between equity and efficiency but as rational individuals we know how to make the best decisions.

The concepts themselves are always somewhat hazy – you won’t get much better than in the quote above but the message soon becomes political and is seized upon in the public debate (pushed presumably by economists who have been fed this indoctrination).

We then read and hear that if the government wants to enhance equity through redistribution (perhaps a progressive tax system) then this undermines growth because it creates inefficiencies (taxes are alleged to distort the work efforts of the productive).

When we dig further we realise that the concept of efficiency is heavily biased towards the calculus of private costs and benefits rather than the broader system outcomes. Without any scrutiny students accept statements that if business costs are raised by regulation (for example, from a carbon tax) then there will be inefficiencies – lost output, higher prices, etc.

But, for example, the carbon tax is just an attempt to address the fact that true “costs” are not built in to the price of the product and so the firms are getting a free kick and producing and selling more of the product than it would otherwise be able to do. Yes, there are chapters on “externalities” where the divergence between social costs/benefits and private costs/benefits is noted but it comes late in the books usually and never emphasised up front.

Further, the greatest inefficiency – mass unemployment – is constructed so that the obvious cause – a systemic failure to produce enough jobs – is dismissed as out of hand as being contrary to the underlying rational optimising assumptions.

Instead, mass unemployment is dressed up as a failure of policy (excessive minimum wages or excessively generous unemployment benefits) or failure of individual endeavour (laziness, wishful wage demands, etc). Students do not learn in these textbooks that unemployment is a creation of state (fiat) money. In non-monetary societies there is no unemployment.

Students are not told that mass unemployment arises when net government spending is too low. The PoE never introduce students to the fundamental macroeconomic proposition that as a matter of accounting, for aggregate output to be sold, total spending must equal total income (whether actual income generated in production is fully spent or not each period).

In a modern monetary economy, involuntary unemployment is idle labour unable to find a buyer at the current money wage. In the absence of government spending, unemployment arises when the private sector, in aggregate, desires to spend less of the monetary unit of account than it earns.

Nominal (or real) wage cuts per se do not clear the labour market, unless they somehow eliminate the private sector desire to net save and increase spending. Thus, unemployment occurs when net government spending is too low to accommodate the need to pay taxes and the desire to net save.

The other major problem with the efficiency-equity trade-off (however we construct those concepts) is that it is not a reasonable depiction of the way things turn out.

As an example, the most recent literature on economic growth and development is that more equal countries grow faster, other things equal. The strong empirical finding that emerges is that there is a positive relationship between equality and growth. More equal societies generate better educational outcomes and result in higher skill levels than highly unequal societies. The old neo-classical growth models could never conceive of this because they asserted Principles (such as the so-called law of diminishing returns) that denied it as a matter of logic. Never mind looking out the window.

By the way the “law” of diminishing returns is just made up. It doesn’t stand up to empirical scrutiny.

The link between equality and growth is also developed in the public health and sociological literature. It is indisputable that poverty drives other social costs including poor health, increased crime, ghettos that create spillovers of disadvantage. Mainstream economists tend to ignore this literature.

In fact, studies have shown that economists cross-cite other social science research the least of all the social science disciplines. They do not because they start from a world view they believe in as a matter of religious doctrine and anything that would be confronting to that world view (the PoE) are ignored as being non-factual. Mainstream economics is a very arrogant social science.

There is also a huge debate about the concept of scarcity as a motivating force. The capitalist wealth accumulation process which arguably motivates the dynamics of the world economy has very little correspondence with the idea that we are all constrained by available (finite) resources.

The second principle is “opportunity cost” which Gittins says is:

… the cost of something is what you give up to get it. That is, its “opportunity cost”. Economics is about comparing the costs and benefits of alternative courses of action. The benefits of doing something or buying something are usually pretty obvious, but they need to be weighed against the costs involved to see whether option A is superior to other options.

The cost of going to university full time is not the cost of accommodation and food (because you’d face those even if you didn’t go to uni), nor even just the cost of the uni fees and textbooks. The biggest cost is the income you lose by not being able to work full-time – a classic opportunity cost.

The problem here is that the examples used are always trivial. As we will see soon, the underlying indoctrination is that the economy is always producing on its ” production possibility frontier” – which says that all resources are being used fully as a result of (the assertion) that resource allocation is the reflects rational maximising choices by individual.

So students get the classic “guns and butter” example in textbooks. If you want to produce more guns (which is usually constructed as public spending) you have to forego butter production (usually constructed as private output) because resources have to be transferred from one allocation to another. The opportunity cost of public production is the loss of private production.

Students rote-learn this nonsense and repeat it endlessly in examinations and essays before entering the labour market themselves whereupon they perpetuate it, usually dressed up as the statement “public spending is inefficient and private sector spending is market determined and therefore efficient”. Pure nonsense.

Most economies fail to fully utilise their resources. Providing jobs for the unemployed when there are idle resources does not involve a trade-off and seriously compromises the “opportunity cost” principle.

However, mainstream economists counter this by saying the opportunity cost of giving someone a job is the “leisure” the person gives up to take it. In this way they smooth over the destructive waste of resources and personal potential involved in mass unemployment. Anyone who has done any work in unemployed communities will tell you that for most of the unemployed there is a zero valuation on the “leisure” they are alleged by the mainstream economists to be enjoying.

Gittins then introduces the third principle that “Rational People Think at the Margin”. What does this mean? Gittins chooses to glibly reinforce Mankiw’s indoctrination by saying that:

Marginal changes are incremental adjustments to a plan of action. Say you’re running a short course for 10 students at a total cost of $10,000 – that is, an average cost of $1000 per student.

Now say an extra student wants to join the course. How much should you charge him – $1000? No. The first question is: what’s the marginal cost of adding an extra student? It’s probably quite small – say, $50 for the extra set of course notes.

This means that any price you charge above the marginal cost of $50 will leave you ahead on the deal. But if you name a price that’s too high and the student decides not to pay it, you’re worse off to the extent that the amount he would have been willing to pay (marginal revenue) exceeded $50.

Once again note the triviality of the example presented. Neo-classical textbooks always use “folksy” examples. There is a myriad of literature challenging the concept of individual rational decision making.

For example, the contributions from anthropologists (such as Marshall Sahlins, Karl Polanyi, Maurice Godelier to name a few) show in field studies that reciprocity is the basis in production and exchange rather than the rational maximising model supposed by mainstream economists.

This literature spawned the notion of a “gift economy” which stands in sharp contradiction to the competitive “market economy”.

Further, the sociology literature (for example, starting with the early work by Ralf Dahrendorf) shows that individual behaviour is often motivated to pursue social roles rather than to advance a narrow concept of “self interest”. Note again my earlier comment on tautologies. Economists just say that what looks like a social purpose is really just greed.

One of the foundation ideas in Keynes’ General Theory (published in 1936) relates to the impact of psychology – the impact of herds and panics etc. These ideas have been extended in the modern literature in psychology.

Important work from cognitive psychology (for example, Amos Tversky) shows that people continually make “irrational economic decisions”. Famous neo-classical economist Kenneth Arrow admitted in 1996 that:

The hypothesis of rational behavior has been central to economics, though always held with some discomfort … Previous criticism of economic postulates by psychologists had always been brushed off by economists, who argued, with some justice, that the psychologists did not understand the hypotheses they criticized. No such defense was possible against Amos’ work. (Stanford University News Service 1996).

Once again the PoE that rational decision making dominates is just asserted even though the work that has emerged in other social sciences would appear to deny that proposition. There are many other convincing refutations of the concept of rational man which is at the heart of neo-classical indoctrination.

Further, the way in which Mankiw presents the concept is as a “truth” – all people are rational and behave like this. Rational sounds good and irrational sounds bad. That is a powerful vehicle to maintain discipline in the class. I recall professors telling me as a student that it would be irrational if I believed people were unemployed against their will. The dual reinforcement – of rationality, on the one hand, and the dogmatic assertion that unemployment is not a problem, on the other hand – presented the teacher with a power base in front of the class.

The tactic was always to try to humiliate the objection. For me, I turned out wrong! Their attempts at humiliation just strengthened my resolve to get to the bottom of it all and deflect their indoctrination.

Further, you will find no mention in any textbook that the concept of rationality is normative. Rationality becomes entwined with utilitarianism – we must seek to maximise material outcomes. But other social scientists have shown that ethics and other value systems strongly motivate human endeavour and negate narrow concepts such as the pursuit of utility.

Refer back to my earlier comment on tautologies for the mainstream defence here. They just say that what looks likes broader purpose is really utility maximisation. No proof is ever provided to counter the mass of evidence against them. Just blind adherence to the ideology.

Individuals rarely think at the margins. They satisfice, average and use rules of thumb that fit in with social norms and other team (family) roles they play.

The fourth principle is that “people respond to incentives”, which I will leave. There are serious issues defining how people perceive incentives in cross-cultural environments and whether people respond by ranking choices in a “rational” way and take the “best” option. The concept of the “best” option is normative.

The next three principles cover “the way people interact”.

The fifth, “trade can make everyone better off” is captured by Gittins as:

Trade between Australia and China is not like a sporting contest where one side wins and the other loses.

Rather, trade makes both sides better off (though not necessarily equally better off), which is why it happens. Trade between countries is merely an extension of all the trade that goes on within countries between businesses and households.

That is the mantra. But the mainstream approach does not teach students about the distinction between fair trade and free trade. It doesn’t teach students about the negative impacts of trade on poor nations that are forced by IMF programs to turn subsistence (sustainable) agriculture into cash-for-export crops.

Given the amount of trade between the advanced world and Africa, why has the latter become poorer in the last 30 years while the former has enjoyed significant increases in per capita income?

The whole concept is presented as if narrowly defined material benefits adequately define welfare. It allows the economist to avoid issues like environmental degradation in less developed countries; the murder of trade unionists in some countries because they oppose dangerous and poorly paid work offered by multi-nationals who are exploiting poverty to enhance their own “gains from trade”.

Given the current debate about the role of Chinese net exports I would seriously question whether some of the poor industrial workers in China who are working as low wages in dangerous conditions to provide the goods that are shipped to the advanced world are “better off”. The Chinese government has huge stores of financial assets (US dollar denominated) as a result of the trade. But how is the largesse being distributed? These questions are never examined.

Gittins quotes the sixth principle – “markets are usually a good way to organise economic activity” without any further discussion as if it is a self-evident truth. I suppose that is okay given he is just selling the indoctrination:

A market economy is “an economy that allocated resources through the decentralised decisions of many firms and households as they interact in markets for goods and services”.

The other main way to organise economic activity is to have central planners make all the decisions about what goods and services are produced, how many are produced, who does the producing and who gets to buy what’s produced. It doesn’t work.

It doesn’t work for whom? I am doing work in Central Asia at the moment for the Asian Development Bank and one of the stark outcomes from my most recent field trip to Kazakhstan was the difference generational perspectives on the fall of the Soviet system. The older people who had worked all their lives and were provided in return with adequate housing, health care, food and clothing etc in the expectation that when they retired they would enjoy a modest but reasonable pension etc are not happy about the fall. The younger generation who never knew this see the “market” as an opportunity although there is evidence of significant rent seeking (a.k.a. corruption).

When the Soviet system collapsed many older workers lost their entitlements and now face a life of poverty paying market rents without pensions. They are definitely not better off. The Soviet system “worked” for them despite its major shortcomings.

This comment from Adbusters is apposite:

Gregory Mankiw is one of the most effective and talented propagandists of our times. His target: young economics students.But what is most worrisome is that Mankiw’s text presents economics as a unified discipline, entirely committed to the neoliberal agenda. Mankiw believes that markets are the solution to everything – and he would like students to think likewise. According to Mankiw, if a problem persists, it can only be for one of two reasons: the market is imperfect, or it is inexistent. No other explanation for persisting economic or social problems is permitted.

But more generally the market claim underpins the indoctrination that people do better competing against each other. That is is part of our innate human nature to be competitive.

Of-course there is a huge literature negating that conception. For example, the literature from learning psychology and game theory (for example, the work of Robert Axelrod – his notable book is The Evolution of Cooperation published in 1984) show categorically that when given a choice the best outcomes are co-operative rather than the competitive outcome that is suggested by mainstream economics.

The prisoners’ dilemma example runs contrary to the mainstream economics thinking and the co-operative outcome helps us understand how cartels (which are the anathema to the “market” work.

You might like to read this interesting article by John Cassidy in the New Yorker (October 5, 2009) – The real reason that capitalism is so crash-prone. Cassidy says:

Because financial markets consist of individuals who react to what others are doing, the theories of free-market economics are often less illuminating than the Prisoner’s Dilemma, an analysis of strategic behavior that game theorists associated with the RAND Corporation developed during the early nineteen-fifties. Much of the work done at RAND was initially applied to the logic of nuclear warfare, but it has proved extremely useful in understanding another explosion-prone arena: Wall Street.

Imagine that you and another armed man have been arrested and charged with jointly carrying out a robbery. The two of you are being held and questioned separately, with no means of communicating. You know that, if you both confess, each of you will get ten years in jail, whereas if you both deny the crime you will be charged only with the lesser offense of gun possession, which carries a sentence of just three years in jail. The best scenario for you is if you confess and your partner doesn’t: you’ll be rewarded for your betrayal by being released, and he’ll get a sentence of fifteen years. The worst scenario, accordingly, is if you keep quiet and he confesses.

What should you do? The optimal joint result would require the two of you to keep quiet, so that you both got a light sentence, amounting to a combined six years of jail time. Any other strategy means more collective jail time. But you know that you’re risking the maximum penalty if you keep quiet, because your partner could seize a chance for freedom and betray you. And you know that your partner is bound to be making the same calculation. Hence, the rational strategy, for both of you, is to confess, and serve ten years in jail. In the language of game theory, confessing is a “dominant strategy,” even though it leads to a disastrous outcome …

The Prisoner’s Dilemma is the obverse of Adam Smith’s theory of the invisible hand, in which the free market coördinates the behavior of self-seeking individuals to the benefit of all. Each businessman “intends only his own gain,” Smith wrote in “The Wealth of Nations,” “and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.” But in a market environment the individual pursuit of self-interest, however rational, can give way to collective disaster. The invisible hand becomes a fist.

So why didn’t Gittins tell his readers about these complexities.

Further, the belief in the market is also invoked when discussing unemployment.

Adbusters note:

Unemployment is an example of the market being imperfect. For Mankiw, if unemployment exists, it is only because of human inventions such as unemployment benefits, trade unions and minimum wages. Without them, there cannot be unemployment. Mankiw presents this view as being consensual among economists. In fact, quite a few of them admit that the labor market is a very special “market” indeed, where the price – the wage – is not set the same way as the price of other “goods,” say, tomatoes. As Alan Krueger has put it, “it is a gross oversimplification to say that ‘wages are set by the competitive forces of supply and demand,’ or that there is a unique, market-determined wage.”

There is a huge sociological literature on wage determination that is largely ignored by the maintream economists.

As an interesting aside, in November 2001, amidst a divisive campaign at Harvard University where the students protested in support for the cleaners are the University receiving a slight increase in the minimum wage (which was below the poverty line), Mankiw told the Harvard Alumni Magazine that:

To do so would compromise the University’s commitment to the creation and dissemination of knowledge.

You can also see the response by Richard Freeman at the same link.

I suppose that is why among other scandals Harvard was involved in a Russian fraud scandal – see 2006 Time Magazine report which implicated the handling of the then President of Harvard, Larry Summers.

Other reports have noted that Summers was using Harvard’s funds to speculate in financial markets which ultimately led them to lose $US1.8 billion. So a commitment to the creation and dissemination of knowledge indeed.

But in Mankiw’s case, this equates to indoctrination.

Principle seven is that “governments can sometimes improve market outcomes: when there is market failure. I will leave this for now.

Finally, the last three PoE cover my area – macroeconomics.

Principle 8 is that “a Country’s Standard of Living Depends on Its Ability to Produce Goods and Services” which Mankiw says that “where workers produce a large quantity of goods and services per unit of time enjoy a high standard of living. Similarly, as a nation’s productivity grows, so does its average income”. Gittins promotion for this Principle goes like this:

The value of a country’s production of goods and services during a period is measured by gross domestic product.

A simple measure of its material standard of living is its GDP divided by the size of its population. Income per person is very much higher in the developed countries than the developing countries. Why? Mainly because the rich countries have higher productivity – each hour of a worker’s time produces more goods and services.

There are many who consider GDP to be a highly inadequate measure of welfare (standard of living). For example, GDP can increase if a polluting firm which spills oil requires a massive salvage operation to clean it up. In what sense is that an increase in standard of living? A nation that produces military equipment but has its population living in poverty and oppression may have very strong GDP growth rates. Are we saying they have strong growth in their standard of living?

There is a huge literature contesting this view of welfare and living standards. For example, the Genuine progress indicator is a broader measure of human welfare.

Further, the proposition that rich countries do it by dint of better use of their own resources ignores the colonial oppression usually backed by military force (or other more subtle coercion such as the IMF packages) that sees massive resource riches transferred to the advanced countries from the less developed. If the poor nations were able to corral their own resources and use them to develop mass education and public health infrastructure the distribution of rich nations would be very different.

Why are these geo-political matters ignored?

Principle 9 takes the cake. Mankiw says that “Prices Rise When the Government Prints Too Much Money” and suggests that:

When a government creates large quantities of the nation’s money, the value of the money falls. As a result, prices increase, requiring more of the same money to buy goods and services.

Gittins chimes in with the follow-up sales pitch:

This proposition is usually true, but it doesn’t apply when – as now in the United States and Britain – the demand for goods and services is falling far short of the available supply of goods and services.

First, the proposition assumes that governments spend by “printing money”. Mints print money for use by banks and their customers who desire to hold some of their liquidity in the form of notes and coins. This proportion of total financial assets held by the non-government sector is very small.

Governments rather spend and tax by crediting and debiting bank accounts. This is the way new net financial assets denominated in the currency of issue enter the economy. Why obscure this fact? Why not explain as a basic starting point to understanding how the modern monetary system operates how the government interacts with the non-government sector works?

Using emotive imagery of “printing too much money” is indoctrination not education.

Second, inflation is a complex matter and arises because there is an imbalance between nominal demand growth and the real capacity of the economy to absorb that growth.

There is a rich literature tracing this to the income distribution struggle between workers and firms. They both seek to advance their claims on real output by pushing up their nominal claims (wage push, profit-margin push). Ultimately this will drive nominal demand growth ahead of real income and inflation is the only way of resolving this incompatibility without policy intervention.

Why relate inflation as a starting principle to fiscal policy? Students will then believe that inflation is intrinsically related to fiscal policy. It is not. It is related to nominal spending per se which could include excessive net exports, excessive private consumption, excessive private investment as well as excessive net public spending.

But from the perspective of public purpose, why would a government want to deliberately push the economy beyond full employment? It is easy to imagine an investment boom that was the result of uncoordinated private actions creating a nominal spending boom that went “too far” but why would a single entity (the government) not see the folly of doing it?

Third, Gittins claim that it is “usually true” while then providing the current situation (vast stocks of idle resources) as being atypical is further indoctrination.

When was the last time the major economies went close to sustained full employment? Australia hasn’t gone close since 1975. So when is “usually”? Usually, the capitalist economy generates persistent unemployment and inflation is not a threat.

Finally, Principle 10 is that “society faces a short-run trade-off between inflation and unemployment”. Gittins sells the proposition like this:

Usually, the things governments do to reduce inflation have the effect of increasing unemployment and the things they do to reduce unemployment have the effect of increasing inflation.

This relationship is known as the “Phillips curve”‘ after the Kiwi who invented it, but in the long run the trade-off breaks down and if you push it too hard you can end up with high inflation and high unemployment. If you can get people’s inflation expectations down, however, you can enjoy the best of both worlds.

The relationship between inflation and unemployment was not “invented” by A.W. Phillips although his work was a part of the literature. I wrote a PhD on this topic!

Note again the use of the term “usually” as if this is the “normal” situation and deviations from it are “abnormal”. Nothing could be further from the truth. Take the 1990s recovery period where the so-called “trade-off” was continually empirically re-estimated by the mainstream because employment growth was relatively strong around the world and inflation fell.

This reality obviously was a problem for Principle 10, but rather than scrap it they just tried to re-invent the problem.

I have run out of time this afternoon so if you want to see more critique, please start with the following blogs for more discussion:

Further, my recent book with Joan Muysken – Full Employment abandoned – also covered the fallacies involved in the “unemployment-inflation trade-off” literature in considerable detail. It is an academic treatment rather than blog style!

Further, the introduction of a Job Guarantee would allow the government to create as many jobs as were needed to satisfy the preferences of the willing labour force without compromising price stability. Running an employment buffer stock system negates any notion of a trade-off.

Please read my blog – When is a job guarantee a Job Guarantee? – for more discussion on this point.

Anyway, Gittins then attempts to close the deal:

If you’ve followed me this far you’ve passed the course.

While my daily blog readership is now quite large, I suspect it is not as large as the Sydney Morning Herald. So it is a pity that Gittins abuses his position in this way.

The only course that his readers have passed is that they will have a wrong-headed perception of what sound economic enquiry entails. You will not learn that from Mankiw that is clear.

You might like these links:

Diddums …

Diddums – “… How sad, how unfortunate, poor you. Used in a mocking way”.

I said that as I read the Bloomberg report that JPMorgan’s Dimon Said to Call Darling to Protest Tax

The story says that the CEO of JPMorgan Chase & Co has protested to the UK Chancellor Alistair Darling about the 50 percent tax on banker bonuses. He apparently said that in relation to his company’s:

… plans to build a 1.5 billion pound ($2.4 billion) European headquarters in London’s Canary Wharf …

JPMorgan is considering dropping plans to build its European headquarters at Canary Wharf because of the U.K. bonus tax …

In Australia, I recall some kids who were annoyed that they were given out in a backyard cricket game would – if they were the one who owned the bat – storm off home in an attempt to ruin the game. Problem is that bats emerged from all sorts of places including fence pickets so the strategy failed.

Poor JPMorgan though.

This Post Has 13 Comments

  1. Dear Bill,

    Very nice post. Shows how they teach the subject without really questioning or challenging the beliefs. I liked the line below:

    There is a rich literature tracing this to the income distribution struggle between workers and firms. They both seek to advance their claims on real output by pushing up their nominal claims (wage push, profit-margin push). Ultimately this will drive nominal demand growth ahead of real income and inflation is the only way of resolving this incompatibility without policy intervention.

    Maybe we can have a post on this sometime ?

    On a related note, I was looking at the WPI (the Wholesale price index, which is the headline number) inflation data since it makes a lot of headlines here in India. The articles written in the financial media and research articles repeat the same lines rote-learned from toxic textbooks. Manufactured products account for about 63% of the WPI and manufactures don’t change the prices every week. This led most people to conclude that the national statisticians are not doing their jobs (thinking prices change according to supply-demand in “free markets”). Indoctrinated, they could not even believe what is in front of their eyes and called the data incorrect. The Chief Statistician however came on CNBC once for a long interview and explained that manufacturers change their prices utmost twice a year. Plus they blame the central bankers for not having increased the short term rates! The central bank makes its set of mistakes – intervening in the FX markets and preventing the appreciation of the Rupee, and thinking inflow will lead to inflation, whereas appreciation makes oil cheaper!

  2. Dear Bill,

    Is it worth the effort to critique clowns like Mankiw or Gittens given that anyone who believes in what they write probably isn’t worth saving anyway ?

    Cheers, Alan.

  3. Dear Alan

    You are one of the lucky ones who has studied economics within a modern monetary environment (well you had contact with some MMT). So for you the blog is passe. I understand that.

    But for many students (a lot who E-mail me now from around the world – including Harvard) – they want to know more about MMT and also be introduced to a broader critique of the rubbish they are being forced to learn in undergraduate programs. There are also others out there who want to know more but do not know where a critique might begin. For many, neo-classical economics is impenetrable.

    Randy Wray and I are writing a textbook based on MMT at present and I just scrounge some notes I have been creating as part of that process and also a broader book project I am working on to create an accessible blog introduction to give the interested parties something to start with.

    So in that sense I think it is worth it.

    best wishes

  4. Alan,

    I teach financial risk management at a Masters level and by coincidence I’ve just finished writing rejoinders to Mankiw’s “principles” for our students to read in order to deconstruct some of their indoctrinations, and also to help with developing their critical thinking. As the textbook is still used in Australia we need to keep up the battle. So good work Bill!


  5. Good post, as always. I think it is valuable to criticise Mankiw. He has a wide reach.

    I want to make a point about neoclassical policy prescriptions. The efficacy of neoclassical macro policy rests on the discredited claim that a market economy automatically tends to full employment provided real wages and prices are flexible. This suggests that unemployment is caused by a failure of real wages, interest rates or expectations to adjust, and that policy should therefore aim to reduce real wages or real interest rates (whether through micro ‘reform’ or supposedly inflationary policies such as quantitative easing) rather than directly create demand or employment.

    The neoclassical claim is based on two assertions: (a) lower real wages result in higher aggregate employment; and (b) demand adjusts to higher output through price and interest-rate adjustments.

    But assertions (a) and (b) are based on fallacies of composition that were exposed in the Capital Debates. At the aggregate level, it is not valid to suppose an inverse relationship between the real rate of interest and private investment, or between real wages and aggregate employment. The neoclassical ‘demand for capital’ and ‘demand for labour’ functions are both poorly defined and unstable. This has been known for 50+ years, yet is rarely taught. Neoclassical economists ignore it and try to hide it from their students. I think the point should be hammered home frequently.

    For instance, in the passage “Nominal (or real) wage cuts per se do not clear the labour market, unless they somehow eliminate the private sector desire to net save and increase spending”, we could add “and there is no reason to suppose wage cuts, in general, will eliminate the private sector desire to net save. This has been well understood since the Capital Debates.” And then we could provide a link:

  6. Bill,

    After reading this entry, I’ve concluded you are not an economist, but a sociologist. Some consider economics a subset of the broader discipline of sociology, but a true economist’s PRIMARY concern is efficient use of resources, including human resources:

    e⋅con⋅o⋅my  /ɪˈkɒnəmi/ [i-kon-uh-mee] Show IPA noun, plural -mies, adjective, adverb-noun

    1. thrifty management; frugality in the expenditure or consumption of money, materials, etc.
    2. an act or means of thrifty saving; a saving: He achieved a small economy by walking to work instead of taking a bus.
    3. the management of the resources of a community, country, etc., esp. with a view to its productivity.
    4. the prosperity or earnings of a place: Further inflation would endanger the national economy seriously.
    5. the disposition or regulation of the parts or functions of any organic whole; an organized system or method.
    6. the efficient, sparing, or concise use of something: an economy of effort; an economy of movement.

  7. Dear c smith

    My academic life’s work has been mainly concentrated on researching and writing about unemployment in fact (“efficient use of resources, including human resources”). The greatest waste of resources is unemployment.

    After all … Tobin asked “how many Harberger triangles can you fit into an Okun gap?” Answer: a very large number.

    But I am happy for you to consider me to be anything you like. I am also probably the only “sociologist” then that fully understands the intricacies of the monetary (and banking) system!

    Yet I am surprised you are still wasting your time reading the “academic gobbledygook” that I write as you so succinctly put it the other day.

    best wishes

  8. The greatest waste of resources is unemployment.

    1.There exist extremely wide variations in individual productivity.
    2. A GREATER waste of resources is the waste of the capacity (capital, entrepreneurial or otherwise) of the more productive individuals in society via a (coercive) set of disincentives.

    Or, as Chicago gobbledygookian Bob Lucas put it:

    …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.

    Exhibit A: The upcoming 2010 U.S. census. Why does it take 1.4 million Americans to conduct a census, 3 times as many as in 2000? Each (projected) census worker can go out and count 225 of his or her fellow Americans (less than 1 per working day!) and call it a year…

    Why not hire 14 million and “solve” the entire unemployment problem ???

  9. Catechism of the Economic Church

    c smith, be assured that your religious zeal has been recorded in the Book of Life and that your beliefs – as far as you have revealed them – are in strict accordance with the Catechism of the Economic Church.

    Take heart. Those who have submitted themselves to an Economics 101 course in the last decade or so will – by the grace of God – have been indoctrinated into Mankiw’s Ten Principles of Economics, which are laid down in Chapter Exodus of his sacred text, and reiterated in Chapter Deuteronomy.

    It is believed that the Principles were revealed, thousands of years earlier, to Daniel in a vision, but he couldn’t understand the vision, so the Principles were sealed up for the latter days. Some also believe that when Moses broke the first tablets of stone on Mount Sinai, God was so angry that he refused to reproduce the Principles on the second set. Others say God sensed the twelve tribes weren’t yet ready for the Principles, and was secretly relieved when Moses lost his temper. Support for this latter position may be found in Revelation where John eats what appear to be the Principles in scroll form. They taste sweet as honey, but turn sour in his stomach. In any case, what we do know is that God eventually became impatient and sent an angel with golden plates to Adam Smith. Smith was meant to translate the plates into the Ten Principles, but turned his back on God and wrote something about Moral Sentiments instead. This postponed God’s plan – which was all part of God’s plan – until the late nineteenth century, when – at last! – Marginalism was born of a virgin in an inn in England – though some say Austria or Switzerland.

    Marginalism – known as the Goddess Neoclassicalism in pagan mythology – died for our sins circa 1930, but resurrected itself soon after – though there is uncertainty over the precise date or whether the resurrection was literal or allegorical. By the 1990s, Marginalism had reached far and wide – in paganized form – though many who clung to its most cardinal values suffered terrible persecution. It was time for Mankiw the Great of Harvard, on behalf of the New World Order, to clarify fundamental doctrine and clear the way for its dissemination throughout Margindom.

    The Principles require much faith, because – as Professor Mitchell’s post makes clear – nearly all of them appear to contradict current knowledge. But we know that in the end of days the saints will be tested by a great delusion, so we all must hold firm to what we know is true:

    1. We face tradeoffs, such as the tradeoff between equity and efficiency.

    This seems incorrect at the aggregate level when we are operating within our production possibility frontier – which, in practice, is almost all the time – so be patient. In addition, it seems to contradict the superior growth performance of societies with more equal income distributions. This takes wisdom.

    2. The true cost of something is its opportunity cost.

    This Principle also appears to be untrue at the aggregate level whenever we are inside our production possibility frontier. Appears to be untrue. Guard against delusion.

    3. Rationality involves thinking at the margin.

    Aggregation problems were sent to test us.

    4. People respond to incentives.

    But what incentives? And do people rank alternatives in accordance with rationalist dictums? Yes, they do. Get thee behind us, Satan.

    5. Trade makes everybody better off.

    So why has Africa become poorer with the rise of free trade? Sin, of course. Sin.

    6. Markets are usually a good way to organize activity.

    The theory of second best says that when there are market imperfections, correcting some but not all of them will not, in general, result in a Pareto-improvement. The purveyors of this theory claim to be Marginalists, but this is the work of false prophets. There are wolves among us in sheep’s clothing.

    7. Governments can sometimes improve market outcomes when there is market failure.

    A necessary evil. It will not be so in the next world.

    8. Standard of living depends on GDP.

    Even the demons know this, and tremble.

    9. Prices rise when the government “prints too much money”.

    It only seems to be untrue at the moment. Just wait. The apocalypse is at hand. Marginalism will reveal itself. True and just are its judgments.

    10. The Phillips Curve.

    No, it is not the most discredited, flaky concept in economics. That’s just what the apostates say.

    Keep the faith, c smith. The grass of the earth will be spared, whereas locusts with stings like scorpions will torture those who lack the Marginalist zeal. Unbelievers will seek death, but won’t find it. They’ll long to die, but death will elude them.

  10. Hey, alienated…no zealotry here…just going with what works here on planet earth. BTW, I’m right with you on #10.

  11. c smith: if we assume production sets, preference relations and moon orbit are convex, I’m thinking Mankiw’s Principles should generalise to the solar system. 🙂

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