I’ve had a few exchanges with neoclassical economists recently via the East Asia Forum blog, whose editor approached me to write  a version of my “What a load of Bollocks” post on this site. That piece “Why neoclassical economics is dead“, critiqued an East Asia Forum post “The state of economics” by neoclassical textbook authors McTaggart, Findlay and Parkin.

A reply to my article by Adelaide University’s Richard Pomfret, entitled “Too soon for obituaries: economics is alive and (reasonably) well“, concluded with the following statement:

“Why is there such a market in Australia for writers who create a straw man of ‘neoclassical economics’ or, in the 1990s jargon, ‘economic rationalism’? It may reflect the low level of economics literacy across the population as a whole.

Unfortunately that is a vicious circle: people do not want to study economics because it is irrelevant, and they believe it is irrelevant because they have not studied economics. Or perhaps they studied under one of the iconoclasts who told students that neoclassical economics is dead.” (Pomfret)

I haven’t bothered to reply to Pomfret, partly because that East Asia blog doesn’t have all that high a level of discussion (most posts get 5 or less comments on them, rather less than the norm here!), partly because I’d rather let events decide which of us is right, and partly because I know that trying to point out the flaws in neoclassical economics to believers is as futile as a discussion about the existence of a god between an athiest and a theist. But the degree of disconnect between his defence of neoclassical economics, and how people are feeling about economics and the economy today, is remarkable:

“There is a risk/return trade-off to opening the economy and liberalising the financial sector. The OECD countries with the most dynamic financial sectors (the US, the UK, Ireland and to a lesser extent Australia and Spain) had the fastest growth in the 1990s and 2000s and were more exposed to financial crises than say Italy, Germany or Japan – but the reformers are much better off over the two decades, even allowing for the current financial crisis, than the others.” (Pomfret)

Of course he’s also ignoring the myriad academic critiques of the internal consistency of neoclassical economics that I detailed in Debunking Economics, but I’m so used to neoclassical economists ignoring (and more frequently, not even being aware of) such critiques that I saw no point in wasting my breath pointing them out.

However I was pleased to find that at least some students in economics are starting to voice their frustrations with neoclassical economics in class–something that I know is vital if we’re ever to get rid of this pseudo-science and develop a genuinely empirical alternative. A student at Melbourne University who is currently suffering through Intermediate Microeconomics wrote this set of observations (Part 1 and Part 2) on the subject prior to his exams this semester, and distributed it to his classmates.

I hope this isn’t the last time that a student gives a neoclassical lecturer a hard time. It certainly isn’t the first–I was doing likewise almost 40 years ago as an undergraduate at Sydney University, in the struggles that led to the development of the Department of Political Economy there (a quick reminder to any Sydney-based readers that I’ll be speaking at a discussion of Political Economy with Frank Stilwell and Evan Jones at Gleebooks on Tuesday June 16).

That’s not to say that I agree with the manner in which Political Economy has developed since those heady days of student rebellion in the early 1970s. I have always taken a strongly analytical approach to economics; I simply reject the static methodology that dominates neoclassical economics, and too often turns up in rival schools of thought as well because economists in general are ignorant of the standard methods of dynamic analysis that permeate the true sciences and associated disciplines like engineering and computing. Instead I argue that we need to embrace dynamic analysis as a starting point to developing a meaningful, empirical approach to economics (see these proofs of two new book chapters for more details–one on maths and the other on microeconomics).

Hopefully the days of a truly empirical approach to economics are approaching, given the obvious role that neoclassical economics has had in making this crisis so much worse than it would have been without their deregulatory interventions–ones that Pomfret of course applauds in his reply to me:

“In Australia, the advice of economists led to reforms in the 1980s that produced two decades of stellar economic growth. Not only do we have more goods, but we have better goods and choice.” (Pomfret)

Right, those reforms. One of the latest such set came out of The Wallis Committee, at which I argued against deregulation of the financial sector on the basis of Minsky’s Financial Instability Hypothesis. In his piece, Pomfret trots out the “tsunami” defence of the failure of economists to predict this crisis:

“Economists recognized a bubble before 2007, even though they did not predict when and how a financial crisis ensued in the US, UK, Iceland and elsewhere (but not everywhere). As Greg Mankiw says in the article cited by Keen, to blame economists for this predictive failure is like criticising doctors for not predicting that swine flu would originate in Mexico. Steve Keen didn’t predict the timing either.” (Pomfret)

In fact, I did predict the timing–by developing this site, by my commentaries on the inevitability of a debt-induced crisis from December 2005, and by the remarks I made in December 2006 to the Wallis Committee, on the consequences of their recommendation to allow securitised lending. The economic fiasco we are now experiencing was not an unpredictable tsunami, but entirely predictable:

The securitisation of debt documents such as residential mortgages does not alter the key issue, which is the ability of borrowers to commit themselves to debt on the basis of “euphoric” expectations during an asset price boom. The ability of such borrowers to repay their debt is dependent upon the maintenance of the boom, and as the share market reactions to yesterday’s comments by Alan Greenspan reminded us, such conditions cannot be maintained indefinitely.
Should a substantial proportion of eligible assets (e.g., residential houses during a real estate boom like that of 87-89) be financed by securitised instruments, the inability of borrowers to pay their debts on a large scale will not, of course, directly affect liquidity in the same fashion that a failure of bank debtors does. Instead, the impact will be felt by those who purchased the securities, or by insurance firms who underwrote the repayment.
Where this is a government, the impact on liquidity will again be slight, since public debt will replace private.
Where this is a financial institution, such as a bank, it will be in a very similar situation to the State Bank of Victoria (and many others) after the last real estate crash, with similar consequences.
Where this is an insurance company, it could be driven into bankruptcy, with an impact on liquidity via its shareholders and its own creditors. However this would not be as serious as the second instance above.
Where the securities are tradeable, there would obviously be a collapse in the tradeable price, and, potentially, the bankrupting of many of the investors–depending again on their own financing arrangements.

“The securitisation of debt documents such as residential mortgages does not alter the key issue, which is the ability of borrowers to commit themselves to debt on the basis of “euphoric” expectations during an asset price boom. The ability of such borrowers to repay their debt is dependent upon the maintenance of the boom, and as the share market reactions to yesterday’s comments by Alan Greenspan reminded us, such conditions cannot be maintained indefinitely.

Should a substantial proportion of eligible assets (e.g., residential houses during a real estate boom like that of 87-89) be financed by securitised instruments, the inability of borrowers to pay their debts on a large scale will not, of course, directly affect liquidity in the same fashion that a failure of bank debtors does. Instead, the impact will be felt by those who purchased the securities, or by insurance firms who underwrote the repayment.

Where this is a government, the impact on liquidity will again be slight, since public debt will replace private.

Where this is a financial institution, such as a bank, it will be in a very similar situation to the State Bank of Victoria (and many others) after the last real estate crash, with similar consequences.

Where this is an insurance company, it could be driven into bankruptcy, with an impact on liquidity via its shareholders and its own creditors. However this would not be as serious as the second instance above.

Where the securities are tradeable, there would obviously be a collapse in the tradeable price, and, potentially, the bankrupting of many of the investors–depending again on their own financing arrangements.” (Keen 1996)

I would like at least some ackknowledgement from academic neoclassical economists that gee, maybe it wasn’t such a good idea to allow securitised lending after all–even Alan Greenspan has done something of a “mea culpa” after the event. But instead they trot out banalities like “Not only do we have more goods, but we have better goods and choice” as a defence of their policy interventions.

The reason they get away with such isolation from the real world is precisely that: their isolation. Greenspan would have been torn to shreds by the Congressional committee had he used such a defence to them.

We can’t bring Congress, or Parliament, to bear on what happens in academic instruction in economics. But students can give their lecturers a hard time about serving up empirically barren nonsense as economic analysis. Are the students revolting? I certainly hope so!