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.” (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!

The complicated CGS banding system–which determines what the Government provides per student, and varies depending on the discipline being studied–is being rationalised from 14 bands to 7. In 6 of those new bands, the amount being given in 2008 is slightly more than the highest amount given to the previous bands. For instance, the four bands of Maths, Behavioural Sciences, Education and Computing are being amalgamated into one band; the highest funding level per student in 2007 was $8,057 for Computing, and the lowest $5,381 for Maths; the new funding level is $8,217–a 2% rise for Computing, and a 52% increase for Maths.

I certainly don’t disparage the funding boost for Mathematics–God knows mathematics education deserves better support in this country. But the whole thing is being funded by a dramatic reduction in funding for business students.

In one and only one band, the new amount is only slightly larger than that given for the lowest-funded band in 2007. Law and Business are being banded into one; previously, Law got a paltry $1,642 per student, and business got $2,703 (the second lowest amount); now the combined band will get $1,674 per student: a 2% boost for Law, but a 38% cut for business.

Needless to say, with Commonwealth funding as low as it is now, this sharp a cut would bankrupt most Business Faculties in Australia–it would certainly bankrupt mine. So the Government will enable us to top up their drastically reduced funding by increasing HECS: Business disciplines are being moved from HECS contribution Band 2, which has a $7,188 ceiling on what Universities can charge students, to Band 3, with a $8,333 ceiling (page 15 in icss_booklet_2007.pdf from www.goingtouni.gov.au).

So this budget takes over $1,000 out of University funding per business student, and replaces it with up to $1,145 more from each student.

The Government’s rationale for this move is that “CGS funding for Accounting, Administration, Economics and Commerce will be adjusted downwards to match the Commonwealth contribution for Law reflecting the commercial nature of these courses” (Budget Paper 2, Page 115).

If there’s any rationale to this, it’s the belief that business and law students earn squillions and are in it for the cash, whereas other professions are there for love and earn a pittance.

The Budget Overview confirms this with the statement that: “The cap on the HECS-HELP fee and the public subsidy for Accounting, Administration, Economics and Commerce will be aligned with Law to reflect the high salaries that graduates in these disciplines receive” (page 11).

So hit the rich with the tax and let the poor in free–an admirable socialist principle… However, even that Bolshevik logic doesn’t cut the mustard. The starting salaries for business careers are certainly not the highest in the land, nor are they comparable in any way to salaries in Law. Check:

http://content.mycareer.com.au/salary-centre

There you will see that the minimum salary for Accounting (which I presume corresponds to what new graduates can expect) is $37,000–versus $39,000 for a teacher, $41,000 for an engineer, and $50,000 for a career in science.

On the other hand, the band that business students now share their educational bills with includes law (starting salary $49,000) and medicine ($51,000).

So a Socialist interpretation of the Government’s motives here doesn’t make sense–which is just as well, I suppose: coping with the ironies of Higher Education funding in this country is difficult enough, without having to believe that Peter Costello is actually Che Guevara in disguise.

What makes more sense is that this is a smokescreen: it’s a way to seem to be increasing University funding, without really increasing at all. You’re merely stealing from Peter (in business) to pay Paul (in Mathematics). I expect that Education was told there wasn’t much more money for recurrent funding, so shuffle the cards to increase funding for some disciplines, and get the money you need for that from some of the others.

Once again, it’s the business students that have been shafted. This is ironic, coming from an allegedly pro-business government. But it suits the mindset: keep overall government funding constant, make the students pay, and hit the business students first because they’re only there for the money anyway.

The dilemma for us educators is that this funding level–even when supplemented by increased funding from the students themselves–simply isn’t sufficient to prepare students for the environment they’re going to confront when they enter the workforce. Our graduates often get a first job in a trading department of a finance company–and come face to face with a Bloomberg screen for the first time in their lives, because most Universities can’t afford to set up mock trading rooms.

So business-persons, please ask this “business-friendly” government to get real on funding business education. There’s no way that University educators can provide the education you want your graduates to have on this pittance.