Are the students revolting?

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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!

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