Krugman vs. Hudson on Samuelson

by Dollars and Sense

I was alerted by this post on Naked Capitalism to a back-and-forth between Paul Krugman and Michael Hudson on Paul Samuelson.

It started when, on Dec. 14th, the day after Samuelson died, Counterpunch re-published a paper by Michael Hudson from back in 1970, shortly after Samuelson was awarded the recently-established Nobel Prize in Economics. Here's a tidbit:

This is only the second year in which the Economics prize has been awarded, and the first time it has been granted to a single individual—Paul Samuelson—described in the words of a jubilant New York Times editorial as "the world's greatest pure economic theorist." And yet the body of doctrine that Samuelson espouses is one of the major reasons why economics students enrolled in the nation's colleges have been declining in number. For they are, I am glad to say, appalled at the irrelevant nature of the discipline as it is now taught, impatient with its inability to describe the problems which plague the world in which they live, and increasingly resentful of its explaining away the most apparent problems which first attracted them to the subject.

The trouble with the Nobel Award is not so much its choice of man (although I shall have more to say later as to the implications of the choice of Samuelson), but its designation of economics as a scientific field worthy of receiving a Nobel prize at all. In the prize committee's words, Mr. Samuelson received the award for the "scientific work through which he has developed static and dynamic economic theory and actively contributed to raising the level of analysis in economic science. . . ."

What is the nature of this science? Can it be "scientific" to promulgate theories that do not describe economic reality as it unfolds in its historical context, and which lead to economic imbalance when applied? Is economics really an applied science at all? Of course it is implemented in practice, but with a noteworthy lack of success in recent years on the part of all the major economic schools, from the post-Keynesians to the monetarists.

In Mr. Samuelson's case, for example, the trade policy that follows from his theoretical doctrines is laissez faire. That this doctrine has been adopted by most of the western world is obvious. That it has benefited the developed nations is also apparent. However, its usefulness to less developed countries is doubtful, for underlying it is a permanent justification of the status quo: let things alone and everything will (tend to) come to "equilibrium." Unfortunately, this concept of equilibrium is probably the most perverse idea plaguing economics today, and it is just this concept that Mr. Samuelson has done so much to popularize. For it is all too often overlooked that when someone falls fiat on his face he is "in equilibrium" just as much as when he is standing upright. Poverty as well as wealth represents an equilibrium position. Everything that exists represents, however fleetingly, some equilibrium—that is, some balance or product—of forces.

Krugman responded to Hudson on his NYT blog. (As one commenter ("attempter") on Naked Capitalism pointed out, Krugman doesn't even mention Hudson by name: "Krugman couldn't even bring himself to write Hudson's name, but just linked to the anonymous post. (Of course K is always very respectful of anyone properly ensconsed in the Establishment, even where he disagrees with them.) Quite the contrast with his protests over how he and others who were correct on Iraq remain marginalized on that subject.") Here is all of Krugman's post:

A number of people are linking to this reprinted critique of the work of the late Paul Samuelson. I could point out that the critique thoroughly misunderstands what Samuelson was saying about international trade, factor prices, and all that. But there is, I think, an interesting point to be made if we start from this complaint:

Can it be "scientific" to promulgate theories that do not describe economic reality as it unfolds in its historical context, and which lead to economic imbalance when applied?

Actually, there was a time when many people thought that institutional economics, which was very much focused on historical context, the complexity of human behavior, and all that, would be the wave of the future. So why didn't that happen? Why did the model-builders, led by Samuelson, take over instead?

The answer, in a word, was the Great Depression.

Faced with the Depression, institutional economics turned out to have very little to offer, except to say that it was a complex phenomenon with deep historical roots, and surely there was no easy answer. Meanwhile, model-oriented economists turned quickly to Keynes—who was very much a builder of little models. And what they said was, "This is a failure of effective demand. You can cure it by pushing this button." The fiscal expansion of World War II, although not intended as a Keynesian policy, proved them right.

So Samuelson-type economics didn't win because of its power to cloud men's minds. It won because in the greatest economic crisis in history, it had something useful to say.

In the decades that followed, economists themselves forgot this history; today's equation-mongers, for the most part, have no idea how much they owe to the Keynesian revolution. But in terms of shaping economics, it was the Depression that did it.

L. Randall Wray of the University of Missouri at Kansas City (where Hudson teaches, along with lots of other great heterodox economists, responded on behalf of Hudson at the UMKC econ blog. Wray says that Krugman's claim that "Samuelson-type economics" won the day because it had something useful to say in response to the Depression is "bizarre, to say the least," and he gives six reasons for thinking so. Here are the first four:

First, Roosevelt's New Deal was in place before Keynes published his General Theory, and it was mostly formulated by the American institutional economists that Krugman claims to have been clueless. (There certainly were clueless economists—those following the neoclassical approach, traced to English "political economy".)

Second, it was Alvin Hansen, not Paul Samuelson, who brought Keynesian ideas to America. And Hansen retained the more radical ideas (such as the tendency to stagnation) that Samuelson dropped. Further, Hansen was—surprise, surprise—working within the institutionalist tradition (as documented by in a book by Perry Mehrling).

Third, many other institutionalists also adopted Keynesian ideas in their work—before Samuelson's simplistic mathematization swamped the discipline. For example, Dudley Dillard—a well-known institutionalist—wrote the first accessible interpretation of Keynes in 1948; Kenneth Boulding's 1950 Reconstruction of Economics served as the basis for four editions of his Principles book—on which a generation of American economists was trained (again, before Samuelson's text took over). It is in almost every respect superior to Samuelson's text. I encourage Professor Krugman to take a look.

Fourth, Hyman Minsky (who first trained with institutionalists at the University of Chicago—before it became a bastion of monetarist thought) took Samuelson's overly simplistic multiplier-accelerator approach and extended it with institutional ceilings and floors. He quickly grew tired of the constraints placed on theory by Samuelsonian mathematics and moved on to develop his Financial Instability Hypothesis (which Krugman has admitted he finds interesting, even if he does not fully comprehend it). I ask you, how many analysts have turned to Samuelson's work to try to understand the current crisis—versus the number of times Minsky's work has been invoked?

Read the rest of the post.

And last but not least, here's Michael Hudson's response to Krugman, also at the UMKC econ blog.

Labels: Counterpunch, Great Depression, institutional economics, Keynesianism, L. Randall Wray, Michael Hudson, Paul Krugman, Paul Samuelson, UMKC

 

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12/22/2009 01:49:00 PM 0 comments

 

Keynes and the Current Crisis

by Dollars and Sense

We have just posted the latest installment of D&S collective member Alejandro Reuss's web-only series, "The General Theory and the Current Crisis: A Primer on Keynes' Economics."

The new installment (Part III) is entitled Keynes, Wage and Price "Stickiness," and Deflation.

The main page for the series is here.

Enjoy!

Labels: Alejandro Reuss, deflation, Keynes, Keynesianism, wages

 

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9/04/2009 03:53:00 PM 0 comments

 

TDCotE (x): 'Life Is Beautiful' Economics

by Dollars and Sense

The Dull Compulsion of the Economic (x)

A series of blog postings by D&S collective member Larry Peterson


'Life Is Beautiful' Economics and the Strange Co-option of Behavioral Economics

They're at it again: encouraged by the huge rally in equities globally (especially in emerging markets, some of which were considered doomed just a few weeks ago), more and more financial commentators are referring to behavioral economics in an attempt to indicate that the rally may portend a vigorous economic recovery. The latest instance came in Friday's Financial Times, in which US editor Chrystia Freeland joined the chorus with an article entitled "What a Feeling: How Emotions May Yet Drive the Recovery."

I've never been a fan of Freeland's: I think she's easily the most mediocre of the FT's senior staff, and I usually just ignore her usual bland regurgitation of cliches and conventional wisdom. But seeing her refer to behavioral economics really gets me hot and bothered. When I was an undergraduate, I successfully studied graduate-level neuroscience, and have followed developments in what is called behavioral economics (which relies on studies from cognitive psychology and, to a lesser degree, neuroscience) almost since its inception in the 1980s. Accordingly, I think I have a sensibility for both the power and deficiencies of the findings that have been taken up by the new field of behavioral economics which Freeland and a lot of other erstwhile enthusiasts almost certainly don't have. And that's just the start of it. Even recognizing the potential of behavioral economics, I would argue that its use in coming to terms with things like the financial crisis is misguided at best, and ideologically dangerous at worst. Dangerous because I believe a case can be made that it is being used by a discredited profession not only to rehabilitate itself,but to smuggle some of its old, worn-out assumptions in via the back door, dressed up in the garb of cutting-edge science.

Let me try to explain. Behavioral economics is a movement that relies on controlled studies to test the validity of economic assumptions that had been--and still are, to some degree--considered axiomatic by conventional practitioners. Usually the experiments take the form of the playing of games: voluntary participants trade tokens or even, in certain cases, real money in simulated exchanges and so on. So, in a celebrated case, experimenters found that subjects overwhelmingly punish free-riders in such exchanges, even when they stand to gain from cooperating. The upshot of such experiments has been the promotion of a new idea of economic rationality, "bounded rationality", which views rationality operating within limits set by norms and other "non-economic" criteria to a significant extent; accordingly, behavioral economists say that the traditional notion of rationality employed by the economics profession must be changed to reflect this, if only because such recognition will allow for greater predictive power in both experiments and even in the construction of economic models.

This is important because the most recent paradigm that employed widespread popularity in the profession has clearly fallen out of favor. That paradigm, called "rational expectations", was popular with conventional economists precisely because it seemed to solve what they considered to be a major problem implicit within Keynesianism: the fact that Keynesianism didn't have an underlying microeconomics to support its macroeconomic superstructure. And for economists of this sort, who largely continued to accept some version of Say's law (which Keynes rejected, and stated basically that all production is ultimately undertaken to support consumption, rather than, say, profit-taking, hoarding, or accumulation), Keynes' focus on insufficient aggregate demand was a heresy--it couldn't, to them, sufficiently (i.e. in a way that foregrounded the practitioners' very specific notion of rationality) explain the motives of the individual actors whose choices led to outcomes in which full employment could only be considered a special case; and inasmuch as it did, by referring to liquidity preference and speculation, that could only be reconciled with a vigorous notion of rational self-interest with some difficulty. But it wasn't until the failure of what were considered Keynesian policies in the 'seventies that they found an opening to plug this gap. So, first they criticized the failure of Keynesian macroeconomics, and then proposed a new microeconomics that, it was claimed, could restore the link between good, old-fashioned self-interested rationality and the wonderful workings of a whole market system that equilibrated to full employment after all.

This paradigm, which, as many know, was employed originally by members of the Thatcher and Reagan administrations, became renowned for its intransigence: its practitioners stubbornly resisted contributions from economists professing other views, and purged many academic departments, think-tanks and so on of holdouts. And as Thatcherism and Reaganism morphed into Clintonism and Blairism, the situation only got worse. Except on one front: behavioral economics.

Why was this? I think the original encounter with it came because economics, which was being aggressively promoted as a science especially by neoliberal technocrats, but also by financiers, academics and journalists, was considered by the dominant practitioners to have to be as open to what, after all, appeared to be the incontrovertible findings of science--especially sciences of the "harder" variety, like neuroscience--as possible. So, economics slowly, kicking and screaming, opened the door to practitioners of behavioral economics just a crack. Also, as the millennium approached, the collapse of Long Term Capital Management, the Asian crisis, and, eventually, the dot.com meltdown finally revealed all too clearly that the predictive power of monetarist models was not all that it was cracked up to be; and this had a lot to do with the vast, global expansion of the financial sector, a sector which, in part, and to a limited degree, could be examined by experiments devised by practitioners of behavioral economics in ways that the notions of rational expectations couldn't.

Regardless of the cogency of my interpretation, there is no doubt now that behavioral economics is on the ascent. Practitioners like Cass Sunstein occupy high places in the Obama administration, and the current financial crisis (along with its hyper-aggressive monetary and fiscal interventions) has turned the retreat of the rational expectations school into something of a rout. Meanwhile, Keynesian ideas are resurfacing all over the place. And many behavioral economists are beginning to see their own discipline as the one that may provide that elixir of a slightly different sort than that sought after by the rational expectations school: of a "grand theory" that might unify a brand of Keynesianism, complete with an implicit acceptance of the generality of sub-optimality, with a new notion of bounded rationality--but a rationality all the same, one that can, however provide material for falsifiable experimentation, predictive modeling, and, potentially, optimal policymaking potential. So what's wrong with that?

Well, my criticism of behavioral economics focuses on the fact that its predominant use of controlled experiments has, by far, simulated the form of consumer exchanges. For ethical and practical reasons, experimental subjects simply cannot be monitored to the same extent in their capacities as workers, employers, union members or scabs, monitors or even slackers, as they can as simple consumers or even investors. Particularly in cases in which economic behavior is characterized by an asymmetry of real--not simulated--power, it would potentially compromise willing subjects to agree to experimentation, and it's difficult to see how experiments could be devised that controlled adequately for that asymmetry inn the first place. This is all the more the case where the accounting for the impact of underlying initial endowments of capital--of social or monetary variety--or knowledge are concerned. The types of games and experiments so far devised by behavioral economists--even those that employ the most advanced brain scans and so on--simply are least qualified to illustrate anything but the most limited forms of economic behavior. That being the case, to view the findings of behavioral economics as somehow paradigmatic, never mind ultimately fundamental in a microeconomic sense, constitutes to me an extremely dangerous and misleading position. And it is this position that is increasingly being taken up to "explain" the financial crisis, even by people like Freeland, who probably don't know very much about the science in the first place (never mind luminaries like George Akerlof and Robert Shiller, who Freeland refers to in her article).

The big problem with all this is that, in the attempt to explain the financial crisis, commentators, following the implicit example set by behavioral economists themselves in many cases, seem quite content to focus on the most limited kind of economic behavior, and thereby bracket out the most important stuff. There is much talk of the transformative power of sentiment, as if the crash itself was an overreaction that could, potentially, be overcome if only government and business are allowed to "nudge", to use Sunstein's term (developed with the aid of one of the founders of behavioral economics, Richard Thaler), investors and consumers out of their excessively pessimistic box. This completely ignores the very real weaknesses in the economy that will almost certainly continue to plague working people and pensioners all over the world, even if surviving corporations, due to drastic, or even unprecedented shakeouts (not to mention government support) in their industries, attain some level of profitability acceptable to the ruling and accumulating classes. In fact, these weaknesses are so great that it's hard to see how they won't adversely affect large swathes of the latter, and reconfigure that stratum in fundamental ways in the next few years. And economists who privilege explanations based on sentiment over the underlying economic situation, far from elucidating the crisis, may be unwitting tools in shaping it--to the detriment of many people; just as methodological individualism (the idea that economics must focus on individual decision making to attain coherence as a science) was smuggled in via the back door, and even after behavioral economics had played a major role in tearing it down in its fundamentalist form, by the experimental bias of behavioral economics, its practitioners seem all too comfortable with the misuse of limited purview of their findings by politicians and commentators banking on a swift, but highly unlikely recovery.

A couple of years ago a film came out called "Life is Beautiful", in which, preposterously, perhaps to an offensive degree, an inmate in a concentration camp during the second world war attempted to make the life of a child also interred in the camp bearable by getting it to believe that life in the camp was only a game. Far from providing a new Keynes (and I wouldn't say that's the optimal solution), even the most promising school of economics in these harsh times seems to be content with cobbling together narratives devised for something approximating the same purpose.

Labels: behavioral economics, Crystia Freeland, financial crisis, Financial Times, George Akerlof, Keynesianism, Larry Peterson, rational expectations, Robert Shiller, the dull compulsion of the economic

 

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5/10/2009 06:35:00 PM 0 comments

 

Christina Romer Defends Fiscal Stimulus

by Dollars and Sense

Romer is chair of the president’s Council of Economic Advisers (and an economic historian at Berkeley). In a talk at the Brookings Institution on Monday, she took on the crowd claiming that Keynesian fiscal stimulus policies failed in the 1930s:

I wrote a paper in 1992 that said that fiscal policy was not the key engine of recovery in the Depression. From this, some have concluded that I do not believe fiscal policy can work today or could have worked in the 1930s. Nothing could be farther from the truth. My argument paralleled E. Cary Brown’s famous conclusion that in the Great Depression, fiscal policy failed to generate recovery “not because it does not work, but because it was not tried.” The key fact is that while Roosevelt’s fiscal actions were a bold break from the past, they were nevertheless small relative to the size of the problem.

A good omen for fiscal policy.

Alas, her remarks were disappointing on the deeper question of the causes of the crisis:

Most obviously, like the Great Depression, today’s downturn had its fundamental cause in the decline in asset prices and the failure or near-failure of financial institutions.

Too bad she didn't talk about the steep rise in inequality; stagnant real wages; households’ expanding use of credit to fill the gap between those stagnant wages and rising living costs; excess capacity and overproduction...

Read the whole talk here.

Labels: Christina Romer, fiscal policy, fiscal stimulus, Great Depression, Keynesianism

 

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3/11/2009 11:49:00 AM 0 comments

 

Capitalism Hits the Fan: The Film

by Dollars and Sense

Rick Wolff, professor of economics at UMass-Amherst and author of Capitalism Hits the Fan, which ran in our November/December issue, has out with a documentary film on the current economic crisis of the same title. Here are the details from Rick:

I hope that you may find a new film that I made with the Media Education Foundation (MEF) interesting and useful. Called "Capitalism Hits the Fan," it is aimed at colleges, universities, and also high schools for instructional use, but it can serve other purposes as well. You can get a sense of it at www.capitalismhitsthefan.com.

The dvd can be ordered now and will be shipped by month's end. It is also possible to view the full-length version (just under an hour) freely, albeit in low resolution, at the MEF website. While the institutional prices are high, individuals can order the dvd for $ 19.95.

The dvd contains both the full-length version and a shorter 35-minute version.

You may be especially interested in the critical analytical approach to explaining the causes of the current crisis, in the critique of Keynesian stimulus-cum-reregulation "solutions," and in the sketch of an alternative solution.

You gotta love his new website's domain name. I wonder why no one had registered that yet?

Labels: banking regulation, capitalism, financial crisis, Keynesianism, Rick Wolff

 

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2/12/2009 01:18:00 PM 0 comments

 

Feldstein: Let the Stimulus Be Military

by Dollars and Sense

Martin Feldstein, econ professor at Harvard and chairman of the Council of Economic Advisers under President Reagan, reveals in this op-ed from yesterday's WSJ that if he has to be a Keynesian he insists on being a military Keynesian. We are not surprised.

Two noteworthy bits: Marty says that if there should be an increase in DoD spending, "The same applies to the Department of Homeland Security, to the FBI, and to other parts of the national intelligence community." Oh goody. And he actually uses the term "surge" to describe what he is proposing.

Defense Spending Would Be Great Stimulus

All three service branches are in need of upgrade and repair.

By MARTIN FELDSTEIN | OPINION | DECEMBER 23, 2008, 10:04 P.M. ET

The Department of Defense is preparing budget cuts in response to the decline in national income. The DOD budgeteers and their counterparts in the White House Office of Management and Budget apparently reason that a smaller GDP requires belt-tightening by everyone.

That logic is exactly backwards. As President-elect Barack Obama and his economic advisers recognize, countering a deep economic recession requires an increase in government spending to offset the sharp decline in consumer outlays and business investment that is now under way. Without that rise in government spending, the economic downturn would be deeper and longer. Although tax cuts for individuals and businesses can help, government spending will have to do the heavy lifting. That's why the Obama team will propose a package of about $300 billion a year in additional federal government outlays and grants to states and local governments.

A temporary rise in DOD spending on supplies, equipment and manpower should be a significant part of that increase in overall government outlays. The same applies to the Department of Homeland Security, to the FBI, and to other parts of the national intelligence community.

The increase in government spending needs to be a short-term surge with greater outlays in 2009 and 2010 but then tailing off sharply in 2011 when the economy should be almost back to its prerecession level of activity. Buying military supplies and equipment, including a variety of off-the-shelf dual use items, can easily fit this surge pattern.

For the military, the increased spending will require an expanded supplemental budget for 2009 and an increased budget for 2010. A 10% increase in defense outlays for procurement and for research would contribute about $20 billion a year to the overall stimulus budget. A 5% rise in spending on operations and maintenance would add an additional $10 billion. That spending could create about 300,000 additional jobs. And raising the military's annual recruitment goal by 15% would provide jobs for an additional 30,000 young men and women in the first year.

An important challenge for those who are designing the overall stimulus package is to avoid wasteful spending. One way to achieve that is to do things during the period of the spending surge that must eventually be done anyway. It is better to do them now when there is excess capacity in the economy than to wait and do them later.

Read the rest of the article.

Labels: Department of Defense, economic stimulus, Keynesianism, Martin Feldstein, military Keynesianism, military spending, Wall Street Journal

 

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12/24/2008 03:22:00 PM 0 comments