The current economic slowdown constitutes a breakdown for advanced capitalism. Its means of allocating capital – financial markets – froze up and would have collapsed completely if governments had not intervened on a massive scale. The rates of growth of output and employment in most industrialized countries are anemic and persistent. Does not the breakdown of capitalism require some fundamental rethinking of its explanation system, aka economic theory? Today’s troubles and the failure of most economists to predict them have given rise to a lively debate within the discipline about the sources of failure of economic theory and the ways in which it should be reformed. This is a good sign. But the current debate among economists is shallow and confined to a tweaking of its existing toolkit. There is no indication that this debate will produce the intellectual revolution needed to respond to the theoretical and policy challenges facing industrialized countries.
The discipline of economics has been no stranger to methodological controversy. The Methodenstreit (debate over method) among German social scientists in the 1880s, the Keynesian revolution in the 1930s, the ‘F-twist’ debate in the 1960s over the importance of realism of assumptions, and the ‘Cambridge controversy’ over the meaning of capital in the 1970s are some of the most notable debates. But not all methodological discussions are created equal. Some are profound—questioning the very structure of the reigning methodology—while others are more superficial, aiming at incremental reform or merely cosmetic change. We find that the current discussion is for the most part quite shallow, and will remain so unless certain voices in the debate are given more emphasis.
The central problem is that almost nobody dares to rethink the nature of economic life and the proper scope of economic thinking. This deeper approach is precisely what we find in the Methodenstreit and in Keynes’ innovations. On its surface the Methodenstreit was a debate over whether concrete historical analysis or mathematical modeling was better suited to explain economics. But this question ultimately rested on the question of what the realm of political economy was actually like—i.e. whether it was comprehensible as a complex of generic building blocks at the level of individuals, or whether it was a network of irreducibly social institutions that individuals created and lived within. The debate led to revolutionary change —namely, a bifurcation of the discipline. The Historical School’s philosophy of science—updated and improved by Max Weber—ultimately found a home in sociology. The Austrian School, meanwhile, populated the burgeoning discipline of neo-classical economics, with its focus on the properties of a fully-decentralized competitive market system composed of rational and self-interested individuals functioning in a world of scarce resources.
John Maynard Keynes © IMF | imf.org
Keynes’s innovations were pitched at a similarly sweeping level, with the same revolutionary effect. Keynes introduced a new understanding of the concepts of time, uncertainty, and expectations. He argued that aggregate phenomena determine individual outcomes, a reversal of the direction of causality presumed in the dominant theory of his day. He established a new way of thinking about markets by showing how aggregate demand rather than wage flexibility created employment growth. When wages fall, incomes and consumption drop, which can lead business to reduce rather than increase its ranks of employees. Keynes showed how raising demand through real wage increases could thus increase employment.
The economic malaise since 2008 has generated a massive volume of criticism and self-questioning by economists in academic journals, newspapers and blogs. But the discussion has been floating on a shallow level. Roughly, we can separate the positions in the debate into three categories.
A first group proposes that we ‘Do Nothing’ to change economic theory. This group, which includes such prominent macro economists as Thomas Sargent and Eugene Fama, claims that the theory of efficient markets has not been falsified by recent events. Either because the theory is about normal times rather than crisis, or because events don’t show any individual irrational behavior but rather a pattern of damaging economic policies, such as excessively high wages and money growth, leading up to the crisis.
The second group we refer to as ‘Add Finance and Stir.’ This eclectic group, which includes Robert Schiller, Paul Krugman, David Colander and Lance Taylor, sees the main limitation as the failure to link finance to macroeconomic theory. For this group, economics can be fixed by introducing a model of the financial sector that directly influences the ‘real’ sector of the economy.
A third group wants economics to be infused with more complexity and a richer understanding of institutions. This group ranges between those who propose more refined mathematical modeling to those who want to eliminate the use of mathematical formalization in economic theory entirely. We call it the ‘Add Institutions/Complexity’ group.
Unfortunately, these responses are shallow compared to the thorough debates of the past. They offer little hope that economics’ recent failures will be met with substantial reforms. True, some in the third group, for example Geoffrey Hodgson and Tony Lawson, are calling for a re-examination of the purpose of economics and its a priori commitment to the exclusive use of mathematical modeling to analyze economic life. But this view is not taken seriously within the profession.
It is certainly possible that the proper response to economics’ latest malfunction does not require a complete rethinking of the conceptual foundations. But we cannot simply presume that our current toolkit is entirely adequate. We need someone with Keynes’s radical spirit, including a willingness to look beyond the reigning way of doing economics. Refusing to do so is a recipe for superficial debate and cosmetic changes that simply kick the real problems down the road.
We need someone with Keynes’s radical spirit, including a willingness to look beyond the reigning way of doing economics.
The economist/economists you are searching for already exist. They are called Post Keynesians, and are people like Paul Davidson, Geoffrey C. Harcourt, Victoria Chick, Jan A. Kregel, Basil J. Moore, Sheila Dow, Thomas I. Palley, Malcolm Sawyer, Philip Arestis, Marc Lavoie, Steve Keen and Mark Hayes.
They have been challenging “reigning way of doing economics” for decades:
http://socialdemocracy21stcentury.blogspot.com/2010/07/three-varieties-of-keynesianism.html
Post Keynesianism uses the original insights of Keynes, such as non-neutral money, a non-ergodic future, subjective expectations and uncertainty, as well as Hyman Minsky’s financial instablity model and a debt deflation theory of recessions. You have the basis there for a reformed and new macroeconomics.
When theory doesn’t describe correctly the experimental results, the thing to do is to come up with a better theory. Can you think of situations where philosophizing about general classes of theories resolved the inconsistencies? Me neither.
In this case non Keynesian theories such as Austrian efficient markets have been falsified. File with aether and phlogiston. On the other hand, it seems Keynes has held up fairly well (Krugman might add the names of Samuelson and Friedman, I guess). Economists need to work hard on theories that work, not wait for prophets.