Rethinking economics: value, irrationality and debt

I had to cut short my attendance at this year’s Rethinking Economics conference in London (  That was because of the surprise developments in Greece which required my attention under the instructions of the God Mammon.

So I was deprived the opportunity of attending a number of presentations and seminars.  Here is the agenda of the two-day conference
Also, here are my previous posts on last year’s London and New York conferences.

Rethinking Economics is an international organisation of academics and graduate students in economics seeking to develop an alternative and pluralist economics discipline beyond the stifling orthodoxy of mainstream neoclassical theory that dominates nearly all economics departments in universities and colleges.

This year’s looked well attended to me.  The opening contribution was by France Coppola, an economist from the financial sector who regularly blogs at

Coppola treated us to a short lecture on value theory.  She criticised Adam Smith’s distinction between use value and exchange value from his famous example of water having great use value but no exchange value and diamonds having low use value but high exchange value.  She pointed out that the use value of water is much lower in Scotland which is abundant with water than in the Sahara where water is scarce.  Thus the degree of scarcity will affect the level of use value and also the exchange value, as the cost of water has been rising faster than the value of gold in recent years.

Coppola sought to expose Adam Smith’s value theory in this way and thus presumably pose more heterodox alternatives.  The problem with this is that scarcity is not Adam Smith’s value theory.  Smith held to a labour theory of value, as did all the classical economists.  The diamond-water example is, in a way, exceptional to the classical or Marxist approach to value, namely that, under capitalism and market forces, the value of something depends ultimately on the labour time expended to produce it.  It was the neoclassical counter-revolution in economics that turned this objective theory of value into a subjective psychological one of marginal utility (or use value) based on individual consumer ‘preferences’.  I’m not sure Coppola was helping the audience on this question with her approach to value.

Talking of the psychological approach to economic behaviour, the conference was honoured to get Daniel Kahneman, the veteran Nobel prize winning behavioural economist, to speak at a plenary session.  Kahneman is an Israeli-American psychologist, notable for his work on the psychology of judgement and decision-making. His empirical findings challenge the assumption of human rationality prevailing in modern economic theory. In 2015, The Economist listed him as the seventh most influential economist in the world.  Thinking, Fast and Slow is his best-selling book, which summarizes research that he conducted over decades.

Kahneman developed what he called ‘prospect theory’ in criticising the traditional utility theory of value promoted in all the mainstream economics textbooks.  Kahneman’s research has shown that people do not behave as mainstream marginal utility theory suggests: namely making ‘rational’ choices.  Instead people have ‘behavioural biases’.  For example, they are more likely to act to avert a loss rather than look to achieve a gain in any investment or spending decision.  In other words, people have higher utility in avoiding losing than in winning; there is not equal utility, as marginalist theory assumes.

Kahneman argues that there is “pervasive optimistic bias” in individuals.  They have an irrational or unwarranted optimism.  This leads people to take on risky projects without considering the ultimate costs – again against rational choice assumed by mainstream theory.  In an echo of the famous saying by George W Bush’s neo-con defence secretary, Donald Rumsfeld, Kahneman reckons that people usually just make choices on what they know (known knowns), sometimes even ‘known unknowns’, but never consider unknown phenomena, ‘unknown unknowns’, like a financial crash.  People do not consider the role of chance and falsely assume that a future event will mirror a past event.

Kahneman’s work certainly exposes the unrealistic assumptions of marginal utility theory, the bedrock of mainstream economics.  But it offers as an alternative, really a theory of chaos, that we can know nothing and predict nothing.  This was a ready excuse used by the bankers and monetary policy officials to explain the global financial crash in 2008. The official leaders of capitalism and the banking ‘community’ then fell back on the argument of Nassim Taleb, an American financial analyst, that the crisis was a ‘black swan’ – something that could not have been expected or even known until it was, and then with devastating consequences: an ‘unknown unknown’.

Before Europeans ‘discovered’ Australia, it was thought that all swans were white. But the discovery in the 18th century that there were black swans in Australia dispelled that notion.  Taleb argues that many events are like that. It is assumed that something just cannot happen: it is ruled out. But Taleb says, even though the chance is small, the very unlikely can happen and when it does it will have a big impact.  The global credit crunch (and the ensuing economic crisis) has been suggested as an example of the Black Swan theory.

From a Marxist dialectical point of view, the Black Swan theory has some attraction. For example, revolution is a rare event in history. So rare that many (mainly apologists of the existing order) would rule it out as impossible.  But it can and does happen, as we know. And its impact, when it does, is profound. In that sense, revolution is a Black Swan event. But where Marxists would disagree with Taleb (and Kahneman?) is that he argues that chance is what rules history. Randomness without cause is not how to view the world. This is far too one-sided and undialectical. Sure, chance plays a role in history, but only in the context of necessity.

The credit crunch and the current economic slump could have been triggered by some unpredictable event like the collapse of some financial institution or the loss of bets on bond markets by a ‘rogue trader’ in a French bank. And the oil price explosion may have been the product of the ‘arbitrary’ decision of President Bush to attack Iraq.  But Marxists would argue that those things happened because the laws of motion of capitalism were being played out towards a crisis. Similarly, the recent spout of natural disasters like tsunamis, earthquakes, flooding etc are not an act of God.  Global warming is man-made.  The current economic crisis was no chance event that nobody could have predicted.

Kahneman’s work leads to that of behavioural economists like Nobel prize winners, Robert Shiller and George Akerlof.  This school argues that changes in a capitalist economy can be best explained by changes in the unpredictable behaviour of consumers and investors.  This is the inherent flaw in a modern economy: uncertainty and psychology.  It’s not the drive for profit versus social need, but the psychological perceptions of individuals. Thus the US home price collapse came about because consumers have a bias towards precaution and savings as debt mounted – just like that.

Shiller argues that investors and economic agents are so irrational that speculation, ‘herding’ and uncertainty can lead to instability and economic crisis. He wrote a book with George Akerlof, called Animal Spirits, the Keynesian term for investment motivations.  Akerlof is married to Janet Yellen, the successor to Ben Bernanke as head of the US Federal Reserve (see my posts

What worries me with the ‘irrational exuberance’ theory of crises is it leaves economics in a psychological purgatory, with no scientific analysis and predictive power.  Also, it leads to a utopian view of how to fix crises.  Shiller says markets can get out of line and then cause busts.  This is due to the irrational behaviour of human beings, not to the drive for profits by private capital.  The answer is to change people’s behaviour; in particular, big multinational companies and banks need to have ‘social purpose’ and not just want to increase profits.  That is really like asking a lion if he would keep his claws in while stroking the lamb (see my recent post on Inclusive capitalism,

In contrast, in another keynote session, Will we crash again?, Professor Steve Keen, now head of Kingston University economics, presented an objective and empirically testable theory of crises based on the excessive growth of private sector debt.  Keen is noted for his strong post-Keynesian critique of mainstream marginalist equilibrium economics in his excellent book, Debunking Economics and also for being one of the few economists to predict the 2008 crash (I would claim to be another – but that is another long story!).

Keen went through the conditions that led to the current crisis and showed that the conventional wisdom got the crisis back to front – in effect, they blamed the symptom for causing the disease. The real cause – the bursting of a private debt bubble – still hasn’t been addressed and lies in waiting ready to cause the next crisis in the next 2-5 years. To escape, economists need to embrace unorthodox thinking and so must policymakers, but the odds are that they will not.

I have written on Keen’s views in several places on my blog.  See

Keen’s focus on the growth of private sector debt as a key trigger of financial crashes (following the work of Hyman Minsky), is very relevant.  Take the new evidence going back to 1870 on where the dangerous concoction of excessive debt and asset price bubbles can lead (

However, both the Keen-Minsky debt school and the behaviourist ‘animal spirits’ school have one thing in common.  They see the flaws of capitalism in the financial sector only. In contrast, Marx posits the ultimate cause of capitalist crises in the capitalist production process, specifically in production for profit.  That does not mean the financial sector and, in particular, the size and movement of credit does not play any role in capitalist crises.  On the contrary, the growth of credit and fictitious capital (as Marx called speculative investment in stocks, bonds and other forms of money assets) picks up precisely in order to compensate for the downward pressure on profitability in the accumulation of real capital.

And that’s the point. Capitalism only grows if profitability is rising.  In the US, with profitability declining after 2005, the huge expansion of credit (or what Marx called fictitious capital) could not be sustained because it was not bringing enough profit from the real economy. Eventually, the housing and financial sectors (the most unproductive parts of capitalist investment) stopped booming and reversed.

Rethinking Economics is a very good development, opening the doors to more heterodox thinking in academic economics.  But all the conferences that I have attended have been dominated by the views of orthodox Keynesians (Robert Skidelsky was there this year) or post-Keynesians (Keen, Ann Pettifor etc).  The views of Marxist economics were notable by their absence.

10 thoughts on “Rethinking economics: value, irrationality and debt

  1. As I recall Taleb does not think that Black Swans such as systemic financial crises are random events that just happen more frequently and more devastatingly than predicted, He criticizes to death the Gaussian normal distribution function and its (ab)use.He does think that markets have momentum and that they drive themselves over the brink, particularly by the help of quants. According to my memory.Agreed that he is certainly no Marxist.
    Kahnemann is influenced by Taleb. By the way, Kahneman seems very contradictory in your exposé: 1) people want to avoid downside risk at all costs, 2) they are overly optimistic. The problem in much of all that is the definition of rationality as behaviour that conforms to utility theory plus perfect foresight on how markets will behave. This means that theorists who are half-way able to think conclude that ‘people are or behave irrationally’. This then gets confounded with true irrationality when people behave against their best knowledge and intuition.

  2. Aren’t the ‘unknown unknowns’ an updated and philistine attempt to give a philosophical gloss to the ‘hidden hand’ explanation of markets? Also- an excellent- as usual, blog comment. But just a minor corrective: earthquakes and tsunami (which are sub-sea earthquakes) are not a consequence of global warming

  3. “Smith held to a labour theory of value, as did all the classical economists.”

    Actually, as Marx describes in Theories of Surplus Value, Part 1, Smith had a muddled theory of value, which wandered one minute from a Labour Theory of Value, to at another being a cost of production theory of value, to at times slipping into a Physiocratic use value theory of value.

    I gave a response to the water-diamond paradox so beloved of marginalists several years ago here.

  4. (1) @MR Any explanation on why “The views of Marxist economics were notable by their absence.”?
    (2) “Sure, chance plays a role in history, but only in the context of necessity.” For some time now I have been wondering about the shortcomings of dialectics vs systems theory. Dialectics easily leading to simplifications like the “scientific certainty” of the end of capitalism or to a simplified economistic base and superstructure theory. There are a lot of necessities, but they have more the character of necessary (pre)conditions then of outcomes.

    1. 1) the organisers never invite Marxists to speak. That may be because there are so few Marxist economists in any universities at leastts in the US and the UK. Or maybe theyejust ignore Marxist views as being irrelevant.
      2) Big discussion here. Nothing is certain. But let’s set an assumption and then something can necessarily flow from it. If human beings are to move from a world of scarcity and exploitation to a world of abundance and cooperation (assumption), then necessarily capitalism must come to an end. But it is not certain that it will; only probable.

  5. I am not an economist but the labour time for gold is roughly the labour time for say aluminium or coal but the price is different, granted prices are not values, but surely there is an element of ‘scarcity’ in the differing prices?

  6. 1) Taleb also argued in ‘Black Swan’ that a financial crisis was likely in the near future due to how the financial system works (this did not contradict his more general point about Black Swan events).

    2) His argument does not constitute ‘chance is what rules history’.

  7. “However, both the Keen-Minsky debt school and the behaviourist ‘animal spirits’ school have one thing in common. They see the flaws of capitalism in the financial sector only. In contrast, Marx posits the ultimate cause of capitalist crises in the capitalist production process, specifically in production for profit.”

    Why is it, then, that in your analyses on the rate of profit you measure the entire economy rather than only the manufacturing sector? Certainly the tendency of the rate of profit to fall does not act the same way in the service and financial sectors than it does in the industrial. Yet your rate of profit statistics never show any distinction. I’m not even sure if the tendency of the rate of profit to fall even exists in much of the service sector. If the RoP falls here is well, is it possible that an entirely different cause leads to a fall in the RoP of all sectors of the economy rather than the TRPTF? This is why I find the overproduction/under-utilization of capacity theory more convincing than overinvestment…it does a better job of identifying where the real roots of the crisis are: the problems plaguing manufacturing sector, on which the service and financial sectors and, ultimately, the economy as a whole (now that agriculture is now a small fraction of GDP) rest.

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