Paul Romer is a top mainstream economist. Romer has just been appointed chief economist at the World Bank. World Bank President Jim Yong Kim described Romer’s appointment with acclaim: “We’re thrilled to have an economist as accomplished as Paul Romer join us,” said Kim.“We’re most excited about his deep commitment to tackling poverty and inequality and finding innovative solutions that we can take to scale.” For a critical review of Romer’s’ ideas and his likely influence at the World Bank, see this piece from the graduate blog, the New School Economic Review.
So it is big news among professional mainstream economics that Romer should publish just this month a working paper in which he trashes the whole basis of macroeconomics (i.e. looking at an economy as a whole), both neoclassical and Keynesian versions, in what appears to be a parting farewell to his colleagues in economic academia (leo16_romer). This is what he says in his intro to the paper, The trouble with macroeconomics, “For more than three decades, macroeconomics has gone backwards. …Macroeconomic theorists dismiss mere facts by feigning an obtuse ignorance… Their models attribute fluctuations in aggregate variables to imaginary causal forces that are not influenced by the action that any person takes… a general failure mode of science that is triggered when respect for highly regarded leaders evolves into a deference to authority that displaces objective fact from its position as the ultimate determinant of scientific truth.”
Romer’s critique mirrors the criticisms that have been expressed by heterodox and Marxist economists for decades. For example, see Steve Keen’s excellent book, Debunking economics, which exposes the fallacious assumptions and approach of mainstream economics; or more recently, Ben Fine’s critique of both micro and macroeconomics. But now we have top mainstream economist Paul Romer dismissing the approach and methods that he and others have taught in all the economics departments of universities across the world.
Romer starts by an attack on the explanation of crises under capitalism as just being the result of ‘exogenous shocks’ to an inherently harmonious process of economic growth. “Macroeconomists got comfortable with the idea that fluctuations in macroeconomic aggregates are caused by imaginary shocks, instead of actions that people take.” The great economist of models based on shock was Nobel prize winner Edward Prescott. In 1986, he calculated that 84% of output variability (crises) is due to technology ‘shocks’, even though others came up with estimates that “fill the entire range from Prescott estimate of about 80% down to 0:003%, 0:002% and 0%”! (Romer).
By ‘imaginary’ is the idea that mainstream economics just invents possible exogenous causes for crises because it does not want to admit that crises could be endogenous. These imaginary shocks become increasingly unrealistic. As Romer says, the “standard defense invokes Milton Friedman’s (1953) methodological assertion from unnamed authority that “the more significant the theory, the more unrealistic the assumptions (p.14).” Romer adds, “More recently, “all models are false” seems to have become the universal hand-wave for dismissing any fact that does not conform to the model that is the current favorite.”
What this approach leads to is that we cannot make a proper identification of what causes a change economically. If you just keep adding possible ‘imaginary shocks’ to explain sharp changes in an economy, “more variables makes the identification problem worse.” As Romer points out, “solving the identification problem means feeding facts with truth values that can be assessed, yet math cannot establish the truth value of a fact. Never has. Never will.”
Looking at the facts has given way to the purity of mathematical models and seeking the truth has given way to deference to authority. “Because guidance from authority can align the efforts of many researchers, conformity to the facts is no longer needed as a coordinating device. As a result, if facts disconfirm the officially sanctioned theoretical vision, they are subordinated. Progress in the field is judged by the purity of its mathematical theories, as determined by the authorities.”
Romer concludes that “the disregard for facts has to be understood as a choice.” In other words, mainstream economics is stuck in an ideological defence of the status quo and of the ‘conventional wisdom’, to use the term of Keynes and JK Galbraith. The defence of capitalism and the ruling order is more important than seeking the truth.
Romer agrees that leading neoclassical economist Robert Lucas had a point when he reckoned that Keynesian economic models “relied on identifying assumptions that were not credible.” And that the “predictions of those Keynesian models, the prediction that an increase in the inflation rate would cause a reduction in the unemployment rate, have proved to be wrong”. But Romer also takes to task Lucas himself with his now (infamous) quote in 2003 that “macroeconomics in this original sense has succeeded: Its central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades.” As Romer puts it “Using the worldwide loss of output as a metric, the financial crisis of 2008-9 shows that Lucas’s prediction is far more serious failure than the prediction that the Keynesian models got wrong.”
The trouble with Romer’s critique is that he actually accepts the idea of ‘shocks’ external to the endogenous growth of capital accumulation as the cause of ‘fluctuations’ or crises under capitalism. He just has different ones. Romer’s main complaint is that mainstream macro models, because they must be tied to neoclassical models of rational expectations and unrealistic assumptions like ‘perfect competition’, cannot account for ‘shocks’ caused by monetary policy. And it is those changes that cause ‘fluctuations’. He cites as an example that if a central bank raised its policy rate dramatically, by say 5% points, as Fed chair Paul Volcker did in the early 1980s, that will cause a slump. So monetary policy matters. This is his litmus test for the role of money and central banks.
No heterodox or Marxist economist would deny the role of money and credit in the circuit of capital accumulation, but that does not mean that monetary policy action is the main cause of crises. Did Paul Volcker cause the ‘double-dip’ recession of 1980-2 by his attempt to drive down late 1970s high inflation? Or were there ‘endogenous’ causes to do with the very low level of corporate profitability by the late 1970s that led to an investment collapse?
Brad Setser, a right-wing economist, points out Romer seems to accept that the mainstream view that there is some natural equilibrium rate of interest that determines when an economy is growing ‘just right’, with full employment and no inflation. But this ‘Wicksellian’ rate is just as much ‘imaginary’ as the neoclassical ‘shocks’ that Romer criticises. “Romer… claims that the real interest rate is a useful measure of the stance of monetary policy, and it isn’t—not even close. All of the traditional indicators are unreliable. After all, the Wicksellian equilibrium rate cannot be directly observed. You need to look at outcomes”.
As Setser points out, in criticising the ludicrous position of Robert Shiller, the behavioural economist of the mainstream, “Shiller seems unaware that it’s normal for the economy to be weak during periods of low interest rates, and strong during periods of high interest rates. He seems to assume the opposite. In fact, interest rates are usually low precisely during those periods when the investment schedule has shifted to the left (ie DOWN). Shiller’s mistake would be like someone being puzzled that oil consumption was low during 2009 “despite” low oil prices.” The cause of crises lies in the fall in investment which induces lower interest rates, not vice versa.
Nevertheless, Romer has ruffled the feathers of traditional mainstream Keynesian economists like Simon Wren-Lewis. Having spent most of the last month or so writing posts on his blog arguing that the new leftist leader of the British Labour party, Jeremy Corbyn, was a loser and did not have any hope of winning an election (and leaving Corbyn’s advisory council accordingly), he has now tried to defend mainstream economic models from Romer’s critique.
Wren-Lewis argued that Romer was out of date in his critique and the latest (DSGE) models did try to incorporate money and imperfections in an economy: “macroeconomics needs to use all the hard information it can get to parameterise its models. “respected macroeconomists (would) argue that because of these problematic microfoundations it is best to ignore something like sticky prices (wages) (a key Keynesian argument for an economy stuck in a recession – MR) when doing policy work: an argument that would be laughed out of court in any other science. In no other discipline could you have a debate about whether it was better to model what you can microfound rather than model what you can see. Other economists understand this, but many macroeconomists still think this is all quite normal.” In other words, there are good and bad macroeconomists and macroeconomics and we should not throw the baby out with the bath water.
Romer has been quick to retort in an update on his paper that “If we know that the RBC (Lucas) model makes no sense, why was it left as the core of the DSGE (Keynesian) model? Those phlogiston (imaginary) shocks are still there. Now they are mixed together with a bunch of other made-up shocks. Moreover, I see no reason to be confident about what we will learn if some econometrician adds ‘sticky prices’ and then runs a horse to see if the shocks are more or less important than the sticky prices. The essence of the identification problem is that the data do not tell you who wins this kind of race. The econometrician picks the winner.” In other words, Keynesian type DSGE models are just as full of econometric tricks and unrealistic assumptions as neoclassical, non-monetary models.
Leftist journalist Paul Mason wrote a piece on Romer’s critique, highlighting that “Romer’s huge mea culpa on behalf of mainstream economics is a sign that, after a decade-long hunt for trolls and gremlins as the cause of crisis, academia now has to begin the search for the cause of instability inside the system, not outside it.” Maybe, although I am not as optimistic as he is that the mainstream will look at the economic world realistically from now on rather than ideologically. Marx thought that after the end of classical economists, political economy became ‘vulgar’ economics, namely an apologia for capitalism and the rule of capital. I don’t expect that to change because it is still the task of the mainstream.
Mason notes that Marx too tried to develop mathematical models that would help explain an economy but he did not succeed. That does not mean it is impossible to use mathematical models as long as they are based on realistic assumptions and tested empirically. But I’m not sure that Mason is right that such models will be based on “large, agent-based simulations, in which millions of virtual people take random decisions driven by irrational urges – such as sex and altruism – not just the pursuit of wealth.” – whatever that might mean.
In my book, The Long Depression, I argue that Marxist economics is based on scientific method. You start with a hypothesis that has realistic assumptions that have been ‘abstracted’ from reality and then construct a model or set of laws that can be tested against the evidence. The model can use mathematics to refine its precision, but eventually the evidence decides. Moreover, macro-economics is the world of the aggregate, not individual behaviour. That delivers measurable data to test a theory.
Romer ends with an appeal to return to the scientific method. “Scientists commit to the pursuit of truth even though they realize that absolute truth is never revealed. All they can hope for is a consensus that establishes the truth of an assertion in the same loose sense that the stock market establishes the value of a firm. It can go astray, perhaps for long stretches of time. But eventually, it is yanked back to reality by insurgents who are free to challenge the consensus and supporters of the consensus who still think that getting the facts right matters. Despite its evident flaws, science has been remarkably good at producing useful knowledge. It is also a uniquely benign way to coordinate the beliefs of large numbers of people, the only one that has ever established a consensus that extends to millions or billions without the use of coercion.”
True, but I don’t expect mainstream economics ever to be “yanked back to reality”.
8 thoughts on “Paul Romer, the mainstream and reality ”
Personally, I would look for answers in intellectual work around Complex Systems. It is a huge and emerging field.
Because they do not touch economics or politics, they are less likely to become vulgar.
We need to take their work and translate it into Marxian Economics and the opposite.
I should like to request that Michael and all who post on his blog desist from designating bourgeois economists as ‘mainstream, orthodox, conventional,academic’ or whatever; they are all apologists for capitalism, and the Keynesians are far more dangerous than the the followers of von Mises or von(?) Hayek. Let us examine the criticisms that two radical Keynesians, namely Joan Robinson and Steve Kean, aim at Marx for his insistence that labour and not capital produces surplus value.
First, Robinson. She says, ” Indeed, a language that compels us to say that capital …. is not productive rather obscures the issue. It is more cogent to say that capital, and the application of science to industry, are immensely productive, and that the institutions of private property… prevent us from having as much capital, and the kind of capital, that we need.” ( An Essay on Marxian Economics, p19). Frankly, to identify the application of science with capital, is the wilful ignorance of a silly schoolgirl. As Postone (2003, p199) remarks, Robinson ”does not distinguish between what produces material wealth and what produces value. Instead, she reifies capital as wealth per se.” For further criticisms of Robinson, cf Rosdolsky ( Pluto press 1980).
In the preface to the 2nd edition of her booklet Robinson claimed,
”The concept of value seems to me to be a remarkable example of how a metaphysical notion can inspire original thought , though… quite devoid of.. meaning.”
Now I recall a vist to Adam Smith’s birthplace, Kirkcaldy. One has to appreciate that the natives of this fair town do not affect the orotund pronunciation of the hallowed halls of Cambridge, but have the Germanic roots of their language still stamped on their tongues. I entered a store and overheard two good wives:
” Will ye nae jist look at the price o’ this, hen? It just isnae wert it!”
” Ay, a ken. It’s nae value fir the price thir askin.’
At any moment I awaited the indignant shade of Robinson to appear: ”Please, ladies, no Hegelian metaphysics in Adam’s birthplace!”
It was of course Adam Smith who influenced Hegel, and not the other way round. If Robinson’s assertion is to be taken at face value, then we certainly require to add Malthus and Ricardo to the dubious ranks of ”metaphysicians,” for Ricardo wrote critical notes on Malthus’s ‘Measure of Value’, the latter of which opens: ”It may, perhaps, excite some degree of surprise that I should propose, as if it were NEW , a measure of value, which will be found to be the same as that which has been brought forward by Adam Smith.”
Ricardo was not at all impressed and wrote to McCulloch:
“Have you seen Mr Malthus book on the measure of value? His arguments seem to me fallacious from beginning to end- he would have done much better to rest his defence… upon the OLD Arguments….those which he now uses are delusive and scarcely to be understood” (Cambridge 1992 p. xv ). So the philosopher Smith, parson Malthus and the capitalist Ricardo were all dabblers in metaphysics. Keynes of course admired Malthus and promised to refute Ricardo, a promise that he never did nor never could have redeemed.
As for Robinson’s booklet on Marx, demonstrating to Keynes that ” Marx was a very poor thinker indeed” (Skidelsky 2001 p.169), it earned her Keynes’ warmest thanks and the altogether more tangible value of a Cambridge professorship!
LOL on Kirkcaldy. Funny how commonplace all these “Hegelian meta-physicians” have become with their “otherworldly” jabber about the difference of value with price. They imagine things!
Beware, the Jabberwock, my comrades!
It is instructive to consider Keynes’ prediction of the future of capitalism, a 15 hour workweek and the euthanasia of the rentier. How wrong can you be?( I believe in China the workers at times are forced to do a 15 hour workday). Now consider Marx’s prediction :
the concentration and centralisation of capital, the immiseration of the worker, the dominance of the world market etc.
If you cannot refute a theory, or if more probably, you hate it, it is all too easy to damn it as ‘metaphysical’. The bourgeois ideologue, Popper, claimed that neo-Darwinism was a metaphysical program, ”almost tautological” ( echoes of Robinson!), because it is not subject to falsification, hence not a scientific theory. ( ”Thinking about Evolution” Cambridge 2001 P 292 ff).
Popper claimed the same about Marxism. Can Marxism be falsified? Of course it can: if the leading imperialist powers voluntarily disband their standing armies and secret police forces, abolish judges in favour of large juries, stop the invasion of other countries and the massacre of their populations, the assassination of communist and democratic leaders, and the secret bribing of intellectuals to attack the theories of Marxism (cf Saunders “Who paid the Piper” 2000),then I grant Marxism will have been refuted. Wonder if Popper was on the payroll?
Second, Steve Keen, who as I understand it, has two ”refutations” of Marx, which in an onset of hubris he calls ”The Demise of Marx’s Theory of Value”. Well, we have heard that before.
Keen argues that no matter how far back you go there will always be found a commodified residual in the means of production. Now, clearly as a onetime residence of Australia Keen knows the Aborigines did not engage in commodity exchange. We presume he means class or civilised society. Is he right? Let us take leave of Kirkcaldy and Adam Smith and move to Dunfermline, the birthplace of Andrew Carnegie, the King of Steel. Opposite The Carnegie Baths, which the ‘philanthropist’ bestowed on the people of Dunfermline, is the huge facade of the one still relatively intact mill in the town , with the significant date of 1849. Moving a few hundred yards south one comes across Carnegie’s tiny cottage, where the family lived and worked as weavers, before being obliged by mill production to emigrate to America, where he became the richest man in the world thanks to his steel mills. Of course King Steel needs King Coal, so let us move a few hundred yards west through the grounds of the Abbey into Pittencrief Park, also bestowed on the citizens of the town by Carnegie.
Here in 1291 the lord of Pittencrief granted to the abbot and monks of Dunfermline the right to dig for coal on his land ‘for their own use’ and provided that ‘they do not presume to sell it’. In ‘Abbot’s House’, the only surviving medieval building, one can still see the kind of domestic forges where the monks and their serfs would have manufactured their instruments of production, namely picks and shovels. This is the earliest reference I know of to the coal industry in Britain. The mines of Fife along with those of Lanark furnished the coal that powered the steel mills of the west of Scotland, thus enabling the industrial revolution in that part of the country. But the coal was a gift of nature near the surface and easily accessed by pick and shovel.
Keen’s second ‘refutation’ of Marx is as follows ( Journal of the History of Economic Thought pp. 111- 115). Keen argues that Marx has only established that labour is a source of value, not that it is the only source. According to Keen, Marx equated the depreciation of a machine to its productive capacity. He quotes Marx, ”However useful.. a machine may be though it may cost £150…yet it cannot… add to the value of the product more than £150.” But Marx has confused depreciation of a machine with value creation. Keen argues, ”it does not follow that the usefulness ( the value creating capacity) of the machine is equal to its cost (its depreciation).” Further, ”an analogy with labour highlights the fallacy involved.” A worker ” depreciates by an amount equivalent to the subsistence wage… However this depreciation is not the limit of the amount of value that can be added by a worker in a day’s labour- the use value of labour. Value added is unrelated to to and greater than value lost; if it were not , there would be no surplus.” At this stage one merely observes that Keen has forgotten Marx’s observation of the uniqueness of the commodity labour power.
Keen further quotes Marx: ”It also has to be postulated… that the use value of the machine significantly greater than its value;i.e. that its devaluation in the service of production is not proportional to its increasing effect on production.” According to Keen, ”In practice this will mean that the amount it loses in depreciation will be significantly less than the amount it contributes to the value of the output, and it will with labour be a source of surplus value.”
How could Keen have come to such a fallacious non-sequitur?
Following the very sentence Keen quotes from the Grundrisse(p383), Marx illustrates his argument with the examples of a hand-operated printing press and self-acting press. He makes clear that the machine makes LABOUR more productive, because ”It therefore creates more use values and a higher exchange value in the same amount of time.” (p384). Later in Grundrisse Marx makes only too clear his argument (p.694-695). ”In machinery objectified labour itself appears… in the form of the force of production itself…… The accumulation of knowledge and skill, of the general productive forces of the social brain is thus absorbed into capital as opposed to labour, and hence appears as an attribute of capital, and more specifically of fixed capital.
Further, in so far as machinery develops with the accumulation of society’s science, of productive force generally, general social labour presents itself not in labour but in capital. The productive force of society is measured in fixed capital.”
I am afraid Keen has taken appearance for reality. Only an ideological rather than a scientific approach on his part can explain such an elementary blunder, i.e. Keen is a BOURGEOIS economist!
A defender of capitalism !
Meanwhile, ”humanity is on an environmental precipice.” (Wallace ”Big Farms Make Big Flu” 2016, p224)
Thanks for the Romer article. I must soon plunge into Robert J Gordon’s “The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War”, and Gordon makes clear his basis is Total Factor Productivity (TFP) theory. Apparently Paul Romer’s work is important for this theory, and your reference to his NBER paper on endogenous technological change will assist in the necessarily critical read of Gordon.