Yet again, mainstream economics is trying to rethink its effectiveness as an objective scientific analysis of the laws of motion of major economies. Ever since the mainstream failed to foresee the global financial crash, come up with a convincing explanation for what happened and adopt policies that could get the capitalist economy out of the subsequent long depression of growth and investment, the mainstream has been stymied.
I covered various attempts to rethink in posts on this blog by: Dani Rodrik, Paul Romer, Robert Skidelsky and more recently by John Quiggin. I have also covered the attempts of more heterodox economics to critique mainstream failures.
Now we have yet another bout of navel gazing. The latest issue of the Oxford Review of Economic Policy is devoted to ‘Rebuilding macroeconomic theory’ (all the articles are free to view until February 7). And Martin Sandbu in the UK’s Financial Times has reviewed the various papers in the journal from such eminent mainstream economists as former IMF chief economist Olivier Blanchard, Nobel prize winners Paul Krugman and Joseph Stiglitz; and leading UK Keynesian Simon Wren-Lewis.
In these papers, the usual criticisms of modern macro are repeated: the failure to cover ‘irrationality’ and uncertainty; the insistence on ‘micro-foundations’ for macro models of economics reality (ie the Lucas critique) and the use of unrealistic assumptions in so-called DSGE models that have no relation to empirical evidence.
Sandbu sums up his review of these new efforts of the mainstream to rethink its faults and failures and concludes: that it “leaves little doubt that mainstream macroeconomics is in deep need of reform.” He says: “the question is how, and whether the standard approach, DSGE modelling, can be sufficiently improved or should be jettisoned altogether.”
Well, as for the latter, opinion in the mainstream is divided. As Sandbu says, “DSGE macroeconomics does not really allow for the large-scale financial panic we saw in 2008, nor for some of the main contending explanations for the slow recovery and a level of economic activity that remains far below the pre-crisis trend.”
Yet Paul Krugman, while admitting the blind spot of conventional DSGE, argues that existing macroeconomic theory is “good enough for government work” and policy advice. What he means is that mainstream economic theory cannot explain the motion of capitalism but it can be used for quick economic solutions. This is Krugman’s way – if you read his book on the crisis, End this Depression Now!, he says, there is no need to explain the Great Recession; let’s just get on with adopting policies to get out of it. I think most of us would think that we wont know what are the right policies if we don’t know what caused the crisis in the first place!
And others in the Oxford Review reckon that with a bit of tweaking, DSGE models can be made useful in forecasting crises. And one attempt cited by Sandbu from the review does lead to some interesting results. It tries to ‘model’ the current Long Depression and finds that its model explains why the major economies have not ‘recovered normally’ nor slipped into deep deflationary depression.
It’s due to the failure of investment in the capitalist sector to return to previous levels: “the economy can get caught in a prolonged period of stagnation. In addition, productivity growth is embedded at least in part in investment: hence investment-induced stagnation can tie down productivity growth to very low levels.” However, even this model falls back on the explanation of low investment as due to a lack of a “shift to the optimistic scenario about future growth” (ie lack of ‘animal spirits’ a la Keynes), which is no explanation at all.
Other mainstream economists like Simon Wren-Lewis or Olivier Blanchard are not sure that DSGE models can ever be fixed: “The attempts of some of these models to do more than what they were designed to do seem to be overambitious. I am not optimistic that DSGEs will be good policy models unless they become much looser about constraints from theory. I am willing to see them used for forecasting, but I am again sceptical that they will win that game.” (Blanchard).
Joseph Stiglitz condemns the very ‘microfoundations’ of modern DSGE models as unrealistic. That means microeconomics, in particular general equilibrium theory, utility theory and marginalism provide no sound basis for analysis of the ‘agents’ at work in the movement of modern capitalist economies. Macroeconomics has come to a dead end because microeconomics is flawed. As Sandbu puts it “Bad macro is, to some extent, a case of too much bad micro.” Not good news for mainstream macro.
But what else is there? Despite recognising that “the fundamental difficulty of microfoundations is that we simply do not have a comprehensive and convincing theory of economic behaviour at the micro level”, Sanbu wants to plough on with “a more expansive and liberal form of DSGE”. So no change then for mainstream economics: it will continue to use marginalism and general equilibrium theory, but try to incorporate ‘animal spirits’ or ‘irrationality’ into its models of modern economies. Good luck!
In a new piece, Keynesian biographer, Robert Skidelsky complains of the failure radically to rethink mainstream economic theory and attacks Krugman for his view that macroeconomics is “good enough” for policy decisions. Skidelsky, in contrast, sees modern macro theory as having crucial faultlines: “the problem for New Keynesian macroeconomists is that they fail to acknowledge radical uncertainty in their models, leaving them without any theory of what to do in good times in order to avoid the bad times…. macroeconomics still needs to come up with a big new idea.”
What Skidelsky and other critics of mainstream economics (both in its micro and macro parts) fail to recognise is that no new big idea will appear because mainstream economics is a deliberate result of the need to avoid considering the reality of capitalism. Its theories are ideological justifications of capitalism( its supposed tendency to harmonious growth, equilibrium and equality). When reality does not bear out the mainstream, it is ignored. That’s because ‘mainstream’ means support for the existing dominant ideology.
‘Political economy’ started as an analysis of the nature of capitalism on an ‘objective’ basis by the great classical economists Adam Smith, David Ricardo, James Mill and others. But once capitalism became the dominant mode of production in the major economies and it became clear that capitalism was another form of the exploitation of labour (this time by capital), then economics quickly moved to deny that reality. Instead, mainstream economics became an apologia for capitalism, with general equilibrium replacing real competition; marginal utility replacing the labour theory of value and Say’s law replacing crises.
Even the so-called Keynesian revolution that came out of the experience of the Great Depression was hardly ever applied and was soon dumped when capitalism faced renewed crisis in the 1970s. The Keynesians are now either advocates of theory that is ‘good enough’ or critics with no ‘big new idea’.