After having examined a lot of relevant, useful and insightful material on the failure of orthodoxy, some of which that came up in the responses to my post, I have come to a conclusion that there is a viable project we could undertake together, which has the chance of creating a revolution. There are several points that need to be taken in consideration to shape the project.
Insight Number 1:
The first point comes from Edward Fullbrook’s remark that:
If Samuelson had any claim to genius it was that he understood better than anyone else that nothing in economics is nearly as important as Economics 101. Marshall, Samuelson’s target, understood it also.
Samuelson’s was the textbook which defined economics in the twentieth century. I propose that we work together on writing the textbook which will define economics in the twenty first century.
Insight Number 2:
Why did Keynesian economics become dominant? Because Keynes, and no one else, was able to explain one feature of the Great Depression – long and persistent unemployment — and offer a remedy. Samuelson also succeeded because he claimed the mantle and legacy of Keynes and created the IS-LM model which can also explain unemployment. As many have remarked, the IS-LM has little relation to the original Keynes. This is not of importance to the issue currently under discussion. The point here is: Economic theories SUCCEED if they explain major economic events/catastrophes. It is also true the theories FAIL if they do NOT explain major economic events. A case in point is the old institutional economics. It was among the most respected schools, and had a solid theoretical framework based on historical and qualitative analysis. However, this framework was adapted to the long run and was not suitable for explaining short run critical phenomena like the Great Depression. The school went into decline and perished as a result, since the institutionalists could not come up with a solution to the major problem of the times. The New Institutional School does not really qualify as a revival or a continuation of the Old School since they adapted a lot of mathematical frameworks in order to fit themselves into hegemonic paradigms of neoclassical economics. SIMILARLY, Hayek and Friedman and other free marketeers lost respect and went into hiding, since free market paradigms were manifestly shown to be defective by the Great Depression. This provides a clear target for what our textbook should accomplish:
GOAL OF NEW TEXTBOOK: EXPLAIN satisfactorily the major economic events of the past century.
Insight Number 3:
Bernanke has called explaining the Great Depression to be the Holy Grail of Macroeconomics. The failure of quantitative easing has demonstrated to the world that Friedman’s explanation is false. It is not a question of restrictive money supply. Thus the search for the Holy Grail is on, and we have the chance to capture it. We need to explain satisfactorily the Great Depression and the Global Financial Crisis. I believe that the explanation is nearly the same for both, which would lend strength and credibility to the explanation. If our textbook can succeed in providing a believable explanation, it would have a good chance to be the defining textbook of the twenty first century. Of course, we would also need to provide a credible explanation of things like austerity in Greece, failure of the Argentinian Currency Boards, the effects of NAFTA and many other major economic phenomena. The explanations should be integrated and coherent, based on a common and understandable framework. Newtons theory had spectacular success because they used a single principle to explain a vast range of phenomenon. Similarly we need to use a limited set of ideas to explain a large number of economic events of the past century.
I believe that the Holy Grail is within our reach. Keynes was about 40% of the way there. He got some of the elements of the explanation but also missed a number of key issues. In particular, the aggregate consumption function is a mistake. One of the keys to the Great Depression and the Great Recession is role of “vacuum-cleaner” effect (opposite of trickle down). As income is re-distributed to the top, the aggregate demand falls, since the wealthy only want to increase their wealth, and do not consume. This is one of the key insights of Angus Deaton, that we need to break down consumption by income level because consumption patterns are different and cannot be stably aggregated across income levels. This is especially true when income distribution is changing.
Atif Mian and Amir Sufi in House of Debt have gone a lot further. They are about 80% of the way there. In my review of their book, I have summarized some but not all of their insights. The crucial role of leveraged debt is central to their analysis, which is missing in Keynes. Their analysis provides a common framework which can be used to analyze both the Great Depression, the Global Financial Crisis and the ensuing Great Recession.
Elements missing from the analysis of Mian and Sufi are the role of money creation by banks, the role of government de-regulation, especially the political aspects, and also the role of insurance – in particular the failure of the largest insurance company in the world, the AIG. The role of money and banks are well covered by Ellen Brown. The political aspects are also well covered by Michael Hudson. The pieces of the puzzle are all there and we only need to put them together. By combining available analysis, I believe we can get all the way there. Remember that Keynes succeeded with only a 40% correct analysis. Even if we cant get 100% of the way there, I am sure we can do a LOT better than any competitor; especially conventional macro-economists will be simply unable to compete because they have their hands tied behind their backs. They cannot invoke historical explanations and politics because this is ruled out of bounds by their methodology.
ACTION PLAN: STEP 1:
There are many other elements that we need to take into account in writing a successful textbook. However, I believe that we need to take things one step at a time, so that we can move forward together. I think the first step is to create consensus on the causes of the GFC and subsequent GR. I have put down my views, which are more or less a summary of Main and Sufi – I have added a few minor elements to their analysis.
STEP 1: Create an explanation of the Global Financial Crisis 2007-8 and the Great Recession. I think my explanation (which summarizes Mian and Sufi) in Review of “House of Debt” is a good place to start. There are a few quibbles one could make. One is that I have said that Keynes used wage rigidity as an explanation for prolonged unemployment – Paul Davidson will take me to task for this. I was deliberately oversimplifying here – In fact Keynes DOES say that wage negotiations are conducted in terms of nominal wages not real wages, and workers will strike if nominal wages are cut, but will not respond in the same way to a general increase in the price level. Anyway, we can fix the problem by providing a more detailed explanation of Keynes’ views.
GOAL OF STEP ONE: CREATE A CONSENSUAL HETERODOX EXPLANATION OF THE GFC & GR
This explanation is not meant directly for the textbook – this is for discussion amongst ourselves. At a later stage, we will break the explanation down into its elements, and provide each element with a pedagogical exposition suitable for students. Here we can split up the pieces into separate chapters. A crucial element is the notion of asset price bubbles. Here someone could do a chapter with historical details from Kindleberger, and so on.
As I said earlier, there are MANY MORE elements required to make this work, and I hope to discuss these other aspects in detail later on, after we get started on this project. We need to use a different format to start – for example, we can use GOOGLE DOCS for a shared editable document.
Shared Google DOC: Review of House of Debt – Currently I have shared and allowed EDIT rights to anyone. This allows anyone with the link to open and edit document and/or add comments.
ONE OBJECTION I would like to dispose of early is the following. In doing a historical and qualitative analysis of the type that I propose, where we will pull in specific historical details of regulations, East Asian Crisis, etc. people will object that we have provided a history but there is no theory. Theory must rise above particulars. Where are the equations? Where is the model?
I propose that we use Judo – use the force of the attack against the attacker. I propose to view theories themselves as products of historical experience. Keynesian theory was developed in response to the Great Depression and CANNOT be understood outside this context. Thus ALL theories have historical specificity. In the course of the textbook, we should analyze the emergence of theories as part of the historical process. This reverses the idea that we should use theories to analyze history and economic experience. In fact, puzzling historical experiences generate theories which a required to explain, analyze and shape responses to the history. THUS theories cannot be understood outside their historical context, as all current conventional economics attempts to do.
A second important fact is that we will be using politics and social phenomenon in explaining the major economic events of the past century. This will make it clear to all that one cannot study economics in isolation. This is one of the strengths of Polanyi’s methodology. Polanyi provides a very brief historical explanation of the Second World War in terms of economic factors. If we can similarly explain social and political phenomena, this would substantially strengthen the textbook.