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Because of Western dominance, brilliant thinkers from the East get very little attention in global media. Even though brilliant economists from East Asia and China have created globally acknowledged economic miracles in their countries, none of them have received a Nobel Prize. On the other hand, Western economists whose theories were demonstrably in conflict with the events that took place in the global financial crisis — like Lucas, and Fama — have received Nobels. One of our greatest un-sung Eastern Heroes is Mahbubul Haq. My recently published article describes the revolution he created in economic thought:
HDI

Goethe starts his famous East-West Divan with a poem about the journey (Hegire), both physical and spiritual, from the West to the East. In this essay, we consider the analogous journey from Western to Eastern conceptions of development. This involves switching from viewing humans as producers of wealth, to viewing wealth as a producer of human development. To start with the Western conceptions, both Adam Smith and Karl Marx defined economic growth as the process of accumulation of wealth. The range of diversity of Western thought is bounded by the Left-Right spectrum. Ideas on which both extremes agree command widespread consensus in the West. Consequently, a core concept of modern economic theory is that wealth is the means and ends of the process of economic development. Unfortunately, due to the dominance and influence of Western paradigms, this concept has been widely accepted and adopted in the East today.

Mahbubul Haq was indoctrinated into the Western development paradigm which gives primacy to wealth at leading universities, Yale and Harvard. He got the chance to apply these economic models as the chief economist in Pakistan during the ’60s. However, because of his Eastern upbringing and heritage, he was able to see the murderous message at the heart of the cold mathematics of the Solow-Swan growth models. These models focus on savings, created by reducing present levels of consumption, as the only route to the accumulation of greater future wealth.

Mahbubul Haq realised what is not mentioned in the economics textbooks: obsession with production of wealth requires us to use the sordid and cruel tactic of making workers produce wealth, and refusing to allow them to consume it, in order to buy machines and raw materials. He was clear-sighted enough to see the consequences of these policies: wealth did indeed accumulate, but it went into the pockets of the 22 families, without providing relief to the misery of the masses. Today the global application of capitalist growth strategies has led to a dramatic increase in inequalities both inside nations and across nations. Just one among many horrifying inequality statistics is that the top 13 individuals now have more wealth than the bottom 3.5 billion on the planet.

Dissatisfaction with state-of-the-art Western growth theories led Mahbubul Haq to a revolutionary insight, taken from the heart of the traditions of the East, and having no parallels in current Western economic theories. Instead of capital, Mahbubul Haq placed human beings at the centre of the process of economic growth, returning to the ancient wisdom that “human beings are the means and ends of development”. Even though he was called a heretic for going outside the boundaries of contemporary economic thought, the pragmatic genius of Mahbubul Haq sought to minimise differences and create bridges to conventional thinking in order to achieve acceptance for his radically different approach to development.

His Human Development Index (HDI) was a master stroke, combining two inherently incompatible conceptions of development in a compromise which ceded ground to wealth in order to create international visibility for poverty. His friend and classmate Amartya Sen was reluctant to accept the HDI because of certain inherent flaws in this marriage of fire and water, but eventually agreed to its practical necessity. The pragmatic approach of Mahbubul Haq paid off handsomely when the HDI measure achieved global recognition as rectifying major defects in the standard GDP per capita. Widespread acceptance and use of HDI has led to a radical change in the discourse on development, by adding poverty, health, education and other soft social goals to the pure and simple-minded pursuit of wealth. The revolutionary ideas of Mahbubul Haq have led to improvements in the lives of millions, as global consensus developed on the social goals embodied in the MDGs and SDGs.

The Human Development approach of Mahbubul Haq was carried further by Amartya Sen, who defined development as the freedom to develop human capabilities. This notion, closely aligned with Eastern thought, was so alien to orthodox economists that they rejected it. Consequently, a new human-centred field of development studies emerged, which combined many streams of dissent from orthodoxy. Unfortunately, leaders at the helm of policymaking in the poor countries of the world are trained in orthodox economic theories, and have not assimilated the radical lessons of Mahbubul Haq, acquired from bitter experience. The paths to genuine development lie open, but with their backs to the doors, they are unable to see them.

Conventional growth theories create the mindset that the game is all about wealth creation. We will worry about our poor population only after we acquire sufficient wealth to feed them. The poor are a burden on the development process because providing for them takes away from money desperately needed to finance development of infrastructure, purchase of machinery and raw material, and industrialisation. We cannot afford to feed the poor, if we want to grow rapidly. The human development paradigm stands in dramatic contrast to this currently common mindset among planners. Instead of utilising humans to produce wealth, we utilize wealth to develop human capabilities. Our human population, our poor, are our most precious resource. This point of view receives strong support in the empirical findings of a recent World Bank study entitled “Where is the Wealth of Nations?” The study finds that the wealthiest nations are rich because they spend money to develop their human resources, and not because of natural resources.

Thus, instead of being a burden, our poor are our most efficient means to development. If we use available wealth to improve their lives, to empower them, to educate them, and to provide them with the support they need, they can rapidly change the fate of the nation. Furthermore, they are also the end of the development process — that our goal is NOT to produce more and more wealth, a la Adam Smith and Karl Marx — but to ensure that our people lead rich and fulfilling lives. If we use our energies to achieve this goal, we have already arrived at the destination — we do not need to wait for a distant future where sufficient wealth will accumulate to enable us to take good care of our people.

Published in The Express Tribune, May 20th, 2017.

This is an outline of the lecture 3 in Advanced Microeconomics — expands somewhat on the slides available from the link. This should be useful to heterodox economists looking for ways to teach an alternative course, radically different from conventional approaches. First two lectures consisted of some preliminary math, and can be skipped without lack of continuity.  Video of the lecture (90m) is available at the bottom of the post.

Supply & Demand is Central to Economics: This is the modern Theory of Value. The market price determines the value – this is in conflict with classical conceptions of value.

BUT, this theory is WRONG!  The central question in theory of Value is: HOW are prices determined? Why are water and tomatoes cheap, and why are diamonds expensive?

Current answer is the Supply and Demand theory of economics. Classical economists’ answers were  Labor Theory of Value.

Modern Answers are seriously deficient. Classical Schools had substantially more insight into these questions. We will be discussing classical thinking (Adam Smith, Ricardo, Marx, Sraffa) later in the course. This lecture deals with: Failure of Supply & Demand in Labor Market. This failure was the Raison-d’etre of Keynesian Economics

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ideologyinequalityEven though very few people have more than a vague idea about them, macroeconomic theories deeply affect the lives of everybody on the planet. Writings of Piketty, Stiglitz and many others, as well as personal experience of the 1% — 99% divide, have created increasing awareness of the deep and increasing inequalities which characterize modern capitalist economies. However, the link between inequality and macroeconomic theory has not been pointed out clearly. The fact that since the 1970’s top corporate salaries have increased by 1000% while the average worker only earns 11% more is closely linked to the revolution in economic theory that occurred over the 70’s and 80’s. We will try to sketch some parts of the complex and coordinated efforts which led to the emergence of theories which provide the invisible foundations and the enabling environment for this inequality.

The oil crisis of the early 70’s destroyed the consensus on Keynesian macroeconomics, and created the opportunities for ideologies disguised as economic theories to emerge. Chicago school economist Robert Lucas attacked the dominant Keynesian theories which argued that governments must play an important role in eliminating unemployment. Guided by free market ideology, Lucas created macroeconomic theories which suggested that government interventions are always harmful. Some elements of the Lucasian methodology provided genuinely superior alternatives to defects in existing Keynesian models. However, other elements were bizarre. Even though unemployment is a painful reality to vast numbers of people, defender-of-free-markets Lucas argued that this was a free choice. According to Lucas, the Great Depression was really the Great Vacation, where vast numbers of people suddenly decided to stop working in order to enjoy leisure. This, and many other strange assumptions of the Lucasian alternative led famous economists like Robert Solow to say that to engage in a serious discussion with the Chicago school would be analogous to discussing technicalities of the Battle of Austerlitz with a madman who claimed to be Napoleon Bonaparte. For example, Solow wrote that “Bob Lucas and Tom Sargent like nothing better than to get drawn into technical discussions, because then attention is attracted away from the basic weakness of the whole story. Since I find that fundamental framework ludicrous, I respond by treating it as ludicrous – that is, by laughing at it – so as not to fall into the trap of taking it seriously and passing on to matters of technique.”

Recent remarks of eminent economist Paul Romer, a student of Lucas, regarding the dramatic failures of contemporary macroeconomic models have generated shock waves which continue to reverberate among economists. Romer wistfully suggests that if Solow had engaged with the Chicago school, instead of subjecting them to sarcasm, contempt and ridicule, they might have been amenable to reason. Lucas, Sargent, and their followers responded to hostile attacks by closing ranks, ignoring all who disagreed with them, and giving up on basic scientific principles such as using evidence to evaluate models.  Even though Romer criticizes Solow for ridiculing Lucas, he also finds it difficult to take the macroeconomic theories of Lucas and Sargent seriously. Since these models remove essential real factors like money and unemployment from the picture, Romer writes that modern macroeconomic models are reduced to using mythical objects like phlogiston and gremlins to explain real world economic events. What is frightening about this is that these models, which have been blamed for their inability to see the looming global financial crisis, continue to be used by Central Banks for monetary policy decisions throughout the world.

The mystery of how ludicrous theories which invoke mythical objects and causes, came to dominate the scene is not easily resolved. One important element in the success of the Chicago School was their lack of scruples. Stigler, one of leaders of free market thought at the Chicago School, explained that “… new economic theories are introduced by the technique of the huckster” (a door-to-door peddler who sells fake items as if they were genuine}. He defended this intellectual fraud on the grounds that a warrior against ignorance must subordinate the lesser truths to his quest to spread the grand truth. The grand truth, or the ideological conviction, that governments must not intervene in free markets guided the development of modern macroeconomics at the hands of Lucas, Sargent and Prescott. Ideological convictions of the Chicago School are impervious to facts – they ignore the long lines of the unemployed at the soup kitchens, and the strong empirical evidence of correlations between tight monetary policies and high unemployment.

A second crucial element was the creation of an artificial Nobel Prize in economics. Private financiers and bankers who stood to gain massively from the spread of free market theories of the Chicago School decided to purchase respectability for them. The bankers donated funds to create a prize in Economics in 1968 which was deceptively and fraudulently named after Alfred Nobel: “The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel”. The conditions and methods for granting the prize were made to resemble the genuine Nobel prizes sufficiently to deceive the masses into thinking that this was one of the genuine Nobel prizes. After creating an imitation Nobel prize, the Swedish bank proceed to award about half of all of them to Chicago School economists, giving half to assorted others to maintain a semblance of objectivity. This has resulted in a tremendous rise in the prestige of Chicago school doctrines, catapulting them from an eccentric minority to the entrenched and dominant orthodoxy in economics.

This intellectual revolution, the displacement of Keynesian economics by the Chicago School, has been used to justify economic policies to enrich the wealthy, and caused massive damage to the general public. As policies based on free market theories have been enacted globally, wealth has concentrated in the hands of the top 1%, while the fortunes of the bottom 90% have been declining. Seeing that the economic system in place has led to reduction in job opportunities and incomes, and rising costs of necessities like education and health facilities, the bottom 90% have expressed their discontent and desire for radical change in the form of Brexit and Trump. However, fundamental change requires addressing the root cause of the problem, replacing defective ideology based macroeconomic theories with more empirical and evidence based theories.

Published Express Tribune, 9 Jan 2107. My author page on LinkedIn. Other works: Index .Related articles: Economic Theory Creates our World and our Worldview. The Fairy Tale of GNP per Capita.

This post, 6th in a sequence about Re-Reading Keynes, continues to borrow heavily from Brian S. Ferguson, “Lectures on John Maynard Keynes’ General Theory of Employment, Interest and Money (1): Chapter One, Background and Historical Setting” University of Guelph Department of Economics and Finance Discussion Paper No. 2013-06. However the first three paragraphs are mine.

Distinguishing between ideologies and science:

Deduction: According to Lionel Robbins, economic theory uses an axiomatic deductive methodology, based on logical deduction from postulates which are “simple and indisputable facts of experience.” This means that there is no possibility of mistakes, and hence no possibility of learning from empirical evidence. If someone claims to have drawn a triangle where three angles do not sum to 180, we would not examine this triangle carefully to see if our law is empirically refuted. This is exactly the defining feature of an ideology – it does not waver in face of empirical evidence to the contrary.  For more details, see Economic Theory as Ideology. This is important because today we are still fighting the same battles, discussing the same questions, which were being discussed at the time of Keynes. Macroecconomics has been going backwards for decades, and there has been failure to learn from experience, due to the adoption of axiomatic-deductive methodology by economists

Induction: As opposed to this, scientific laws derived from induction are always falsifiable – the next experience may refute them. As a result, revisions are frequently necessary, as more and more experience comes in. The central insight of Kuhn is that scientific progress occurs via revolutions, which destroy one established way of looking at the world, and replace it with another. One of the key assertions of Polanyi is that when social change occurs, people devise theories to try to understand the new phenomena. These theories are often wrong, because lack of experience leads to misunderstandings. The ability to arrive at good theories depends crucially on the ability to revise theories in light of experience.

Learning from Experience: To understand economic events, we must study the wrong theories used by early theorists to understand these events, since responses to these events are shaped by these theories. To understand the impact of economic change, we must study both the (objective) events, and the (subjective) understanding of the events by leading theorists, since the response to the events will be shaped by the joint effects of the external objective circumstances and the internal subjective theories about these circumstances.

Flexibility of Keynes: Keynes had this ability par excellence. There are many anecdotes about how he was quick to change his mind, when confronted with empirical evidence to the contrary. In contrast, economists brought up on axiomatic-deductive methodology disregard conflicts with real world data to the extreme that Romer labeled “post-real.” Some of the ways that Keynes revised his theories in light of empirical evidence are discussed by Ferguson.

Keynesian Theories Developed in Light of Experience

“Hawtrey convinced Keynes that the analytical approach of the Treatise on Money was fundamentally wrong. In the Treatise, Keynes focused on the adjustment of prices to changes in economic conditions, with quantity adjustments being something of an add-on. Hawtrey convinced Keynes that the first thing firms do in response to a reduction in demand is not to cut prices, it is to cut output, with price adjustments following later. This ultimately led Keynes to the formulation in the General Theory in which prices are moved aside and the primary adjustment to changes in aggregate demand take the form of changes in aggregate output and employment.”

Many other instances of how Keynes took concrete practical details about the structure of the UK economy into account in formulating and revising his theories are cited by Ferguson. This is an important differentiating feature of Keynesian theory: it takes real world economic structures and experience into account, unlike conventional “post-real” economics.

Pre-War Prosperity in UK:  Ferguson quotes a long passage from Keynes’ Economic Consequences of Peace, idealizing the pre-war UK economy

What an extraordinary episode in the economic progress of man that age was which came to an end in August, 1914!  …(the poor were comfortable, and had the chance of escaping into) … the middle and upper classes, for whom life offered, at a low cost and with the least trouble, conveniences, comforts, and amenities beyond the compass of the richest and most powerful monarchs of other ages.”

The post-war slump experienced by UK was more disturbing precisely because it seemed that there should be a way to get back to the pre-war prosperity.

Classical Views on Post-War Transition to Peacetime Economy:   As a war economy has to transition to producing peace-time goods, there will a temporary period of transition. How long the transition takes depends on the mix between financial capital and fixed capital utilized in production. Financial capital can easily be transferred, while large proportions of fixed capital would result in delays in transition to new post-war equilibrium.

Initially, as a classical economist, Keynes thought that a return to equilibrium would occur speedily. However, as the 1920’s progressed, unemployment remained high in UK, and Keynes started to have doubts about the classical views. He advocated government intervention to the Macmillan Committee formed to investigate the depressed economy of Britain, because he felt that classical equilibrium mechanisms were taking too long.  Classical economists considered unemployment as part of the business cycle, Keynes came to the conviction that a separate theory of employment was needed.

Puzzle of Long-term Persistent Unemployment:  From a historical perspective, unemployment in the first few years after the First World War was not unusually high: it was, in fact, not much higher, if at all, than its pre-War peaks. What was different after the war was the fact that it didn’t come back down again anything like as quickly as pre-War experience would have predicted. (See Figure below, taken from Ferguson); see also, Creating Full Employment

ukunemployment

Classical Explanations: non-Keynesian explanations can be provided for this:

One: was the presence of unemployment insurance, and strong unions. Labor was able to negotiate an eight hour work week with no reduction in wages. All of these increased labor costs substantially, and may have been the source of higher unemployment

Two: There was a post-war boom because of increased earnings and demand by the poorer segments of society. An inflationary boom began in 1919. The government was slow to respond, but raise the the bank rate to 7% 1921 (Keynes had recommended raising it to 10% and holding it there to stamp out inflationary pressures). What had not been anticipated was the extreme sensitivity of economic activity to the interest rate. The result of the 1921 tightening was not just the end of the post-War boom but a drop into recession. In brief, bad monetary policy was responsible.

Three: The return to the Gold Standard, at the pre-World War One parity in 1925. This made the pound overvalued, made British exports expensive, and imports cheap. This caused substantial harm to domestic industries, and led to deepening and prolonging the slump. Furthermore, to prevent outflows of gold, Britain had to raise interest rates, leading to tight money and low investment, contributing further to the slump. Arguably, British recovery dates from 1931, when Britain went off the Gold Standard, this time for good.

Concluding Remarks

Ferguson argues that what we now call a Keynesian model is an intermediate stage of Keynesian thinking as it evolved and does not capture later stages of Keynesian thought as described in the General Theory. We need to study GT in detail to understand the special features of the Keynesian model, which include a different theory of the labor market.

The homepage for this project is  Re-Reading Keynes.My author page on LinkedIn Index to my writings: AZPROJECTS.  My personal webpage: Transforming Knowledge.

keynesgtFifth Post in a sequence on Re-Reading Keynes. 

Chapter 1 of General Theory is just one paragraph, displayed in full HERE

Briefly: Keynes writes that Classical Economics is a special case of his General Theory. Furthermore, the assumptions required for the special case do not hold for contemporary economic societies,”with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience”

The discussion below borrows extensively, without explicit point-by-point acknowledgement, from Brian S. Ferguson, “Lectures on John Maynard Keynes’ General Theory of Employment, Interest and Money (1): Chapter One, Background and Historical Setting” University of Guelph Department of Economics and Finance Discussion Paper No. 2013-06:

1.       RHETORIC: Keynes wishes to persuade fellow economists. Instead of saying that they are all wrong, blinkered idiots, he says that they are studying a special case, which he wishes to generalize. He also acknowledges that he was misled by the same errors, and creates common ground to enable dialog. He is also making a subliminal appeal to the hugely influential General Theory of Relativity published earlier by Einstein.

2.       INVENTION OF MACRO: The revolutionary contribution of Keynes is to study aggregates, instead of micro-level behavior. He is correctly labelled the inventor of macro-economics; prior to him, economists thought that the aggregate behavior would be obtained simply as a sum of the individual behaviors; there is no need to study macroeconomics separately. Parenthetically, it is this same position to which macro-economists retreated in the 70’s and 80’s with the development of DSGE model. Ferguson writes that:

Arguably, prior to the General Theory, most professional economists thought of the macroeconomy in a general equilibrium sense, as an aggregate of a large number of individual markets, and they assumed that the analysis of how individual markets behaved could be carried over pretty much unchanged to the collection of markets which constituted the economy as a whole. There was, it seemed, no need to think of the economy as anything other than the sum of its parts, and an understanding of how those parts worked was sufficient to understand how the economy as a whole worked. After the General Theory, that no longer held. Economists started to think in terms of aggregates.

3.       COMPLEX SYSTEMS: The flaws of this attempt to build macro on micro-foundations are still not well understood by modern economists due to the blinders of methodological individualism. These flaws include the failure to understand “Complexity Theory”, “Emergent Behaviors” and the influence of community and society on individual behavior. Basically, a complex system is one in which the behavior of the system as a whole cannot be inferred or deduced from the study of the individual parts, because it is the inter-relationships and linkages between the parts which create the system.  An extensive discussion of Keynes and complex systems is provided by John Foster, Why is Economics not a Complex Systems Science? Discussion Paper No. 336, December 2004, School of Economics, The University of Queensland. A brief quote from the abstract for the paper:

The macroeconomics of John Maynard Keynes is … an example of … (a) complex systems perspective on the economy. … the reasons why a complex systems perspective did not develop in the mainstream of economics in the 20th Century, despite the massive popularity of an economist like Keynes are discussed …

4.       MISUNDERSTANDING KEYNES: Very few read Keynes, and those who do fail to understand him for several reasons. Conceptual frameworks and background institutional structures (like the gold standard) are taken for granted and implicit in the analysis and discussion, but these have changed radically over time. In addition, “Keynes was inventing a new way of looking at the economy as a whole. He was struggling to develop concepts and invent terms, and many of the terms which he invented are not the ones we use today.” Because of this mis-understanding, revivals of Keynes (Like New Keynesians) often reject principles which Keynes considered central to his analysis, and accept propositions that Keynes firmly rejected.  Another reason for neglect of Keynes is the positivist reduction of scientific knowledge to binaries: true/false. What matters for a statement is whether or not it is relevant and valid for today, not whether or not Keynes said it, or what he meant. As Krugman puts it: Surely we don’t want to do economics via textual analysis of the masters. The questions one should ask about any economic approach are whether it helps us understand what’s going on, and whether it provides useful guidance for decisions. “So I don’t care whether Hicksian IS-LM is Keynesian in the sense that Keynes himself would have approved of it, and neither should you.” If theories have universal, time invariant, validity, then this would be a correct position. However, the basis premise of this re-reading of Keynes is that economic theories must be understood within their historical context.

5.       SAY’s LAW: The crucial issue under debate, tackled in the 2nd chapter of Keynes is: Can unemployment be reduced using fiscal policy and deficit financing? Keynes argues that it can, contrary to the view of classical that “unemployment” is not a problem – Supply and Demand for labor will equilibrate. Say’s Law holds so that the supply of labor will create the demand for it.

6.       CROWDING OUT: A crucial argument against Keynes is the Treasury View: Government investment will crowd out an equal amount of private investment. Government must borrow credit from the same market that private borrowers do. To the extent that Government succeeds in borrowing, private investors will fail in borrowing. This argument fails if the private sector expands the supply of credit in response to increased government demand for borrowing. Therefore the Treasury View is supplemented by two more pragmatic arguments. Second Treasury argument is based on extreme lags and inefficiencies in the governmental bureaucracies selection and launching of major public works projects. Such lags could mean that a intended counter-cyclical investment could be delayed so long as to become pro-cyclical.

7.       PRACTICAL PROBLEMS WITH PUBLIC WORKS: There were other practical, pragmatic aspects to the Treasury View, that governments cannot or should not spend their way out of a recession. To avoid the lags in fiscal policy, one needs “shovel-ready” projects to finance.  One of the most interesting quotes from Ferguson in this regard is:

cash-strapped local governments would cut back on their spending in response to increased central government spending in their areas. … Herbert Hoover, contrary to the image which he has acquired as a consequence of not being FDR, did not cut American federal government spending in response to the Depression, rather he increased it dramatically. … His first policy efforts involved spending federal money on shovel-ready public works projects, meaning projects which were already well into the planning stages and which needed only to have their commencement dates brought forward. In addition to finding that there weren’t anything like as many shovel-ready projects as he had hoped, Hoover found that state governments, whose own revenues were severely stressed by the Depression, responded to inflows of federal money by cutting their own relief spending, and moving to balance their budgets. (Many years later, officials from Franklin Roosevelt’s administration acknowledged that the bits of the New Deal which had actually worked were the bits they had simply taken over from Hoover. By then, though, Hoover’s reputation was pretty much beyond repair.)

8.       GOOD GOVERNANCE: Another very serious pragmatic Treasury concern was that Keynesian policy would lead to irresponsible excessive spending by politicians.

The need to keep the budget balanced had come to be accepted over the years by politicians as a matter of good governance. Treasury officials were concerned that if they accepted Keynes’ argument and gave politicians an excuse to spend in excess of revenue in some circumstances, the floodgates would burst and it would be impossible to prevent politicians from overspending under virtually all circumstances. The concern seems to have been that no matter what the circumstances, politicians would be able to come up for Keynesian reasons for deficit spending. In that fear, the Treasury officials seem to have been vindicated. As for staying on the Gold Standard the concern within the Treasury was similar: adherence to the rules of the Gold Standard was the best safeguard against unrestrained printing of money. (When Britain went off the Gold Standard for good in 1931, Sidney Webb, a member of a previous Labour party government, was reported to have lamented that when they had been in office nobody had told them that they were allowed to do that.)

Among the predecessors of Keynes, Ferguson writes that Keynes views were aligned with those of Malthus and against those of Ricardo on the following key dimensions:

9.       Against Comparative Statics: Keynes objected to Ricardian analysis on the grounds that it analyzed movements from one equilibrium state to another, without considering the disequilibrium transitional paths, and how long the transition would take. This is the context for his famous aphorism that in the long run we are all dead. He believed that studying transitional dynamics was more important than focusing on equilibrium conditions.

10.   Quick Movement to Equilibrium in Labor Markets:  Keynes objected strongly to Ricardian contentions that “labour markets worked efficiently and that wages would adjust quickly to restore equilibrium after a labour market shock.” This belief, widely held, was labeled “classical” by Keynes. Note that this belief is precisely what was resurrected by Lucas and the Chicago School, in their attack on Keynes.

This post covers about half of the Brian Ferguson article, which is about the “theoretical” context in which Keynes was writing. The second half is about the historical context, which we will cover in the next post. The homepage for this project is Keynes.

My author page on LinkedIn Index to my writings: AZPROJECTS. General Posts on Economics: Unlearning Economics. My personal webpage: Transforming Knowledge.

PRELIMINARY REMARKS: Philosopher Hilary Putnam writes in “The Collapse of the Fact/Value Distinction” that there are cases where we can easily and clearly distinguish between facts and values — the objective and the subjective. However, it is wrong to think that we can ALWAYS do so. There are many sentences, especially in economic theories, where the two are “inextricably entangled” .

This is the fourth post in a sequence about Re-Reading Keynes. This post is focused on a single point which has been mentioned,  but perhaps not sufficiently emphasized earlier: the entanglement of the economic system with the economic theories about the system. Our purpose in reading Keynes is not directly to understand Keynesian theory — that is, to assess it as an economic theory in isolation, and whether or not it is valid and useful for contemporary affairs. Rather, we want to co-understand Keynesian theory and the historical context in which it was born. This is an exercise in the application of Polanyi’s methodology, which I described in excruciating detail in my paper published in WEA journal Economic Thought recently:

Asad Zaman (2016) ‘The Methodology of Polanyi’s Great Transformation.’ Economic Thought, 5.1, pp. 44-63.

I must confess that I am not very happy with the paper; I was struggling to formulate the ideas, and could not achieve the clarity that I always try for. It is a difficult read, though it expresses very important ideas — laying out the foundations for a radical new methodology which incorporates political, social and historical elements that have been discarded in conventional methodology for economics. One of the key elements of Polanyi’s methodology is the interaction between theories and history — our history generates our experiences of the world, and this experience in understood in the light of theories we generate to try to understand this experience. This obvious fact was ignored & lost due to the positivist fallacy that facts can be understood directly by themselves. The truth is that they can only be understood within the context of a (theoretical) framework. Once we use theories to understand experience, then these theories are used to shape our responses to this experience, and so these theories directly impact on history — history is shaped by theories, and theories are shaped by history. The two are “inextricably entangled.”

A key mistake of logical positivism is the attempt to separate the objective and the subjective — an idea that we have all swallowed in the course of our education. In fact reality is shaped by a complex interaction of the two. When we taste a fruit, the flavor is determined partly by the objective characteristics of the chemicals in the fruit, but also by the characteristics of the taste buds on our tongues, and ALSO by the interpretative apparatus within our brains which interprets the stimuli coming into the brains. To reduce this complex process to the external and objective characteristics of the fruit would be a great mistake. It is this mistake which is embodied in conventional economic methodology. Economists do not understand that they are very much a part of the economic system. How the economic system operates is STRONGLY influenced by the theories propounded by economists. The economy of communist Russia was created under the influence of Marxist theories, and cannot be understood without understanding Marxist theory. The operation of the US economy is strongly influenced by the dominant economic theories. Quantitative Easing, QE, is a brainchild of Bernanke, based on Friedman’s understanding of the Great Depression. QE has strongly affected economic conditions in the USA and throughout the globe. The observer cannot be detached from the system being observed.  Just taking this one methodological insight from Polanyi on board is sufficient to completely invalidate the current methodological approach used by economists.

I have a 45 minute video lecture on “The Methodology of Polanyi’s Great Transformation” which attempts to explain these methodological ideas in a more user-friendly way. This is linked below:

This 1000 word article is the third in a series of posts on Re-Reading Keynes. It traces the impact of Keynesian theories on the 20th century, as necessary background knowledge for a contextual and historically situated study of Keynes. It was published in Express Tribune on 4 Nov 2016.

The Global Financial Crisis (GFC) has created awareness of the great gap between academic models and reality. IMF Chief Economist Olivier Blanchard said that modern DSGE macroeconomic models currently used for policy decisions are based on assumptions which are profoundly at odds with what we know about consumers and firms. More than seven different schools of macroeconomic thought contend with each other, without coming to agreement on any fundamental issue. This bears a striking resemblance to the post-Depression era when Keynes set out to resolve the “deep divergences of opinion between fellow economists which have for the time being almost destroyed the practical influence of economic theory.”

Likewise, today, the inability of mainstream economists to predict, understand, explain, or find remedies for the Global Financial Crisis, has deeply damaged the reputation of economists and economic theories. Recently, World Bank Chief Economist Paul Romer stated that for more than three decades, macroeconomics has gone backwards. Since modern macroeconomics bears a strong resemblance to pre-Keynesian theories, Keynesian theories have fresh relevance, as described below.

In the aftermath of the Great Depression, economic misery was a major factor which led to the Russian Revolution and the rise of Hitler in Germany. Conventional economic theory held that market forces would automatically and quickly correct the temporary disequilibrium of high unemployment and low production in Europe and USA. Keynes argued that high unemployment could persist, and government interventions in the form of active monetary and fiscal policy were required to correct the economic problems. Many have suggested that Keynes rescued Capitalism by providing governments with rationale to intervene on behalf of the workers, thereby preventing socialist or communist revolutions. There is no doubt that strong and powerful labor movements in Europe and USA derived strength from the economic misery of the masses, and also took inspiration from the pro-labor and anti-capitalist theories of Marx. While it is hard to be sure whether Keynes saved capitalism, we can be very sure that Keynes and Keynesian theories were extremely influential in shaping the economic landscapes of the 20th Century.

Keynes actually met Roosevelt (FDR) to try to persuade him of the necessity of an aggressive fiscal policy and of running budget deficits, in order to lift the US economy out of recession. He was only partially successful. FDR, like nearly all political leaders as well as economists of the time, was convinced of the necessity of balancing budgets: this is the same ‘austerity’ being touted today as the cure for economic problems. Leading economists like Lionel Robinson and Friedrich Hayek argued in favor of austerity, and said that Keynesian remedies were dangerously wrong. They held the view that the Great Depression had been caused by excessively easy monetary policies in the pre-Depression period, and Keynesian interventions in the form of further easy monetary and fiscal policies would only prolong the agony.

FDR was not quite convinced by Keynes, but was politically savvy enough to announce that he would not balance the budget on the backs of the American people. Accordingly, he did go against his personal convictions, as well as his campaign promises of balancing the budget, which he believed to be a sound and necessary economic policy. Keynes felt that the economic policies of FDR were timid and hesitant, and prolonged the recession un-necessarily. In light of contemporary experience of the tremendously aggressive expansionary monetary policy in the post-GFC era, we can see that bolder steps by FDR would not have caused the harms that he was afraid of. In fact, after the economy recovered somewhat, FDR went back to conventional wisdom and started reducing budget deficits in 1936. This created a mini-recession which has been labelled the “Roosevelt Recession of 1937”. Duly chastened, FDR embraced Keynesian policies with greater conviction, and increased deficit spending right up to the second World War. It was the effectiveness of Keynesian policies that led even arch-enemy Friedman to state that “We are all Keynesians now,” though he later recanted. Indeed, he master-minded the Monetarist counter-revolution in the 1970’s which eventually led to a rejection of Keynesian insights, and a return to the pre-Keynesian ideas of austerity as a cure for recessions.  Forgetting the hard-learned lessons of Keynes led to a recurrence of problems very similar to those faced by Keynes in the form of GFC 2007.

Following the GFC, there has been a resurgence of interest in Keynes and Keynesian Theories. In the “Return of Depression Economics”, Krugman argued for the continuing relevance of Keynes, and stated that we could end the Great Recession immediately by implementing Keynesian policies.  China implemented Keynesian policies, and used a fiscal stimulus of $586 billion spread over two years, to successfully combat the global recession created by the GFC.  Unlike countries forced to implement austerity, which further wrecked their economies, the Chinese economy was able to perform well in the aftermath of the GFC. The Shanghai index had been falling sharply since the September 2008 bankruptcy of Lehman Brothers, but the decline was halted when news of the planned stimulus leaked in late October. The day after the stimulus was officially announced, the Shanghai index immediately rose by 7.3%, followed by sustained growth. Speaking at the 2010 Summer Davos, Premier Wen Jiabao also credited the Keynesian fiscal stimulus for good performance of the Chinese economy over the two years following the GFC.

Meanwhile, even IMF acknowledged the failure of austerity, the anti-thesis of the Keynesian policy. Massive damage was caused to Greece, Ireland, Portugal and other economies which were forced to tighten budgets in response to the recession. In the see-saw battle between Keynesians and Monetarists, after three decades of darkness, the Keynesian star seems to be rising. Strange as it may seem, many fundamental insights of Keynes were never actually absorbed by conventional economists. Keynes himself said that he had the greatest difficulty in escaping the habits of thought created by an economics education. Mainstream economists never made this escape. As a result, Keynesian theories remain an undiscovered treasure offering deep insights into current economic conditions.

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