Looking back, after the Second World War, new theoretical and applied work in economics fostered empirical techniques that included structural estimation, the development of input-output methods and linear programming. Among the theoretical advances, the Keynesian revolution, the mathematical modeling of the business cycle, game theory, dynamic modeling, new models of consumer behavior and general equilibrium analysis can be highlighted.
What is significant about these changes is that, as theoretical and empirical work became more formal and mathematical, the conceptions of economic theory and of its relationship to various types of applied work changed. “Measurement without theory”, as Rutledge Vining explained, means that empirical work was needed in order to discover the appropriate theory. The ensuing debates were dominated by this view, that also included Milton Friedman’s contribution that turned out to be one of the most widely read methodological essays in economics.
By the 1970s, mainstream economics was centered on mathematical modeling of maximizing agents and econometric models were widely spread in applied work. Consequenlty, economics was becoming more methodologically homogeneous despite the protests from heterodox economists. In this setting, new theories for specific fields in economics were developed. As Backhouse and Cherrier claimed, there has been a process of unification and fragmentation in economics.
Some of the new theories fostered a renewed understanding of economic behavior, bringing in imperfect information or psychological evidence. In this context, behavioral economics rejected the commonly accepted model of rational choice. In order to demonstrate the existence of cognitive biases, behavioral economists rely on empirical data, collected through designed experiments, surveys and field studies. Beyond the belief in positive analysis, behavioral economics developed normative recommendations to make people “happier” as the result of government interventions (nudge) that can help people change their behaviors and act more rationally. This normative program has been called Libertarian Paternalism by Richard Thaler and Cass Sunstein.
However, behavioral economists have not abandoned the ideal of rationality in economics. According to Stefan Heidl, psychology is treated as a mere add-on to mainstream economics and, therefore, behavioral economics faces the same methodological limitations.
In accordance with the same line of thought, Leonard adds: ‘The irony is that behavioral economics, having attacked homo oeconomicus as an empirically false description of human choice, now proposes, in the name of paternalism, to enshrine the very same fellow as the image of what people should want to be. Or, more precisely, what paternalists want people to be’.
Taking in account the spread of behavioral public policies in contemporary research and economics education, the relevant concern is related to the implicit political and social processes at stake.
In our view, the dominant ideology underlying behavioural public policies is the self-governance of nudging that reflects a neoliberalization of everyday life.
References
Backhouse, R. and Cherrier, B. (2014). Becoming Applied: The Transformation of Economics After 1970. Department of Economics Discussion Paper 14-11. University of Birmingham.
Heidel, S. (2014) Philosophical Problems of Behavioural Economics. PhD dissertation University of Bonn.
Leonard, T. C. (2008). Review of “Richard H. Thaler, Cass R. Sunstein, Nudge: Improving decisions about health, wealth, and happiness”. Constitutional Political Economy, 19 (4): 356-360
Friedman, M. (1953). The Methodology of Positive Economics. In Essays in Positive Economics. Chicago: University of Chicago Press. pp. 3-43.
Vining, R. (1949). Methodological issues in quantitative economics: Koopmans on the choice of variables to be studied and of methods of measurement, The Review of Economic and Statistics, 21 (2): 77- 86.
Guest Post by Donni Wang [author details at bottom of post]. Republished from The Economic Historian blog: “No Go from the Get Go: Adam Smith’s Bad History, Lessons from Ancient Greece, and the Need to Subsume Economics” – She is a historian, and argues here that a false history which portrays progression and progress actually seals off alternatives and choices which we could, and indeed need to, make today. Correcting Adam Smith’s views about history of mankind, using lessons from Ancient Greece, thus creates new possibilities for us today.
WORLDVIEWS THAT gain traction tend to be comprehensive in nature. They account for a wide range of phenomena that define the human condition, one of which being the changes that occur to society over time. This is true also for capitalism as an extensive body of thought. Although there is much emphasis placed on the modern epoch that features the rise of the industrial nation in the West, the weltanschauung of capitalism does supply a neat story of human development that extends back to earlier periods.
The obvious source for this narrative is to be found in the writing of Adam Smith. Having been rightly credited as the father of capitalism, Smith has contributed much to the overall coherence of the market system by reinforcing it with a supportive philosophical foundation. In fact, his narrative of the past, which is still being circulated in contemporary textbooks and popular discourse, has not only rationalized the ascent of market forces in 18th century Europe, it also validated the major assumptions that undergird orthodox economic thinking today.
The historical account proffered by Smith, however, does not hold up even to the most basic test. A closer look at actual history, particularly that of Greek antiquity, renders the type of the human past constructed in service of modern economics untenable. In fact, a careful analysis of the Greek experience yields a historical society that resoundingly rejected the current capitalist logic. Furthermore, the ancient Greek case brings forth a different economic model, one that supplies a radical paradigm-shift at a time when the governing structural configuration of the last two hundred years appears increasingly incapable of dealing with escalating crises.
First, a very brief recap of Smith’s theory of the past. In The Wealth of Nations, Smith stated that human society had gone through four consecutive stages: the age of hunters, the age of pasturage, the age of agriculture, and the age of commerce, with each succeeding one more advanced than the previous.1 At the same time, Smith stressed that human beings have always been driven by self-interest, a powerful primordial force that remains operative throughout time.
Smith’s narrative performs two functions. First, it aligns all prior historical movements along a neat evolutionary path, so that the emerging commercial society which Smith presided over automatically gains affirmation. As Smith asserted, a huge gap exists between the “savage nations of hunters and fishers” and “civilized and thriving nations” of his time.2 Secondly, adherence to a universal conception of human nature ensures that economic and state policies that legitimize and reward self-interest reign supreme.
In fact, while Smith simultaneously expresses reservations about capitalism elsewhere — notably in The Theories of Moral Sentiments— those feelings are exclusively directed at the excesses and extremes of market forces, but not the general condition itself. As a result of these discursive features, readers of Smith would be prepared to accept governmental measures that compensate for economic volatility, such as regulation, welfare, and charity, but not any serious appraisal of the fundamental cornerstones of modern economics, such as private property, wage labor, and commercialization, which generate social disintegration in the first place. This idiosyncratic moral tale hinders the possibility that capitalism can be resisted and overthrown — as feudalism was — as it refuses to question the very core assumption that the individuals in pursuit of market-based material interest is the best vehicle for social progress.
This is not the place to dwell on the incredible stunt of both illustrating dramatic stagial change and insisting upon constant human nature at the same time. The current task is a simple one: to square Smith’s story against the knowledge about ancient Greece, one of the best documented, widely-known, and most relevant European cultures, according to both the standards of the 18th century and our time.
FIRST, TURNING ancient Greece into an agricultural society at the low end of a linear trajectory departs from other meaningful engagement with antiquity in Smith’s day. Back then, learned men became enamored with Greece and Rome because of the extraordinary cultural, artistic, and philosophical achievements of these two places. This fascination suggests a firm refusal to reduce the legacy of the ancients to the specifics of economic activity, and this anti-materialist approach opens the possibility of viewing history as moving in the direction of decline/fall, prompting a more critical evaluation of 18th English bourgeois society as well as its lingering ideology.
The details of Smith’s argument also betray a poor reading of the ancient texts. Drawing on the Homeric epics, Smith identified the prevalence of self-interest in antiquity by pointing out that the Trojan war “was not undertaken with a view to conquest but in revenge of goods that were carried off.”3 As all readers of the Homer are aware, the immediate cause of the war was the abduction of Helen by the Trojan prince Paris. That Paris was able to meet his lover in the first place owes to the fact that he was entertained as a guest-friend by Helen’s husband Menelaus. This tradition of hosting foreigners as guest-friends, called xenia, was an important custom in ancient Greece. The cultural institution of xenia mandated the circulation of goods and objects for the purpose of cementing long-term social bonds.
In this light, the punitive expedition was prompted by Menelaus’ desire to seek redress for an errant act that violated the norms of cordial exchange, and the long-distance campaign was made possible by a prior oath of solidarity shared by the Greek princes who were peers to Menelaus. These motives, which grew out of strong expectation of reciprocity, could hardly be equated to the universal human propensity to truck, barter, and exchange. If anything, it can be argued that a trusting and mutually-beneficial relationship was so central that its breakdown led directly to violence and war.
Just as problematic is Smith’s generalization that all the disputes mentioned in the epics “were concerning some women, or oxen, cattle, or sheep or goats.”4 To be sure, the Greeks looted cities and competed for booty during their ten-year campaign, but Homer explicitly states that the heroes fought for undying glory (kleos). It is for this kleos that Achilles was willing to give up a long and prosperous life.
True, the Homeric warriors were no ascetics, and this glory they sought after very often had to manifest tangibly in the physical objects they won as rewards in the eye of the public. Nevertheless, kleosis fundamentally defined by its symbolic and interactive dimension, and its pursuit must be consciously aligned with the common goals of the community, a collective entity that determined what sort actions were praise-worthy or reprobative — in contrast to the invisible hand that is neither known nor needs to be taken into account by the individual.
If Smith’s overarching historical narrative seems reductive and problematic for his own time, it is even more so given what we have learned since then. Economically speaking, scholars now see Athens as the home to vibrant manufacturing, large public works, extensive long-distance trade, and diverse banking practices. In short, the city was far from being a simple farming society that Smith made it out to be. Furthermore, historians of recent years concluded that the Athenian society enjoyed relatively decent standards of living and was remarkably egalitarian, upsetting a simple image of civilization steadily marching from a primitive, impoverished state toward more advanced and progressive ones.5
Since the 19th century, ancient Greece has also become a symbol for democracy and freedom, inspiring many in the age of revolution to turn against the ancien regime. This tradition of drawing lessons of social justice and equality from ancient Greece rather than fixating on its level and amount of production remains strong. It is true that some of us moderns living in the 21st century could rightly fault the Athenians for having failed to include women, slaves, and foreigners in their democratic experiment.
This moral high ground, however, was not available to Adam Smith, for 18th century England was involved in the colonization of indigenous lands, enslavement of natives, and denial of equal rights to women. Furthermore, the industrial revolution in Smith’s time allowed appalling living conditions to afflict domestic citizens through precisely the type of division of labor that he marveled at in his writing.
IF WE are to reject the Smithian historical narrative, which legitimizes a certain notion of the 18th century commercial society that appealed to his class, then what kind of alternative can we envision when we consider the more nuanced dynamics of the ancient world? A new account of the Greeks that does more justice to their actual lived experience is given in Before the Market. This new historical study points to a different model of political economy that is diametrically opposed to the core structural logic of liberal capitalism.
This economic system called Olympianism, revolved around a specific understanding of human nature that was central to the world’s first and only direct democracy which took roots in Athens. According to the distinctive moral philosophy of Olympianism, it is natural for human beings to connect the wellbeing of the community with their own through acts of horizontal collaboration, mutual trust, and solidarity. This powerful paradigm, rendered in literary texts and conveyed by political practice, shifts the focus of historical gaze from material pursuits to civic deeds, and short-circuits the kind of linear, stagial story postulated by Enlightenment thinkers like Adam Smith.
By learning about other articulations of human nature and human potential, and by recognizing that history was highly contested and contingent rather than teleological, we are forced to take the experience of societies before us very seriously.6 The knowledge that we can live very differently through our own constructed notion of who we are is empowering as it brings moral responsibility and moral choice back in the crucial debate on what sort of economic system we ought to adopt.
About the Author
Donni Wang received her B.A. in Economics from U.C. Berkeley and her Ph.D. in Classics from Stanford University. Her first book, Before the Market: The Political Economy of Olympianism, came out in February 2018. An excerpt of it can be downloaded from academia.edu. Her research interests revolve around a series of hard and urgent questions that are critical of both the market and the nation-state. She currently lives in Berlin and hopes to expand her academic oeuvre as an independent scholar. In her spare time, she writes popular history (most of which in Chinese), goes to ballet classes, and carries out her duties as a citizen of the emergent global democracy.
In the introductory note to the book Trade and Market, Polanyi invites the readers to re-examine the notion of the “economy” since many people think that the only way of organizing the livelihoods of men is the market economy. In his own words:
‘What is to be done, though, when it appears that some economies have operated on altogether different principles, showing a widespread use of money, and far-flung trading activities, yet no evidence of markets or gain made on buying or selling? It is then that we must re-examine our notions of the economy.’ (Polanyi et al, 1957: xvii).
In order to develop an alternative notion of the “economy”, Polanyi proposed a new theoretical approach to explain the place and role of human beings in social and economic systems. He addressed that men value those material goods that serve the end to promote protection and social standing. As a result, in his approach, social matters turn out to be anthropological ones and the role of history is highly relevant. As Polanyi wrote:
“But a purposeful use of the past may help us to meet our present over concern with economic matters and to achieve a level of human integration, that comprises the economy, without being absorbed in it” (Polanyi et al., 1957: xviii).
Indeed, while considering different historical references, Polanyi provided a guide to examine the non-market economies and claimed that empirical observations reveal economic life in archaic and primitive economies to be entirely different from that assumed by formal economic analysis (Polanyi et al, 1975: 243-44). Against the methodological approach to economics based on assumptions, premisses and deductive reasoning, Polanyi proposed the method of economic anthropology that depends upon principles of economic behavior that are induced from empirical observation.
From the empirical evidence of economic life in ancient times and primitive economies, Polanyi explained the concepts of reciprocity and redistribution. The reciprocity principle implied that there was an unspoken agreement in society and on its behalf people produced goods and services that could be redistributed according to their needs among all who contributed according to their abilities to the common welfare. Their motivation to produce and share was not the economic motive, but the fear of losing the social status and prestige.
Although Polanyi addressed that ancient and primitive economies had market places, they were not market economies. In this scenario, daily local markets were merely exchange places operating within the broad system of reciprocity. Local craft and provision markets were isolated by the local authorities from the long distance ones (ports of trade) that only sold items which could not be provided within the local system of reciprocity (Polanyi et al., 1957).
In the nineteenth century, however, Polanyi noted that the emergence of a market economy pushed to the side the old economic and social systems based on reciprocity and redistribution. Since then, the new market economy has been characterized as an economic system controlled by prices that determine what, how and how much is produced and how is distributed. As Polanyi explained, the decisions about production and distribution are guided by the economic motive and they do not aim at achieving common welfare. Indeed, as he highlighted in The Great Transformation, the process of social change created by the market economy might lead to the emergence of poverty on a large scale.
Karl Polanyi described the desolation, dehumanization and degradation of human lives as necessary steps for the emergence and expansion of the labor market in a market economy:
“Before the process had advanced very far, the laboring people had been crowded together in new places of desolation, the so-called industrial towns of England; the country folk had been dehumanized into slum dwellers; the family was on the road to perdition; and large parts of the country were rapidly disappearing under the slack and scrap heaps vomited forth from the “satanic mills.” Writers of all views and parties, conservatives and liberals, capitalists and socialists invariably referred to social conditions under the Industrial Revolution as a veritable abyss of human degradation” (Polanyi, 1944: 41).
Polanyi’s analysis also enhanced a critique of some well-known economists and public men such as Townsend, Malthus, Ricardo, Bentham and Burke who considered that the provision of extensive relief to the poor by the government (such as the Poor Laws in England) would negatively affect the rate of economic growth.
Polanyi decisively condemned the hunger of workers as the only way to increase the levels of production in a market economy. In fact, Polanyi addressed that the “iron” laws governing a competitive market economy are not human laws. It is worth recalling his own words:
“The true significance of the tormenting problem of poverty now stood revealed: economic society was subjected to laws which were not human laws.” (Polanyi, 1944: 131).
References
POLANYI, K. (1944) The Great Transformation: The Political and Economic Origins of Our Time, New York: Rinehart.
POLANYI, K. (1977) The Livelihood of Man, New York: Academic Press
POLANYI, K., ARENSBERG,. H. and PEARSON, H. W. (eds.) (1957) Trade and Market in the Early Empires: Economies in History and Theory, Glencoe, Illinois: The Free Press.
POLANYI-LEVITT, K. (ed.) (1990) The Life and Work of Karl Polanyi, Montreal: Black Rose Books.
My article with the title above is due to be published in the next issue of the American Journal of Economics and Sociology (2019). This was written at the invitation of the editor Clifford Cobb, as an introduction to Islamic Economics for a secular audience. The Paper explains how modern economics is deeply flawed because it ignores the heart and soul of man, and assumes that the best behavior for humans is aligned with short-sighted greed. Islam provides a radically different view, showing how generosity, cooperation, and overcoming the pursuit of desires leads to spiritual progress. Islam seeks to create a society where individuals can make spiritual progress and develop the unique and extraordinary capabilities and potentials which every human being is born with. Pre-print – to appear in American Journal of Economics and Sociology, 2019 – is available for view/download at the bottom of this post.
As an excerpt, I am posting Section 2 of the paper, entitled
The Flawed Foundations of Modern Economics
The defeat of Christianity in a battle with science led to an extraordinary respect and reverence for scientific knowledge, sometimes called the “Deification of Science,” in Europe (Olson 1990; Zaman 2015a). This had fatal consequences. Even though all scientific knowledge is inherently uncertain, a concerted effort was made to prove the opposite—that scientific knowledge is not only certain, but it is the only source of certain knowledge. Because of distortions necessary to prove something which was not true, the methodology of science was dramatically misunderstood by the logical positivists. Nonetheless, this philosophy became tremendously popular, because it purported to prove both claims: science is certain, and is the only source of certain knowledge. When this became widely accepted in the early 20th century, modern social sciences were born out of an attempt to gain greater intellectual respectability for the humanities by adopting the methodology of science as it was (mis)understood by the logical positivists. (See “Origins of Western Social Sciences“). This led to a re-formulation of the humanities as “social sciences”—a set of universal laws stripped of their historical, sociological, and institutional context. Eventually, logical positivism collapsed under the weight of mounting evidence of failure on multiple explanatory fronts. However, economists never undertook the exercise of re-building the logical positivist foundations of economic theory. Methodology is treated superficially in textbooks, with the result that most economists continue to believe in the central tenets of logical positivism.
The ideas briefly discussed thus far are strongly in conflict with dominant narratives being told about economics. I have examined these counter-narratives in more detail in Zaman (2009, 2013, 2015a). We can summarize them as follows:
The dominant understanding of the methodology of science in the early 20th century was based on logical positivism, which became wildly popular for a brief period of glory, before going down in flames in a spectacular crash (see Rise and Fall of Logical Positivism).
Modern social sciences were born in early 20th century on the basis of a conscious effort to emulate the methodology of the physical sciences, as mis-understood by the logical positivists. This attempt to mathematicise, quantify, and study general laws of motion in societies, reflected a break from the past, in which the study of social phenomena was more qualitative and historically oriented, aligned with complexities of human behavior. Hodgson (2001: 79-94) discusses the Methodenstreit, or battle of methodologies, in Germany, in which the historical and qualitative school lost to the mathematical and quantitative approach. (see Method or Madness?}
The foundations of modern economics were laid in 1930s by Lionel Robbins as a science of choices subject to scarcity, replacing earlier conceptions based on human welfare. The new foundations were strongly aligned with positivist misconceptions regarding the methodology of science. Cooter and Rappoport (1984) provide an account of how the misconception of that welfare was not observable (and hence not scientific), led to the definition of “scarcity” by Robbins, which replaced earlier conceptions based on human welfare. (see the Methodology of Modern Economics)
The collapse of positivism should have led to radical re-consideration of these foundations. This did occur in other areas in the social sciences. However, economists continue to use the same foundations, and continue to believe in central tenets of logical positivism. [see “Is Scientific Methodology Axiomatic ?“A recent survey by Hands (2009) concludes:
So most modern economists generally consider rational choice theory to be a positive, not a normative, theory; endorse the position that normative statements/concepts should be prohibited from scientific economics; and equate normative theories/presuppositions with ethics.
Manicas (1987) and Reuben (1996) provide empirical evidence and arguments for the counter-narrative. The idea that “science” is a special way of knowing the world, which is radically different from other types of human knowledge, continues to be firmly embedded in the Western intellectual tradition. Manicas (1987) argues that the Western conception of “science” itself is mistaken. Removing misconceptions about the nature of science could lead to a thoroughgoing revolution in received theories. In historical context, Reuben (1996) explains how the internal dynamics of the academia, coupled with the emergence of positivism, led to a re-conceptualization of the nature and function of the humanities, reformulated as the social sciences. In particular, Weber’s ([1918] 1956) influential essay led to the attempt to remove the subjectivity associated with normative and action-oriented elements of the social sciences.
As I have only recently come to realize, stabilizing the exchange rate at the wrong level can have massively harmful effects. One can trace major economic tragedies to such attempts. The British attempt to go back to the gold standard after post WW1 failed because they set the level too high (as Keynes pointed out). This attempt set of a sequence of events which had far reaching consequences. A similar story is told about Pakistan in “The Rupee is falling; let it crash”. Linked article shows that overvaluation of Pak Rupee de-linked the Pakistan and Indian Economies, which may the economic root of current political hostilities. Current problems of the European Union are a more advanced version of the same problem, where the rate of exchange between European countries cannot be re-aligned according to the gaps between their imports and exports. This is a subject worth exploring further, and if readers have more pointers/articles, I would appreciate learning more about it. The article below deals with the Dutch Disease in Pakistan.
Today, we can find, fairly cheaply, an amazing variety of imports from all over the world in Pakistan: honey from Germany, vegetables from Brazil, milk from Australia, and clothing from India. The Government of Pakistan subsidizes imports of luxuries for the elites by spending billions in foreign exchange to keep the price of the dollar low. Many different economic indicators show a pattern of consistent and maintained overvaluation of the Rupee over the past several decades. In contrast, many competitors who started out behind us, like India, Bangladesh, and China, have surpassed us in exports by keeping their currencies consistently under-valued.
Long term cheap availability of imports has a well-known effect called the “Dutch Disease”. Normally, the Dutch Disease strikes countries which are rich in resources (like oil). This makes it possible for them to earn foreign exchange cheaply, without learning how to manufacture world class exports. When the exchange rate is too low, imports are cheap, and prevent the development of local industry. At the same time, exports decline because they are too expensive on the world market. Services sector enjoys a boom because services are locally produced and have no cheap foreign imports to compete with. Over the past few decades, the Pakistan economy shows all the characteristic symptoms of Dutch disease, with deindustrialization, declining exports, increasing imports, and a boom in the service sector.
The proxy war between US and Russia in Afghanistan made massive amounts of dollars available to Pakistan, creating favorable conditions for the Dutch disease. Remittances have also been a significant source of easy foreign exchange earnings. We did not have the wise leadership required to use the availability of foreign exchange to build productive capacity in the domestic economy. Instead, we fell into the trap of building a consumer-oriented economy based on cheap imports, which is attractive in the short-run, but enormously costly in the long run.
An agricultural country imports $6 Billion worth of agricultural products, like food, raw cotton, edible oil, only because over-valuation makes it cheaper to import than to produce. The government must burn billions of dollars to maintain an over-valued rupee, enabling the wealthy to enjoy foreign luxuries. Unfortunately, the standard sources from which we used to borrow to finance our spending spree have dried up.
The future is in our hands. We can continue to borrow, from other sources, and maintain an economy driven by consumption, and by industries which make profits by using artificially cheap imports. Or we can bite the bullet and go for the structural transformation required to create productivity in the domestic economy, which is the only route to long run sustainable growth. But there are serious obstacles in the path of the needed structural transformation. Currently, when we pump money into the domestic economy, it is channeled into imports because dollars are cheap. If the exchange rate was higher, people would demand domestic products. However, currently, those domestic products do not exist. The industries which could have come into existence had imports been expensive were never born. There is no domestic capacity to fulfill the additional demand, if it is blocked from going into foreign imports. Thus, increased aggregate demand for domestic products will only lead to inflation – increased prices of domestic goods in the desirable sectors. Contrary to common belief, this type of inflation is not harmful. In fact, high prices are required to send a signal to the domestic sectors that extra production is desirable and will be profitable. If we can sustain the policy of keeping aggregate demand in domestic products high, higher prices in the desired sectors will lead to creation of extra productive capacity and stimulate domestic industry, which is exactly what is needed.
However, there are many obstacles in the path. When the subsidy of billions of dollars for imports is withdrawn, there will be a lot of rich and powerful losers. They will demand continuation of the previous policies which created huge profits for them. The potential beneficiaries of the structural change are as yet unborn, and therefore cannot speak in favor of the change.
The challenge facing the current government is to manage the transition in a way which would minimize disturbances to the masses, and provide social support to those who need it the most. The greatest dangers come from the privileged classes, accustomed to extracting revenues without having to work. The billions pumped into supporting the rupees end up, indirectly, in their pockets. Withdrawing this subsidy will lead to loud screams by the rich and powerful, disguised to sound as if they are coming from the people. Whether the present government has the courage t
Good practices for development need leaders who help turning ideas into action. A well-working economy needs leaders who push boundaries, innovate, and make inspirations doable. Any change needs visionaries with strong values and a bold, clear vision of a better world. This applies on both local and global scales. Theories about economy and development are just a part of the bigger scene on which the actors are the actual people with the potential to make things happen. And because people do matter—as agents of change—the contribution of those who plant hope and give inspiration should not be overlooked.
Paweł Adamowicz (1965-2019), the Mayor of Gdańsk city of Poland since 1998, was one of such great leaders. His successful management that turned Gdańsk into an important business centre in the Baltic Sea region, efficacy, passion and the love for people he served granted him popularity. The many accomplishments of his office include the development of a modern transportation and business infrastructure, and civil budget. Adamowicz promoted an economy that protects local business, but is also open to international investors and working force from abroad, welcoming immigrants. He was not shy of bold visions. Before his sixth, and last, reelection as the Mayor of Gdańsk in 2018, he envisioned his city—which he called “the city of freedom and solidarity”—as the most important port in the Baltic Sea, a goal that he wanted to pursue during his most recent post. Adamowicz was also known for his openness and respect for people across divisions and borders such as nationalities and gender. In many ways, this local Pomeranian leader embodied values of global development, global justice, and civil society. These values and visions made liberal Adamowicz also a controversial figure on a strongly divided Polish political scene.
On January 13, 2019, Mayor Adamowicz was stabbed during the finale of the biggest national charity event, The Great Orchestra of Christmas Charity (GOCC).* He was on the scene for the opening of the GOCC’s concert in Gdańsk. The assailant, Stefan W., was a 27 year-old man with a history of instability, violence, and assaults. The motives were, allegedly, a mix of a political vendetta against the Civil Platform party to which Adamowicz once belonged, and personal reasons, which remain unclear. After being stabbed multiple times resulting in serious injuries, Adamowicz underwent 5 hours of surgery. He died on January 14, leaving a mourning family and his people. Gdańsk lost a leader of great charisma and power to make things happen.
To many, the assault on Paweł Adamowicz is not a discreet event. It is more a representation of a deeper friction in society, reflected in hateful attitudes towards different orientations (be it political, sexual, national, or the like), lack of accountability in social media and public space that allows for the language of hate and destruction, and the propagation of vengeance rather than peace. But in the midst of such tragedy, beautiful things happen that give hope and inspire to development–personal and societal alike. The deputy of the Mayor Adamowicz for social affairs, Piotr Kowalczuk, reached out to the mother and family of Stefan W. offering them support. Such a gesture reminds us of the power of humanism and peace that stands with the legacy of the Polish pope Jean Paul II.
In the dawns of such a tragedy like the murder of a great leader, it is necessary to take a stand. And so this is a stand against hatred and ideological divisions that create mindsets capable of unspeakable crime. But more importantly, it is a stand for peace, solidarity, and responsibility. It is also an invitation to cultivate positive leadership, good practices, and bold visions of a better future. There are always plenty of reasons to criticize and improve economic theories and existing practices. But we should not lose from sight all the greatness around us that is nevertheless happening. With this tribute to Paweł Adamowicz, I invite you to acknowledge and share the goodness that comes from, and is inspired by, great leaders and good practices in your region.
The memory of Paweł Adamowicz has also a moral for teaching students. An economy that embodies the values of justice, civil society, and solidarity is a building block of global sustainable development and peace. We tend to look at the bigger picture, a perspective from which we can easily spot flaws. But the local level is the level where things happen on a day-to-day basis. While many of the great actors are not visible or recognized in the bigger picture, local governance, local leaders, and local community is what gives shape to universal, global ideals. Development goes hand in hand with a democratic mindset and institutions, a lesson learned from the real-world example of the work of Paweł Adamowicz in Gdańsk. The assault on these values should not be an excuse for creating more hatred and divisions. It should be an encouragement to carry on the legacy of our great leaders, and to act together for change.
* The Great Orchestra of Christmas Charity (GOCC) was founded in 1993. The foundation uses the collected donations to purchase the most modern equipment for hospitals that treat children. Over almost a quarter of a decade, the GOCC contributed with modern equipment to all hospitals for children in Poland, and to many other medical facilities. The initiator of this popular and trusted NGO is Jurek Owsiak, who resigned from his function of the Chairman of the GOCC after the attack on the Gdańsk Mayor. Owsiak has just been nominated for the Nobel Peace Prize 2019.
This post is the third part of lecture 8 of Advanced Macro L08C: Fisher’s Debt-Deflation Theory of the Great Depression. In previous segments of this lecture L08A: Micro-Foundations for Keynesian Economics, and L08B: Keynesian Explanation for Great Depression: Seriously Incomplete, we examined the Keynesian explanation for the Great Depression, and found serious deficiencies in it. L08A explains that many different kinds of outcomes, with and without unemployment, are possible depending on how we specify details of the micro-structure that Keynes failed to specify. L08B explains that a simple deficiency in aggregate demand created by savings does not suffice to create unemployment because savings of current period is income/wealth of the next. It is necessary to look at abnormal savings, together with fixed prices, to create surplus production which signals shortfall in aggregate demand to the producers. Thus, many elements – micro-structure, role of debt, and different sectors of the economy – must be added to the Keynesian model to achieve the outcome of unemployment due to shortfall in aggregate demand that is at the center of Keynesian analysis.
This post deals with the last segment of the lecture, which explains Fisher’s Debt-Deflation theory of inflation. The lecture goes through and explains the article: Fisher, Irving (1933), “The Debt-Deflation Theory of Great Depressions”, Econometrica – making only minor commentaries. The goal is to understand what Fisher was saying, before attempting analysis, critique, and extensions. Many elements of this explanation are crucial to understanding the Great Depression, but are not available in the standard Keynesian analysis. Recently, elements of this theory have been picked up and presented as “Fisher-Minsky-Koo approach: Debt, Deleveraging, And The Liquidity Trap: A Fisher-Minsky-Koo Approach” Gauti B. Eggertsson and Paul Krugman: The Quarterly Journal of Economics,Vol. 127, No. 3 (August 2012), pp. 1469-1513. In this lecture, we only present Fisher’s original paper. Post covers portion of lecture from 37m to 1:15m.
Summary of Fisher’s Econometrica paper on Debt-Deflation.
Fisher starts with an insight which comes straight from the experience of living through the Great Depression. An economic system is complex, subject to numerous conflicting forces acting simultaneously and repeatedly through time. It is unlikely to ever be in equilibrium. It is unfortunate the modern economics rejects this fundamental insight.
Fisher starts by asking how we can study disequilibria? In theoretical terms, the answer is to look at the forces which are acting in a given economic situation. Instead of looking at the long run outcome of how these forces would be resolved to arrive at equilibrium, we should use historical experience to judge the relative speed and strength of these forces. This would be a radically different methodology from the one currently in use in economics today.
By using this methodology, Fisher comes to the conclusion that the Business Cycle is a myth. There are many different kinds of economic forces which create multiple cycles. The complex of of forces can acting in tandem or at cross purposes. There are three types of tendencies (forces) – both cyclical and non-cyclical: (1) Those which create growth; (2) Those which create random fluctuations; and (3) Those which create cycles – these cycles can be stable and unstable, and they can be due to (or interact with) internal factors, or external shocks to the economy.
He compares the economic system to a boat, which can resist small waves, but will capsize in a major storm. The system can accommodate small cycles, but may fall into crisis in big ones. There are some economic variables which can systematically deviate from equilibrium values. He names Capital Stocks, Real Income, Prices. In particular, Say’s Law is regularly violated. The production of goods can be in excess, or deficient, both in stocks and in flows. Forces in temporary disequilibrium will determine what happens next. Overshooting or Undershooting targets for production is common. BUT – this is NOT the cause of BIG disequilibria. The CENTRAL diagnosis of Fisher is the following:
The biggest cause of economic crises is: Too little money (too high price) mistaken for excess of goods!!
NOTE: This resonates with Friedman’s insufficient money supply explanation. Also, the Keynesian explanation, both of which work with short run fixity of prices.
In arriving at this diagnosis, Fisher lists and considers many common factors which lead to disequilibrium, and rejects them as sources of major crises. He then focuses attention on the Big Bad Actors – Debts and Deflation – as the cause of crisis. H says that the Apparent Causes are Over-Investment & Over-Speculation – this was obvious to all in the aftermath of the Great Depression. But Fisher thinks that the real Harm is caused by UNDERLYING debt which is used to finance this activity.
The mechanism which Fisher outlines starts with excess debt taken in a booming economy. Since assets like land, stocks are booming, people are happy to take debt at low interest, planning repay from the gains they make due to rapidly rising prices of stocks and real estate. Banks are happy to lend because they have the valuable asset as collateral for the loan, so even if the lender cannot repay, they will be able to cover their costs by selling the asset. Since banks create the money they lend, there is no check on the process, and loans increase geometrically leading to a situation with excess debt.
At some point, the bubble bursts. This is generally caused by failure of nerve of some party – either the banks, or the lenders. As indebtedness increases, people take loans to repay interest on past loans, and eventually, a steady stream of failures to repay emerges to public notice. At this point some people panic and start selling their assets, which sets off a chain reaction. As people sell to pay off loans, money supply contracts, and loans become less available. Now people who were relying on borrowing to repay previous loans start defaulting, or start to sell assets to cover loans. As more and more people sell assets, asset prices collapse. The collapse of prices leads to DEFLATION. Deflation increases the value of money, so that the debt burden becomes heavier. Paradoxically, the attempt to pay off debt puts people deeper into debt.
Balance sheets of banks, and firms, contain assets which are priced according to their market prices (This is called Mark-to-Market in accounting terminology). When stock and real estate prices collapse, the net worth of banks and businesses can become negative. Similarly, mortgage loans go under-water; they have negative equity. In simpler terms, this means that the value of house you own is less than the amount of loan you must pay to the bank to get ownership of the house. In this situation, it pays for the homeowner to declare bankruptcy and walk away from the loan and the house. Similarly, businesses whose net worth has become negative can collapse. This leads to panic and loss of confidence about the future in the general public. As expectations about the future become negative, people stop investing, business stop producing and lay-off employees. Heavily indebted people lose incomes and ability to pay off loans. Negative expectations about the future become self-fulfilling prophecies.
In the “Fisher” Sequence of events which leads to major crisis, Fisher says that two diseases – excessive debt, and price deflation – act together to create crisis.The effort to pay off debt leads to falling asset prices, which leads to further increase in real debt, and decrease in ability to pay. This is a vicious cycle which leads to collapse. Either one of the two forces acting individually would tend to return the system to equilibrium. The system can take small shocks and return to equilibrium, but large shocks, acting in tandem, lead to collapse.
Some Comments on Fisher’s Debt-Deflation paper
Fisher attempts to define “over-indebtness” which would lead to crisis, but failed to do so satisfactorily. Here Hyman Minsky made a major contribution. Minsky identifies three stages of debt in the business cycle. In the first stage, people & firms borrow to invest, and their stream of earnings is enough to pay off the interest and the principal. In the second stage, earnings are not sufficient to pay the principal, but enough to pay interest. Now loans are re-financed when the principal is due. In the third stage, earnings streams are not even sufficient to repay interest, and borrowing is done to pay interest on the loan. This last stage is what Fisher wanted to define as “over-indebtedness”, but failed to do.
He attempts to quantify the size of loans relative to assets/income available to repay. He writes that debts in 1929 were at historically highest known levels. By 1933, debts reduced by 20%, Prices decreased by 55%. Value of dollar increased by 75% — real debt increase 40%. This provides support for his key hypothesis: As you pay off debt, you go deeper into debt
Fisher offers the solution as price reflation, breaking one of the two components of the vicious cycle. He thought that if we could take policy actions to prevent prices from falling, or to put them back up to pre-crisis levels, then the economic system would find its way back to equilibrium. However, subsequent authors have cast doubts on this, suggesting that the levels of debt are so high that they cannot be repaid, even if assets do not lose their value. Thus the only solution would be to require debt-forgiveness.
The Wikipedia entry on Debt-Deflation provides a good summary of key points of Fisher’s thesis, and also its influence on subsequent work, and later developments. In fact, Fisher’s theories were ignored and neglected in favor of Keynes for a long time, prior to revival of interest in the 1980s. One of the reasons for this neglect was the idea that debt did not matter. What is a debt of one person is an asset of the other, so debts cancel. This mirage – that debts do not matter – continues to mislead economists. It is the large-scale inability to repay debts which is ignored in this picture.
As debts mounted up, Fisher’s Debt-Deflation theory has enjoyed a resurgence in popularity. It seems clear from a lot of research that levels of debt play a very important role in leading to financial and economic crises. For example, Atif Mian and Amir Sufi in House of Debt, highlight the role of leveraged debt as a key factor in the Global Financial Crisis. “Deflation”, or a dramatic fall in inflated asset prices, also plays a major role, and when combined with leveraged debt, this creates the catastrophic combination that Fisher identified. In retrospect, it seems that the widely accepted Keynesian explanation for the Great Depression was seriously incomplete, and Fisher identified some key elements missing from Keynes. For an update on Fisher, see: DEBT, DELEVERAGING, AND THE LIQUIDITY TRAP: A FISHER-MINSKY-KOO APPROACH by Gauti B. Eggertsson and Paul Krugman, in The Quarterly Journal of Economics,Vol. 127, No. 3 (August 2012), pp. 1469-1513
Last Portion of Lecture 8 – from 1hr 15m onwards
The last portion of the lecture L08D Friedman-Schwartz discusses the Friedman-Schwartz book on the Monetary History of the United States, which puts forth yet another diagnosis for the reasons of the Great Depression. They argued that it was the sharp contraction in the money supply that was responsible. This diagnosis was the one that was actually followed by Bernanke during the Global Financial Crisis, who massively increased money supply via Quantitative Easing programs. This did prevent financial collapse, but could not prevent the Great Recession, invalidating the Friedman-Schwartz hypothesis about the causes of the Great Depression. Furthermore, as a result of Quantitative Easing, reflation of asset prices has also occurred, which was Fisher’s proposed remedy. This has not proven very satisfactory, in many different ways. Of the two problems, Fisher thought that taking care of Deflation would suffice, but it seems to be only half of the remedy. The other half is the “Debt”, which can be removed by various methods, such as debt-forgiveness.
