Globalization has been associated to a new financial regime and great transformations in the pattern of economic growth. In the last decades,  financial capital  has exercised control over the structural forms necessary for the continuing cycles of valorisation of productive capital, thanks to the centralized money at  disposal. Indeed, a trend of high expansion of financial assets, while economic growth remains limited and sporadic, has given way to widespread  income and wealth inequality. The same policies that have obliterated social services and kept labour cheap have favoured global enterprises and financial deepening.

In his deep social and cultural analysis of  globalization, the well-known sociologist Zygmunt Bauman (1925-2007) stated at the beginning in the early 2000s:

The downsizing obsession is, as it happens, an undetachable complement of the merger mania…. Merger and downsizing are not at cross-purposes: on the contrary, they condition each other, support and reinforce. This only appears to be a paradox….. It is the blend of merger and downsizing strategies that offers capital and financial power the space to move and move quickly, making the scope of its travel even more global, while at the same time depriving labour of its own bargaining and nuisance-making power, immobilizing it and tying its hands even more firmly.”  (Bauman 2000, p. 122)

Accordingly Bauman, financial power are business models are interrelated. Capital mobility, liquid strategies and behaviours, speculation, mergers and acquisitions have submitted livelihoods to huge losses in terms of unemployment, working conditions, workers´ rights and income distribution have been relevant. The outcomes were not socially acceptable since the restructuring programs have put pressure on social and economic protections for all workers. Therefore, the apprehension of the dynamics of  high finance is decisive to improve the understanding of the social impacts of business strategies in contemporary capitalism. As corporations and investors  privilege short-term results, decisions taken by investors to reorganize the business and markets have turned out to increase social vulnerability.


At the heart of Bauman`s  argument is that the capital accumulation process and the merger mania involve social relations driven by profit and competition.  Consequently, the clear cut between investors and managers favours the redefinition of the labour relations. At this respect, he addressed:


“Flexibility is the slogan of the day, and when applied to the labour market it augurs an end to the “ job as we know it”, announcing instead the advent of work on short-term contracts, rolling contracts or no contracts, positions with no in-built security but the “until further notice” clause. Working life is saturated with uncertainty” (Bauman 2000, p. 147)


What Bauman adds to our understanding about the real-world flexible working conditions is that business liquid strategies shape a social dynamics where  the search for flexibility enhances a kind of rationality that is functional to reinforce short-termism. Indeed, in spite of the euphemisms  rationalization and capital flexibility, capitalist finance regulates the pace of investment and the process of adjustment of the labour force. Workers are fired to improve  short-term profits, and those who remained are responsible for carrying the burden by increasing productivity.  In the context of  labour flexibility, workers cannot deal with all deep changes occurring in their working environments. Therefore, rationalization and flexibility happen to increase uncertainty in working life.

Indeed, Zygmunt Bauman’s  prominent contribution in social and cultural theory enhances  our  understading of the recent historical trends that  have shaped uncertainties, inequalities and inhuman conditions.



Zygmunt Bauman (2000) Liquid Modernity. Blackwell Publishing Ltd.

complexThis continues the sequence of posts on re-reading Keynes. The fundamental point about the labor market which is made in Chapter 2 is that the micro level negotiations on wages between firms and laborers do not determine the real wage in the macro-economy. Before explaining this point in detail, we want to show how it is just a special case of the general idea that the economy is a complex system which cannot be understood by looking at simple sub-systems.

The idea of complex systems is beautifully illustrated by the parable of the blind men and the elephant. Each one understood correctly and accurately one small part of the big picture. When we don’t understand the system as a whole, the descriptions of subsystems appear conflicting and contradictory. Once we have an understanding of the complex system, we can assemble the partial insights into a coherent whole. The main contribution of Keynes can be understood as an attempt to describe the economy as a complex system. Unfortunately, most of his followers were blind to the main insights of Keynes. Accordingly, there have been many different interpretations of Keynes; some followers saw the trunk, others the legs, and yet others the tail of the system that Keynes was describing. But no one appears to have understood the fundamental insights of Keynesian complexity: the system as whole does not act as a simple aggregate of the actions of the individual agents within the system. Pre-Keynesian macroeconomics was based centrally on the misunderstanding that the macroeconomy can be understood by scaling up the microeconomic behaviors of individual agents. While Keynes forcefully rejected this thesis, and created a complex system view of the macroeconomy, simple-minded followers failed to understand complexity, and went back to the pre-Keynesian views.

Blind Men Thesis:  20th Century Economists as a whole failed to understand the central insight of Keynes that the economy is a complex system. This means that what happens in the macroeconomy cannot be reduced to the microeconomic behavior of the agents.

Proof of the Blind Men Thesis: When we simplify an economy by creating a representative agent, we have thrown out the baby with the bath water in the process of simplification. A complex economy cannot be understood by reducing to a single agent, and then replicating this one agent. Similarly, aggregation of micro-behavior cannot be done to get macro-behavior. The very fact that this is widely done exhibits a failure to understand the central thesis and the fundamental contribution of Keynes.  We now list some commonly used approaches to understanding the macro-economy which illustrate the widespread failure to understand complexity:

  1. The Sonnenschein–Mantel–Debreu theorem illustrates complexity of the demand function. The properties of the micro-agents are not replicated at the macro level when we aggregate the demand functions.  Frank Hahnregarded the theorem as the most dangerous critique against the micro-founded mainstream economics. Nonetheless, modern economics textbooks blithely ignore complexity and continue to assume that macro level aggregate demand satisfies microeconomic assumptions.
  2. The widely used DSGE model with a representative agent reflects a failure to understand complexity. In his testimony to the Congress on the failure of economics, Solow understood this problem with the DSGE model and explained that “One important consequence of this “representative agent” assumption is that there are no conflicts of interest, no incompatible expectations, no deceptions.” Complex phenomena like unemployment and irrational exuberance cannot be captured in such models.
  3. Solow himself fails to understand complexity. The Solow growth model which aggregates Labor and Capital, illustrates exactly the same problem. If the complex interactions between laborers and capitalists create macro-phenomena which are not reflected in the micro-economy, then aggregation will miss crucial elements of the system behavior and fail to capture the process of economic growth. In the same testimony cited above, Solow writes that aggregation is a good first approximation. The main point of complexity is that this is not true – in a complex system aggregation of micro behavior is a hopelessly bad approximation to system-wide behavior.
  4. The Cambridge Capital Controversy is another illustration of complexity. Can we add up all the capital in the hands of all the capitalists and pretend that there is one aggregated quantity Capital, to create the Solow growth model? In a complex system, obviously not. Joan Robinson made the case that capital cannot be aggregated, but not on complex system grounds. Because she was right, Solow eventually conceded the point, and called aggregate capital a “Parable”. Modern textbooks blithely ignore this controversy, and continue to describe an economy using aggregates of capital and labor, directly in conflict with the insight that the economy is a complex system.
  5. The widely used textbook examples of Supply and Demand Analysis in a single market is another failure to understand complexity. See Saglam and Zaman: The Conflict between General Equilibrium and the Marshallian Cross for an explanation of how the complex system captured by general equilibrium conflicts with insights obtained by looking at a simplified subsystem within one market.
  6. The fundamental point about the labor market (which will be discussed in detail in a later post) being made by Keynes in Chapter 2 is a complex system point. We cannot understand the behavior of the labor market as a whole, by aggregating our understanding of negotiations between firms and laborers at the micro-level.In particular, supply and demand of labor interact, since as more labor is hired, aggregate income and aggregated demand increases. Thus the labor market cannot be studied in isolation from the goods market, and there are strong emergent effects.
  7. Many other points made by Keynes depend essentially on complexity (for more examples, see John Foster (2006) Why Is Economics Not a Complex Systems Science?,Journal of Economic Issues, 40:4, 1069-1091). Among them, the central role of money in an economy emerges from complexity. If we can aggregate all the money, and similarly aggregate prices, neutrality may hold. However, if it is the interactions between agents which are of crucial importance, then exactly the same amount of aggregate money, distributed in different ways, will change system behavior. Modern macroeconomists fail to understand this, continuing to believe in the long run neutrality of money, even though Keynes explicitly denied it and provide clear (but complex) arguments for his position.

Ironically, failure to understand Keynes led to dismissal and contempt “Paul Samuelson felt he could say that “it is remarkable that so active a brain would have failed to make any contribution to economic theory . ..” (cited in John Foster 2006). Because Samuelson could not understand the complexity of Keynesian theory, he wrote that: “[The General Theory] is a badly written book, poorly organized; any layman who, beguiled by the author’s previous reputation, bought the book was cheated of his 5 shillings. It is not well suited for classroom use. It is arrogant, bad-tempered, polemical, and not overly generous in its acknowledgements. It abounds with mares’ nests and confusions: involuntary unemployment, wage units, the equality of savings and investment, the timing of the multiplier, interactions of marginal efficiency upon the rate of interest, forced savings, own rates of interest, and many others. In it the Keynesian system stands out indistinctly, as if the author were hardly aware of its existence or cognizant of its properties; and certainly he is at his worst when expounding its relations to its predecessors.”

Samuelson’s arrogance in believing that he understood the Keynesian system better than Keynes created the biggest barrier to understanding Keynes for 20th Century economists. Because of his stature, he became the authorized interpreter of Keynes, and very few went back to original writings to try to understand them. Those who did also failed to come to grips with complexity, and as a result, it is impossible to count the variety of interpretations of Keynes — see for example, Backhouse and Bateman. The Keynesian elephant has a huge number of parts, it seems.

The current search for micro-foundations for macro is another expression of ignorance about Keynesian complexity. Keynes macroeconomic already has micro-foundations, but the macro does not replicate the micro. Failure to understand complexity leads to the complaint that since the macroeconomic system cannot be reduced to the behaviors of representative agent, it is not micro-founded.

This psycho-history is important because, as Keynes wrote: “The difficulty lies not in the new ideas, but in escaping the old.”   To the extent that we believe we already know what Keynes said, through his bastardized interpretation at the hands of Samuelson, his contribution will escape our understanding. Many recognized the illegitimacy of Samuleson’s interpretation, but provided equally wrong alternatives, which failed to capture the central Keynesian insight of complexity. The over-confidence of Krugman that we don’t really need to understand Keynes since we can independently arrive at the truth does not seem empirically justified in light of the numerous failures on this front. Perhaps it is true, as some complexity theorists have said, that human minds are not built to understand complexity. However, today we have the computational tools necessary to model, analyze and understand complex systems. Thus major progress is possible, with the help of agent based models and complexity theory.

wisdomThe adventure of leaving home, and exposure to unlimited educational opportunities as well as a radically different social environment, made us heady with excitement as freshmen at MIT. We often stayed up all night discussing our new experiences. Since we could not come to any conclusion regarding the most important question we face: “what is the meaning of life?”, we resolved to seek guidance from one of our professors. Most were teaching technical subjects like math, physics and chemistry, but our history professor occasionally talked about the bigger issues of life. Upon being asked, he gave us an answer which satisfied us at the time: he said that first we must learn the little things that we were being taught, in order to be able to answer the bigger questions that life poses.

It was many years later that it gradually dawned upon me that we had been scammed. Our teachers had no answers to these questions, and so they shifted our attention to the questions that they could answer. We were counselled to look under the light, for the keys which had been lost in the dark. It was not always that way. In The Making of the Modern University: Intellectual Transformation and the Marginalization of Morality, Harvard Professor Julie Reuben writes that in the early twentieth century, the college catalogs explicitly stated that their mission was to shape character, and produce leaders. Students were to learn social and civic responsibilities, and to learn how to lead virtuous lives. However, under the influence of an intellectual transformation which gave supreme importance to scientific knowledge, and discounted all other sources and types of knowledge, consensus on the meaning of virtue and character fragmented and was gradually lost. Universities struggled very hard to retain this mission of character building, but eventually gave up and retreated to a purely technical curriculum. Because this abandonment of the bigger questions of life has been extremely consequential in shaping the world around us, it is worth digging deeper into its root causes

Enlightenment philosophers had hoped that reason would lead to a superior morality, replacing what they saw as the hypocrisy of Christian morality. They thought that Truth was comprehensive, embracing spiritual, moral, and cognitive. However, by 1930’s this unity was decisively shattered. The triumphant but fatally flawed philosophy of logical positivism drove a wedge between factual cognitive knowledge and moral/spiritual knowledge. It became widely accepted that science was value-free, and distinct from morality. Prior to the emergence of this division, social scientists had defined their mission as understanding and promoting human welfare. Social and political activism had been a natural part of this mission. However, this changed in the early twentieth century with the widespread acceptance of Max Weber’s dictum that social science, like physical science, should be done from a value neutral perspective of a detached observer.

Positivist philosopher A J Ayer said that moral judgements had no “objective” content, and hence were completely meaningless. Similarly, Bertrand Russell said that despite our deep desires to the contrary, this was a cold and meaningless universe, which was created by an accident and would perish in an accident. These modern philosophies displaced traditional answers to the most important questions we face as human beings. According to modern views, we must all answer these questions for ourselves. No one else has the right to tell us what to do. All traditional knowledge is suspect, and instead of following custom or authority, we should arrive at the answers in the light of our limited personal experience and reason. Indeed, this is a core message of Enlightenment teachings which is built into the heart of a modern education.

The treasure of knowledge which is our collective human heritage has been collected by hundreds of thousands of scholars, laboring over centuries. Imagine what would happen if we were required to use our reason to establish and validate every piece of knowledge that we have. It would be impossible to learn more than a very tiny fragment of this knowledge. As a practical matter, we accept as givens vast amounts of material taught to us in the course of a modern education. This is necessary; if told to re-discover mathematics from scratch, even the most brilliant and gifted child would never get beyond the rudiments of the material in elementary school textbooks. But for the most important question we face in our lives, we are told that all traditional knowledge is useless; we must work out the answers for ourselves. There is a huge amount of discussion, conversation, and controversy contained in the writings of ancients. But we were educated to believe that the wisdom of the ancients was merely meaningless verbiage of the pre-scientific era. Thus, we never learned about Lao Tzu’s saying that loving gives you courage, while being loved gives you strength.  We learned fancy techniques and tools, but never learned how to live.

Real education can only begin after removing positivist blinders, and realizing that we have no choice but to trust the stock of pedigreed knowledge. It takes a lifetime of reasoning to arrive at a few simple results – we can look at the lives of those who made remarkable discoveries and see how, despite the magnificence of their contributions, their work was confined to a narrow and specialized domain.  Furthermore, they were only able to see far by standing on the shoulders of giants of the past. In benefitting from the stock of accumulated knowledge, our main task is to discriminate, to extract the gold nuggets from the mountains of dirt, and to avoid being deceived by fool’s gold. Today, as always, and in all fields of knowledge, the best path to expertise is via discipleship, unquestioning acceptance of instruction from experts. A premature application of reasoning and critical thinking leads to rejection of thoughts which contradict our prejudices, and makes learning impossible. Discipleship requires putting away preconceptions, emptying our cups, and opening ourselves to complex systems of thoughts entirely alien to anything we have ever conceived before. It is only after absorbing an alien body of knowledge that we acquire the ability to understand, reason and critique. A modern education creates multiple barriers to the pursuit of real knowledge that we desperately need to lead meaningful lives, by renaming ancient knowledge as ignorance, and by presenting us with illusions masquerading as knowledge. Like the wife of Alladin, we have gladly given away the ancient lamp for the bright and shiny modern one, without being aware of our loss. The path to recovery is long and difficult, as unlearning requires being open to possibilities and exploring directions that seem patently wrong to our modern sensibilities. It is not easy to suspend judgment and let go of what we have already learned, in order to acquire new ways of looking at the world. Yet, this is exactly what is required, if we are to learn to live, and not waste this unique and precious gift of life that has been granted to us for a brief moment only.

See also: The Secrets of Happiness, and Re-Enchanting the World. Published in The Express Tribune, 26th December, 2016.Posts on Diverse Topics: My author page on LinkedIn. Other works: Index .

unemploymentThis 7th post in a series about re-reading Keynes, starts the discussion of Chapter 2 of General Theory, which deals with the Classical (and neoclassical) Postulates characterizing the Labor market. The astonishing fact is that Keynes central arguments regarding how the labor market can fail to be at equilibrium, despite flexible wages, were never understood. As a consequence, the theory of the labor market is taught today exactly as it was prior to Keynes, and completely disregards Keynesian objections, and the Keynesian alternative. This post makes a start on Chapter 2, and the analysis will be continued in later posts.

In this chapter, Keynes formulates and rebuts the (neo)-classical theory of the labor market and presents an alternative theory of employment. This chapter was apparently never understood by economists, who mis-interpreted it as stating that unemployment arises due to price rigidities. In fact, Keynes held this position earlier, but renounces it explicitly in this chapter. His theory of employment states that the real wage is an “emergent” phenomenon. That is micro level decisions and actions of laborers and firms are based on nominal wages, but the complex economic system itself determines the general level of prices which is not in control of individual agents. So the real wage is out of reach of individual actors, and even though all parties may try to reduce real wages, they may fail to do so, because prices may respond in un-anticipated ways.

Keynes starts out be stating the classical postulates for the labor market, which continue to be the basis of modern labor economics.

Axiom I: The demand for labor by firms is determine by the marginal product of labor. As they hire more laborers, the marginal product will go down, while the wage goes up. Equilibrium will occur when the wage required for additional labor exceeds the revenue which will be generated by this hire (this revenue will be the profits from sales of the additional production, minus cost of all other inputs required in addition to labor).

Axiom 2: The supply of labor is determined by setting the wage equal to the marginal dis-utlity of work. Laborers will cease to offer labor when the going wage is less than the marginal disutility of work.

Keynes notes that these axioms allow for frictional unemployment and voluntary unemployment, but do not allow for involuntary unemployment. I assume this is familiar ground to most readers; for those who need a refresher, please see:  Zaman, Asad and Syed Kanwar Abbas, “Efficiency Wage Hypothesis – the case of Pakistan.”  Pakistan Development Review, Vol 44  number 4, Winter 2005, 1051-1066

Keynes notes that it is self-evident that involuntary unemployment is present – after the Great Depression, many workers would have been happy to work at the going wages, but could not find jobs. This sets up the problem that Keynes wishes to resolve: how to modify the axioms to allow for the observed existence of involuntary unemployment.

His first observation is that negotiation for wages between laborers and firms occurs in terms of NOMINAL wages and not in terms of real wages. He provides a very interesting and powerful empirical observation to support his assertion. In doing so, he deviates from the axiomatic methodology of economics; this observation is neither a self-evident axiom, nor can it be logically derived from any self-evident axioms. It does not conform to any principles of maximizing behavior. The observation is very simple. If firms would announce a cut in wages, the workers are likely to strike – this happened often enough in England. However, if there is an increase in the general price level, the workers do not go on strike; nor do they immediately require a compensating increase in wages. These observations firmly establish on empirical and non-axiomatic grounds that in the short run, it is the nominal wages which are the primary concern of the laborers.



1: Reshaping theories to conform to experience: This is a hallmark of science: empirical evidence trumps the beauty of mathematics. As Feynman said, “It doesn’t matter how beautiful your theory is, it doesn’t matter how smart you are. If it doesn’t agree with experiment, it’s wrong.” In particular, observational evidence used by Keynes to construct his theories was specific to England at that time. These observations do not have universal validity. In other economic systems, strikes may not be possible, or workers may react negatively to general increases in the price level. The observations used by Keynes to construct his theory cannot be derived from a priori axiomatic reasoning, but are nonetheless of crucial importance. Note that modern economists do not follow this methodology. Despites overwhelming empirical evidence against neoclassical utility theory, economists not only continue to use it, they even seem to be satisfied that even though macroeconomics is in trouble, microeconomics provides a sound basis to build on.

2: Complexity: Partial Equilibrium Intuition Conflicts with General Equilibrium. Keynes argues that real wage is outside the control of individual actors. In particular, the asymmetry between laborer reactions to cuts in nominal wage and rises in general price level shows that partial equilibrium wage negotiations are conducted in terms of nominal wage. The real wage depends on the general price level which is not in control of the agents in any particular firm or industrial sector. He argues that general equilibrium effects may go in the direction opposite of the desires and intentions of the agents negotiating in smaller subsectors of the economy. In particular, rising nominal wages will generally be accompanied by declining real wages, because both represent conditions where employment and production is increasing. In this situation, as production capacity limits are approached, there will necessarily be a decline in the marginal productivity of labor in real terms. Thus nominal and real wage will move on opposite directions. This is a “complexity” argument – the actions of individual agents have unexpected aggregate effects.

3: Failure of Second Axiom: Keynes argues that involuntary unemployment is observed, and this proves that the second axiom is false. Laborers continue to work even after real wage has declined following a general increase in the price level. This means that they did not equate marginal disutility of work with real wages, else they would have left their jobs following a general increase in prices. Again this illustrates Keynes doing what neoclassical economists have repeatedly failed to do: revising fundamental axioms after observing empirical evidence to the contrary.

We will end this post by listing some insights from Brain Ferguson “Lectures on John Maynard Keynes’ General Theory (2): Chapter 2, “The Postulates of the Classical Economics

  1. This chapter is crucial, and lays out Keynes theory of employment, which differentiates Keynesian theory from Pigou and other classical economists. Ferguson writes:”the classical model doesn’t have a model of unemployment, treating it instead as a side-effect of the business cycle. What Keynes wants to do in the General Theory is to make the determination of unemployment the central issue in macroeconomics, rather than covering it with rather ad hoc explanations”
  2. Another argument for why nominal wages matter is that for conversion to real wage, laborers use a price index for the consumer goods they purchase, while firms use a price index for their inputs and outputs, and these two are different.
  3. The only way observation of involuntary unemployment – workers demanding but not finding jobs at going wages – can be reconciled with the classical postulates of the labor market is if some mechanism (like strong labor unions) prevents reductions in nominal wages. In this connection, Ferguson quotes Keynes as follows:

…the contention that the unemployment which characterises a depression is due to a refusal by labour to accept a reduction of money-wages is not clearly supported by the facts. It is not very plausible to assert that unemployment in the United States in 1932 was due either to labour obstinately refusing to accept a reduction of money-wages or to its obstinately demanding a real wage beyond what the productivity of the economic machine was capable of furnishing.

  1. Ferguson uses this quote and additional evidence to show that while Keynes had earlier believed in price rigidities and lagged adjustment of nominal wages, he had abandoned this position by the time he wrote General Theory. The central features of the Keynesian theory of employment involve flexible nominal wages together with unemployment. Interpretations of Keynes have almost universally relied on wage rigidities as the source of Keynesian unemployment, and hence have missed the essence of the Keynesian model.
  2. To further elaborate, the previous point, Keynes states that he has two observations about the labor market: the first is a non-fundamental point and the second is fundamental. The first point is what we have discussed in the post: Labour resists cuts in nominal wage but does not reduce quantity of labour supplied in response to identical change in real wage caused by increases in price of consumption goods. This observation has been interpreted as meaning that Keynes argued for downward rigidities in nominal wages and that labour suffered from money illusion – that they judged their wages only in terms of the number of currency notes in their pay-packet and not in terms of the amount it could buy. These are mis-interpretations of Keynes

(re-reading & analysis of GT Chapter 2 to be continued. The second, fundamental point, of Keynes will be discussed in a later post.  …)







subprimecrisisThis is my book review on Amazon — I thought it would be of interest to WEA readers.

In a complex world, discovering causality is very difficult. Many things happen simultaneously, and post hoc ergo propter hoc reasoning is a common fallacy that is hard to detect and critique. Here is how I understand Meltzer’s arguments. Meltzer defines Capitalism as private ownership of means of production, and free enterprise with minimal government regulations. In practice, ALL economies have government regulation of free enterprise, and a mix of private and public ownership. This gives Meltzer a free hand in proving that Capitalism works. Wherever he sees growth, he attributes it to the “capitalist” portion of the mixed economy. Wherever he sees failure, he attributes it to the “communist” portion – government regulations and control of production.

For example in a 90% capitalistic economy in the USA, a small injection of regulations (say 5%) leads to disaster and catastrophe. However in China, an economy which remains largely communist (government owns more than half of means of production), growth is attributed to the small injection of capitalist methods. Whereas the gradual liberalization of Chinese is praised, the Russian experience is not mentioned at all. At insistence of free market ideologues like Meltzer, Russia was forced to adopt a radical free market strategy (Shock Therapy of Jeffrey Sachs) which led to disaster.

In addition to wrong attribution of causality, I disagree with Meltzer on some factual claims. He considers the Reagan-Thatcher era of de-regulation to be a general success on economic fronts. Here is my capsule summary of banking regulation history, which is drastically different from Meltzer’s portrayal of the same history. Wild speculation by banks led to collapse of banks in 1929, wiping out life savings of millions, and creating massive misery which lasted for decades in the USA. In wake of this failure, a regulatory structure which included the Glass Steagall act, was put into place which PREVENTED competition and speculation by banks. This worked very well for fifty years, with only minor and inconsequential bank failures until the 1980’s. Then, with much fanfare, Reagan deregulated the S&L industry via the Garn-St. Germain Act, announcing a new era. Inside Job: The Looting of America’s Savings and Loans by Pizzo, Fricker & Muolo documents how the deregulation led to systematic looting and the S&L crisis. As a result of the crisis, Taleb estimates (see page 43 of The Black Swan: Second Edition: The Impact of the Highly Improbable: With a new section: “On Robustness and Fragility”) “large American banks lost close to all their past earnings (cumulatively),about everything they ever made in the history of American banking – everything.” Similarly, repeal of the Glass-Steagall act, which prevented banks from speculating, eventually led to the global financial crisis of 2008, in which free enterprise by banks led to the loss of trillions of dollars. An antidote for the belief that the private sector is more efficient and less corrupt than the government is a series of articles by Matt Taibbi, for instance “The Bank of America: Too Crooked to Fail” [ see […] ]

To summarize, unregulated free markets led to the Great Depression. Regulations and Keynesian economics (which allows Governments to help the unemployed) led to stability and prosperity until the 1970’s. De-regulation and liberalization in the Reagan-Thatcher era led to a massive increase in concentration of wealth at the top, and repeated financial crises, including the S&L crisis of the 80’s and the global financial crisis of 2008. HOWEVER, free market ideologues like Meltzer have an ENTIRELY different interpretation of this same history. According to them, the Great Depression was caused by mis-management of the monetary policy by the US Government. The same mistake caused the S&L crisis in 1980’s, and again, government (mis-)regulations are to blame for the global financial crisis.

One point on which Meltzer and I agree is that the Dodd Frank act is not worth the paper it is written. However, to Meltzer, this is evidence that regulations don’t work. Many others, including myself, see it as evidence of regulatory capture. The 37 page Glass-Steagall act clearly and strictly prevented banks from speculative investments, and worked very well for half a century. The strength of the financial sector prevented the passing of the necessary regulations, and created the 900+ page monstrosity of Dodd-Frank, full of loopholes one could drive a truck through. Effective and necessary regulation could not be passed because the strong private sector prevented it from happening.

How can we decide who is right? From the birds eye perspective taken by Meltzer, I believe that it is impossible to be sure. However, when one gets down to the nitty gritty details of history – who did what to whom, a pretty clear picture of the causal chains emerges. In this respect, Naomi Klein’s book The Shock Doctrine: The Rise of Disaster Capitalism is fantastic. I can honestly say that I learnt more about real world 20th century economic history and theory from this one book than I did from my Ph.D. in Economics at Stanford. The reader is invited to read both books and decide on the answer to Whether Capitalism works? for herself or himself.

Business strategies around long-run investment have varied over time. In General Theory (GT), John Maynard Keynes reinforces the analysis of the modifications in the structure of the capitalist class to explain the differences between entrepreneurs and investors in terms of the effects of their behaviour and decisions on capital accumulation. In Chapter 12 (GT), he establishes the difference between the old and the new business models. This historical approach shows that, in the old business model, there was an irrevocable commitment towards investment. Taking into account the new business model, the decisions about what amount and where to invest are no more an irrevocable commitment for investors and managers. Indeed, in the new business model, investors decide the volume of investment, but aggregate investment is not irrevocable since liquidity is the target.  This fact fosters macroeconomic instability in the economic system. As Keynes wrote:

Decisions to invest in private business of the old-fashioned type were, however, decisions largely irrevocable, not only for the community as a whole, but also for the individual. With the separation between ownership and management which prevails today and with the development of organized investment markets, a new factor of great importance has entered in, which sometimes facilitates investment, but sometimes adds greatly to the instability of the system” (Keynes, General Theory, 12, III).

And he added:

If I may be allowed to appropriate the term speculation for the activity of forecasting the psychology of the market, and the term enterprise for the activity of forecasting the prospective yield of assets over their whole life, it is by no means always the case that speculation predominates over enterprise. As the organisation of investment markets improves, the risk of the predominance of speculation does, however, increase” (Keynes, General Theory, 12, VI).

The historical changes in business have been related to qualitative transformations in capital accumulation and competition. Mainly after the 1970s, the changing practices in corporate finance fostered the growth of the participation of institutional investors, such as pension funds or private equity firms, in business management as relevant shareholders. The drive to increase the share-holders’ value and the incorporation of the managerial strata through share options has tended to postpone long-term investments. In addition, these practices have favoured mergers and acquisitions and fostered financial speculation.

After the middle 1990s, public policies and private strategies influenced the dimension and composition of balance sheets in different economic sectors. Among the main features:

  • The household sector has got increasingly indebted.
  • Corporations have moved to “surplus units” running financial surpluses that have been diverted towards the acquisition of financial assets instead of financing physical investments.
  • The balance sheets of mutual investment funds are now larger that before the global crisis with respect to the GDP and they have influenced the flows of investment in companies.

Considering the evolution of the business models since the 2000s, the strategies  of corporations and private equity funds have turned out to focus on short-term gains and the distribution of dividends to shareholders, that is to say, to investors. In other words,  the current business model can be apprehended as a form of governance that aims increasing short-term earnings by means of a “clash of rationalization”. In this context, competitiveness and productivity have been put together in the attempt to promote higher business performance.

In fact, the centralization of capital, through waves of mergers and acquisitions, created new challenges to business stability. Accordingly the OCDE, the current investment chain is complex due to cross-investments among institutional investors, increased complexity in equity market structure and trade practices, and an increase in outsourcing of ownership and asset management functions. In this scenario, the economic and social outcomes have involved a trend to ‘downsize and distribute’, that is to say, a trend to restructure, reduce costs and focus on short- term gains. In practice this has meant plants displacement and closures, changing employment and labour conditions, outsourcing jobs, besides the pressure on supply chain producers in the global markets.

As a result of current business strategies, investments that are fixed for society turn out to be liquid for investors. Today, the dominance of a culture based on short-term speculation has major implications that go far beyond the narrow confines of the financial markets.  The costs of this business model fall disproportionately on society because of the commitment to liquidity.  As Keynes warned,

“Thus the professional investor is forced to concern himself with the anticipation of impending changes, in the news or in the atmosphere, of the kind by which experience shows that the mass psychology of the market is most influenced. This is the inevitable result of investment markets organized with a view to so-called ‘liquidity’. Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of ‘liquid’ securities. It forgets that there is no such thing as liquidity of investment for the community as a whole” (Keynes, General Theory, 12, V).

If we WEA economists want to disseminate among our students these relevant changes in business models, then it would be interesting to include some of the following readings  mainly in micro and macroeconomic courses.

Berle, Adolf A., and Gardiner C. Means (1932), The Modern Corporation and Private Property, Macmillan.

Blair, Margaret M. (1995) Ownership and Control: Rethinking Corporate Governance for the Twenty-First Century, Brookings Institution.

Crotty, J. (2002) “The effects of increased product market competition and changes in financial markets on the performance of nonfinancial corporations in the neoliberal era”. Working Paper Series, n. 44.  University of Massachusetts Amherst, Political Economy Research Institute,

Çelik, S. and Isaksson, M. (2013) “Institutional Investors as Owners: Who Are They and What Do They Do?”, OECD Corporate Governance Working Papers, No. 11, France: OECD Publishing. (accessed 10 October 2015)

Fligstein, N. (2001) The architecture of markets, New Jersey: Princeton University Press.

Jacoby, S. (2008)  Finance and Labor: Perspectives on Risk, Inequality and Democracy, Working Paper, Institute for Research on Labor and Employment, USA, California Digital Library.

Keynes, J. M. [1936 (1964)] The General Theory of Employment, Interest, and Money. New York: Harcourt Brace.

Lazonick, W. (2013) “From Innovation to Financialization: How Shareholder Value Ideology is Destroying the US Economy” , in Martin H. Wolfson and Gerald Epstein, eds., The Handbook of PoliticalEconomy of Financial Crises, Oxford University Press.

Lazonick, W. and O´Sullivan, M. (2000) “Maximizing shareholder value: a new ideology for corporate governance”, Economy and Society, 29 (1).

Seccareccia, M.  (2012) “Financialization and the transformation of commercial banking; understanding the recent Canadian experience before and during the international financial crisis”, Journal of Post Keynesian Economics, 35 (2): 277-300.

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


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.