Modern Developments in Macroeconomics: More Ado About Nothing

But at the same time technical progress is being speeded up to keep up with accumulation. The rate of technical progress is not a natural phenomenon that falls like the gentle rain from heaven. When there is an economic motive for raising output per man the entrepreneurs seek out inventions and improvements. Even more important than speeding up discoveries is the speeding up of the rate at which innovations are diffused. When entrepreneurs find themselves in a situation where potential markets are expanding but labour hard to find, they have every motive to increase productivity.

Joan Robinson

The stronger the urge to expand … the greater are the stresses and strains to which the economy becomes exposed; and the greater are the incentives to overcome physical limitations on production by the introduction of new techniques. Technical progress is therefore likely to be greatest in those societies where the desired rate of expansion of productive capacity … tends to exceed most the expansion of the labour force (which, as we have seen, is itself stimulated, though only up to certain limits, by the growth in production).

Nicholas Kaldor

The above quotes are from the early post-Keynesians suggesting that the rate of investment, and therefore long-run growth, can be influenced by aggregate demand — a conclusion at odds with virtually every mainstream macroeconomic model. Only a fairly recent paper, Aggregate Demand, Idle Time and Unemployment, has managed to incorporate a version of this insight into a mainstream framework. The paper uses a ‘matching’ model, where buyers and sellers (of both labour and products) may meet but not actually exchange goods, creating idle workers in the market and therefore a role for aggregate demand to increase production.

I recently discussed how modern econometric techniques are sometimes used to make a big methodological fuss about things that are fairly intuitive and obvious from descriptive statistics.* In this case I think modern macroeconomic modelling techniques are being used to make points that, while not ‘obvious’ in the same sense, have been well known by non-mainstream economists (and perhaps others, such as business executives) for a long time.

It could be argued that the mainstream framework allows us to link things together and produce novel predictions which are not possible with wordy tomes or simple mechanical models, but this does not seem a defensible proposition in the case of the above paper. Most of the 60 (!) pages of the paper are devoted to deriving a model at increasing levels of complexity, but this merely culminates in predictions of positive correlations between (a) the tightness of the labour market and employment and (b) the tightness of the product market and output (tightness meaning ‘more available capacity is employed’). In other words, if the aggregate demand story is true than the more firms are making use of their available resources, the higher employment and output. I don’t think it’s unreasonable to suggest those predictions could be inferred from the Kaldor and Robinson quotes above.

This is not a lone example. At the most recent ASSA Annual Meeting, the former head of the Council of Economic Advisors Jason Furman presented 6 ‘stylized facts’ about the modern US economy that must be explained:

· Market concentration is rising

· Firms’ mark-ups over cost are high

· Investment is falling

· Productivity growth has slowed

· Inequality has risen

· Reduced dynamism/churn

Any neo-Marxist, post-Keynesian or Kaleckian will instantly recognise these stylised facts as symptomatic of something called ‘monopoly capitalism’, which they have been discussing for decades both with and without models. As Jo Michell has argued, contemporary debates about ‘secular stagnation’ would benefit from a look at this literature.

A recent working paper, Tobin’s Q and Inequality, has tried to tackle a version of this question within a comprehensive mainstream framework, albeit with an additional focus on financialisation. The model distinguishes between financial capital and physical capital and produces the simultaneous phenomena of rising mark-ups, monopoly power, sluggish real wage growth, an increase in Tobin’s Q (the ratio of market value to replacement value, an indicator of over/undervaluation), and low aggregate productivity. The paper is again around 60 pages long and produces little unsaid by its neo-Marxist antecedents. As with most mainstream macroeconomic models, it is quantitatively ‘calibrated’ to fit the observed facts post-hoc rather than tested, and as with most mainstream macroeconomic models it contains an unnecessarily large number of parameters relative to the data to which it is fitted.

This kind of approach is why despite my initial enthusiasm, I was ultimately disappointed by the Rebuilding Macroeconomic Theory issue of the Oxford Review of Economic Policy — the Carlin paper in particular doesn’t say much you couldn’t find in The General Theory. The post-Keynesian economist Engelbert Stockhammer, in his own (2004) paper on the effects of financialisation on investment, perhaps put it best when he said that “basic assertions of Post-Keynesian economics [have] been slowly and painfully rediscovered by neoclassical economists over the past decades”. I would add that the monopoly of mainstream economic models can actually obscure debate, not merely slow it down, something also illustrated by the Tobin’s Q paper.

One of the main contributions of the paper is to reconcile the ‘Piketty Puzzle’, whereby the return on capital remains high despite high capital accumulation, so that both the capital-income ratio and capital’s national share of income increase. This is a major bone of contention in the mainstream post-Piketty debate: Piketty’s mechanism for increased inequality relies on an excessively high ‘elasticity of substitution’ between capital and labour, meaning that firms can easily switch to capital and displace workers, to the latters’ detriment. Mainstream critics of Piketty have pointed out that typical values of the elasticity estimates in the literature are much lower than are required by his story.

Yet as my friend Marshall Steinbaum has pointed out, the discrepancy between Piketty’s required elasticity and those estimated in the literature is only an issue if you assume a standard neoclassical model. If you instead allow the return to financial (or more broadly, unproductive) capital to differ from the return to physical capital (something the Tobin’s Q paper does within a neoclassical framework) then this is no longer a problem. Piketty himself has endorsed Suresh Naidu’s more radical interpretation of his work, which moves away from the neoclassical model, suggesting he shares a similar view.

The preponderance in mainstream economics of such ‘puzzles’, which exist only if you use an unrealistic model, is something noted by economists other than me, and it is a bad thing for intellectual progress in the field. One more example is from another recent paper on secular stagnation, which links it with job polarisation, and argues that the notion of Total Factor Productivity has led many economists to the misguided idea that there is simply nothing we can do about stagnation. If we instead allow investment to depend on demand a la Robinson and Kaldor, we come to a very different conclusion. You may dispute who is right, but as long as only one type of approach is allowed mainstream models will continue to miss insights appropriate to answering the question.

I should add that this it is not only post-Keynesians and their close cousins whose valuable insights are now being rediscovered via the slow route of being forced into mainstream macroeconomic models. Economist David Chivers recently linked me to a paper which incorporates womens’ time allocation into a mainstream development model as evidence of progress in the field. But the central insight of the paper — that infrastructure investment can uniquely help women in less developed countries, since they often shoulder the burden of transporting food/water and other resources — is stated explicitly in a quote from a World Bank conference in 2008 as the motivation for the paper! I do not want to be unfair to the authors themselves, who are obviously pushing in the right direction, but this again begs the question: why do we have to put something into a mainstream model to believe it? I’ve no doubt the oft-neglected school of feminist economists would agree with me, and would have plenty to contribute to this (and related) research questions.

Given this dynamic, it puzzles me that mainstream economists continue to resist pluralism. The typical response to arguments like mine is that pluralist ideas ‘can be incorporated into the mainstream’, but this is easily turned around: what is gained by doing so? While in some cases things will be gained, hopefully I’ve shown above that in other cases the answer is: at best nothing; at worst a slowdown or reversal in intellectual progress as people have to shoehorn the debate into the confines of neoclassical models.

*Defenders of economics accused me of cherry picking, so here are 5 more examples that do the same thing to varying degrees