What’s wrong with macroeconomics?
Remarks prepared for NIESR Seminar – 29 November 2016
My father in law was an engineering worker. When people asked him: “what do you make in there?” he replied: we make tools and excuses, and the excuses are excellent.”
If I could, I would put that saying over the door of every economics department.
My starting point is that capitalism is a time-limited social formation with a beginning, a middle and an end. If you want a definition of what divides political economy from economics that would be it. Indeed the puzzle for the political economists – from Smith and Ricardo to Marx and Mill – was that it had survived so long.
That puzzle is solvable if we understand capitalism as a complex adaptive system. The sources of its crises are not simple mechanisms (as for example Marx looked for) but the breakdown of complex organic and spontaneous stabilisers. Another source both of crisis and stabilisation has been the open-ness of capitalism to an outside world that is not capitalist.
For me the attraction of the work of Kondratieff, Schumpeter and Carlota Perez in the modern era, though I am critical of them all, is that they ask the right set of questions: how are societal, even global-level economic paradigms established; how do they break down; and what role does class, distribution, innovation etc play?
For complex systems theorists, capitalism adapts and survives through major mutations, driven by the interplay of technology, markets and states; and by the interplay of the system itself with the pre-captialist outside world.
Now suppose my starting point is bullshit – and capitalism is, indeed a permanent and immutable social formation, which always successfully adapts to crisis.
What would you still have to do to macroeconomics?
First you would have to fix the problem Paul Romer identifies in “The Trouble With Macroeconomics”: over-abstract models, divorced from data, based on over-restricted assumptions. Deference to authority where “objective fact is displaced from its position as the ultimate determinant of scientific truth”.
Next, you would have to relentlessly chase down the sources of the massive miscalculation of risk preceding 2008. These include a failure to factor in crime and malfeasance; the inability to measure or trace risk in the shadow banking system; the failure even to model the dynamics of banking as a separate and distinct agent. And the complete failure to model or accept the need to account for irrational human behaviours.
Third you would have to understand that, as a profession, economics is much less inured to the production of ideology than it thinks. This is true in all periods – of Marxism, marginalism, Keynes, Stalin’s Five Year Plan though to the Laffer Curve and expansionary fiscal contraction.
If you had a my slogan up over your desk, or on the front of every Powerpoint presentation, you could have said: look – our models are predicting that house prices can go on expanding infinitely above household incomes because the credit system looks infinitely elastic and the central bank is pre-programmed to loosen monetary policy… but: this might be a duff tool.
In fact, we are so worried by our sudden discovery of a gravity defying credit system that we have despatched our best minds to try and test it to destruction; to factor in all kinds of concrete possibilities, like what if one of the banks is moving all its negative assets off balance sheet the day before its quarterly results, and back on again the day after
But we didn’t do that. In fact the economics profession treated heterodox economists with disdain, ridiculed them and more importantly created a career path and a sociology where heterodox thinkers are excluded.
These three things: the turn to data instead of relying solely on abstraction, a forensic re-run of the last 16 years, identifying the key influential pieces of research that said, first, that financial complexity equalled safety; then that boom-bust was impossible; then that austerity would rekindle growth…and on top of that, the active promotion of heterodox thinking, are obligatory.
But they still only get you to the edge of the high diving board.
Because you would then have to do root cause analysis: why did we come to rely on DSGE over data; why did we prefer models that mis-estimated systemic risk; why did we refuse to model finance as a specific macroeconomic variable when it was becoming the major factor in economic life; why did we diss the post-Keynesians, the Minskyites, the financialisation school, the behaviourists.
My answer would be: because you are trying to model a complex system as a simple one; a time-limited system as an eternal one.
And because that idea fits very well with the specific interest of those who benefit distributionally from the current set up, they will go on rewarding you with professorships, nobel prizes just as the Egyptian pharoas were quite nice to high priests who told them they would live forever if only they would be buried alongside their cat.
Now suppose I am right. Suppose in fact JM Keynes was right in the Economic Possibilities for our Grandchildren – that capitalism eventually gives way to abundance.
If so, macroeconomics should suddenly become instead of a theory based on the assumption of equilibrium and rationality, one based on the assumption of disequilibrium and shocks – not just external shocks but shocks generated inside the system.
And specifically it would have to begin to address teh problem that I think lies behind the financial crisis, and behind the threat of secular stagnation – which is technological abundance.
All around us the non-economic has become economic. Every company in the world transacts with Wikipedia – yet it does not appear on the profit and loss account because it is free. Nor do the people writing it get paid wages; nor does anyone manage them.
The rise of the network is destroying the barriers to collective activity and the exponential cheapening of some technologies is making some things so cheap to prodiuce that they could be, and should be free.
If exponential technological progress is happening, then the adaptation mechanisms, or organisms, capitalism has relied on in the past to survive crisis are not so reliable. The promise that everyone will have a secure and decent job is just a lie, unless you are prepared to retard progress, end globalisation and create behind a national wall, a re-enactlent society of the 1950s. Clearly, the president elect of the USA thinks that’s a plan, not a joke.
We have to learn how to measure the market and the state against the rising non-market. The positive externalities and network effects have become the basis of enture business models, but they were called externalities for a reason – they did not fit into a simple model of the economy where market transactions capture all value. Ask your tech peple – how much of what we think is our proprietory IP, our own tech – is actually tools made, improvd and shared for free and uncapturable as property. The answer will be a lot.
So as well as mending macro-economics, so that it better describes the mutable and crisis-ridden capitalist economy and its own failures, I would also challenge you to construct an economics that can measure the value of my iphone in the same units as it measures the value of the time I spend reading Wikipedia on it, or writing it.
Mises in the socialist calculation debate conceded that the only possible measuring stick between a non-market economy and a market economy is labour. If the labour theory of value were correct, said Mises, it would be problem solved.
The really interesting thing – for which I would deploy everything from DGSE models to huge synthetic populations and agend based modelling – is to understand what might happen if the market were becoming spontaneously replaced, in certain parts and segments, by relative technological abundance.
One thing that would happen is that the future would start sending signals to the present via the market: it would say – when you repeatedly stack up debts inside a finance system that looks so complex that you can mitigate extreme risks, there is a danger that the future value those debts should be repayed with is not there.
Because scarcity might not be there, and because human labour might not be very necessary, and the adaptation process everybody assimes – the replacement of low skilled jobs by high skilled jobs, higher wages, higher consumption, might actually not happen.
On the 80:20 principle I would say the profession can and should spend four days out of five working on fixing macroeconomics of capitalism so that they assume breakdown, irrationality, crime, inadequate and asymmetric information. But one day a week exploring the dynamics of a transition to luxury communism.