Archive for December, 2012

Debunking Economics, Part XVIII: Response to Criticisms (2/2)

This is the second part of my response to criticisms of Keen’s Debunking Economics. In my previous post* I covered some of the fundamental objections Keen had to neoclassical theory. Here, I will cover Keen’s exploration of alternatives: first, a brief note on dynamics and chaos theory; then a discussion of Keen’s own models; finally, his dismissal of the Marxist Labour Theory of Value (LTV).

Dynamics and Equilibrium

Many economists have argued that Keen’s contention that economists do not study dynamics is false. I agree. Keen does not really address the DSGE conception of equilibrium, which is highly different to the typical conception of a steady state. An equilibrium in an economic model occurs when all agents have specific preferences, endowments etc. and take the course of action which suits them best based on this. This can be subject to incomplete information, risk aversion or various other ‘frictions.’ These agents intermittently interact in market exchanges, during which all markets clear. Basically, ‘solving for equilibrium’ means you specify the actions and characteristics of economic agents, then see what happens when markets clear. It’s entirely possible that the subsequent model could exhibit chaotic behaviour.**

Now, there are obviously many problems here. The fact is that the overwhelming majority of people who learn economics will not touch this. They will instead be faced with static-style equilibrium models, which they have been told are unrealistic but ‘elucidate certain principals.’ This is nonsense – they elucidate nothing, and simply need to be thrown out. Nevertheless, many policymakers, regulators and business economists are working under this framework. Furthermore, even those economists who have gone beyond this level seem to have the concepts deeply ingrained into their minds, and regard them as useful.

However, even the more advanced ‘dynamic’ equilibrium clearly has problems. First, the presence of irreducible uncertainty – which, as far as I can see, is a concept entirely misused by economists – means that it is virtually certain not all expectations will be fulfilled, while equilibrium assumes they will be. Second, ‘fulfilled expectations’ is far stronger than economists seem to think – for example, it eliminates the possibility of default! Third, the assumption that all markets clear is obviously false, otherwise supermarkets wouldn’t throw out old food. Anyway, I digress: Keen could easily address all of these criticisms, but for some reason he doesn’t. This is indeed a shortcoming of his book.

Keen’s Models

First, a brief note on Keen’s model of firm behaviour: it seems to make the error of maximising the growth rate of profits, rather than profits themselves. I am not sure if this has been fixed. Nevertheless, I regard it as subsidiary to Keen’s main criticisms. His most important model is the Minsky Model of banking and the macroeconomy.

Keen recently had a debate over his Minsky Model with the Cambridge economist Pontus Rendahl. Andrew Lainton has a  post on this, along with a contentious discussion with Rendahl, over on his blog. In my opinion, Rendahl – though overly dismissive in tone, and not causing as many problems for Keen as he seemed to think – highlighted a number of issues with Keen’s model in its current form:

(1) Say’s Law holds. In Keen’s model, income is simply a function of the capital stock, and there is no role for demand.

(2) In what was generally a model set in continuous time, which used ODEs, there is an equation which uses discrete time intervals. Such equations cannot be solved in the same way, so Keen’s methodology is inconsistent.

(3) There is, as of yet, no role for expectations in Keen’s model.

(4) Rendahl argues that DSGE models are also Stock Flow Consistent (SFC). I think he is correct – see, for example, his own paper, which has agents accumulating stocks of money from previous periods. The major differences between SFC and DSGE appear to be: a lack of micro foundations; continuous functions; use of classes; market clearing; fulfilled expectations; and, of course, with Keen’s, the role of banks and private debt.

In terms of assumptions, I’d say Keen’s model is in the ‘heuristic’ stage – it’s not  completely right and needs development. The criticisms are essentially things that have not yet been added to the model, rather than conceptual or logical problems (save the inconsistent equation). This means they can be added as it develops. However, if the model makes good predictions, it may prove to be useful, even though that should never serve as a barrier to making it more realistic and comprehensive.

Labour Theory of Value

If neoclassical economists want a lesson in how to respond to a critique you strongly disagree with without being vitriolic and dismissive, then they need look no further than the marxist responses to Keen’s critique of the LTV. This is all the more ironic given said economist’s willingness to dismiss marxists as illogical and dogmatic.

Keen’s critique is threefold, so I will discuss it briefly, followed by the marxist responses.

The first critique  is Bose’s commodity residue. The idea is that no matter how far you go back in time, disaggregating a commodity into what was required to produce it, there will always be a commodity residue left over. Hence, no commodity can be reduced to merely labour-power. The problem here is the projection of capitalism into all of history. For Marx, a commodity only resulted from capitalist production. However, if you go back in time you will find non-capitalist production, and eventually you will be able to reduce everything into land/natural resources and labour, which Marx never defined as commodities. Having said this, one question remains: can the natural resources or land not be a source of surplus value? Could this surplus value not have been transferred into capitalist commodities?

Second is Ian Steedman’s Sraffian interpretation of Marx. Simply put, it seems Steedman had his interpretation wrong – Marx’s is not a physical, equilibrium system based on determining factor prices. This is something that actually struck me on the first read of Keen’s LTV chapter: Steedman simply converts Marx into Sraffian form without much justification. If Marx did not intend this to be the case, the criticism is defunct from the outset.Hence, it follows that Steedman’s model is simply a misinterpretation of Marx, and it is not even necessary to go into the maths. There is, of course, a possibility that this is an overly superficial interpretation and I am mistaken.

The third criticism is that Marx’s treatment of use-value and exchange-value is inconsistent: properly applied, it implies that a commodity’s use-value can exceed its exchange value, and hence be a source of surplus value. Now, I remain unsure of this area so I might be wrong in my exposition, but here is my attempt to explain the Marxist response: (warning: the following paragraph will contain a vast overuse of the word ‘value’ in what is already a necessarily convoluted explanation).

Marxists contend that Keen’s is a misinterpretation of use-value, which is simply a binary concept and not quantifiable. Something may have any number of uses which give it a use-value, which is a necessary condition for it to have an exchange-value. However, the exchange-value cannot ‘exceed’ the use-value, because the use-value cannot be measured. It is in this sense that labour is unique in Marx’s conception of capitalism: its specific use-value is the production of surplus for capitalists. It is the only ‘factor of production’ that can do this – after all, capital ultimately reduces to past labour value. If production could take place without labour, prices would fall to zero and, while Marx would be refuted, nobody would care because the problem of economic scarcity would vanish. Hence, surplus production and profits depend on labour producing more than it is rewarded.

I remain neither convinced of the LTV, nor of its critics.*** For me, most discussion of the LTV appears to rest on the LTV as a premise. The debate is split into people who accept the LTV and people who not only reject it, but see no need for it. For this reason, critics seem to misrepresent and misinterpret it continually – a common theme is to try and abstract from historical circumstance, when it’s  clear Marx emphasised that his analysis only applied under capitalism, which he saw as a particular social relation. For me, the main issue remains the same as it is for other theories: what is the falsification criteria for the LTV?

Overall, a couple of points stand out for post-Keynesians for their own theories, both of value and economic systems. The first is that DSGE models are probably not that different to some heterodox models, and identifying the actual differences is crucial to opening up a dialogue between mainstream and heterodox economists.

The second is that I would caution left-leaning economists not to be too hasty to dismiss Marxism as dogmatic (in my experience marxists are anything but), or avoid it simply out of fear of being dismissed themselves. In my opinion, the LTV – while not entirely convincing – is a cut above the neoclassical ‘utility’ conception of value, and I’d sooner be equipped with Marxist explanations of a crisis when trying to understand capitalism. This isn’t to say post-Keynesians haven’t thought about Marx; moreso that the issue is often approached with a degree of bias. At the very least, the distinction between use-value and exchange-value is something that befits post-Keynesian analysis well.

So, as far as theory goes, this is the last post on Keen’s book. I will, however, do some closing notes from a more general perspective. As I said before, if there are any other criticisms of Keen that I have not covered, feel free to discuss them in the comments.

*It is worth noting that in my previous post I was somewhat – thought not totally – off the mark with my discussion of Keen on demand curves. The Gorman conditions for the existence of a representative agent do indeed have many similarities to the SMD theorem and conceptually they are dealing with the same issue: aggregation of preferences. Nevertheless, Keen weaves between the two, when it would have been more accurate to note economists have used two (main) different methods to get around the problem, and critiqued them separately. Similarly, though Keen’s quote from MWG was incorrect, it is true that economists such as Samuelson have used the assumption of a dictator to aggregate preferences. However, the specific one Keen presented was not right.

**However, that does not make it the same as chaos theory.

***For me, claims that worker ownership of production would be desirable don’t really rest on the LTV; instead, the simple point is that workers could employ capital themselves.

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Are Libertarians Just Lazy Marxists?

One of the features libertarianism (propertarianism) shares with neoclassical economics is that it tends to take the existing economic system as a given, and proceeds to analyse from there. The result is that much of what follows could be labelled as question begging: incidence of market failure do not merely beg the question ‘how can we fix this?’ but also ‘why are there so many of these?’ Questions over ‘human nature’ become questions of ‘how humans behave under capitalism.’ Neoclassicism’s failure to address any questions about capitalism as a whole is a major flaw, and libertarianism – sharing, as it does, many intellectual similarities with neoclassicism – carries over this flaw. The result is that libertarian analysis, even when cogent, fails to ask truly difficult questions.

Public Choice Theory

A major area where this is obvious is public choice theory. Libertarians will cry “don’t use government healthcare! It will simply benefit special interests!” Meanwhile, Marxists will scratch their heads and instead argue that the problem is not public healthcare in and of itself, but the fact that under capitalism, asymmetries of wealth create (and reinforce) asymmetries of power, and those with the most money are able to corrupt public programs for their own gain.

Ultimately the question is: who is the source of corruption, the corrupter or corrupted? While no one can deny that hatred for feckless politicians is surely deserved, blaming them strikes me as not really addressing the problem. Why do we see continual corruption, across countries and across time? The ultimate source of the vested interest is, of course, the vested interest! Remove the interest and the problem disappears. Remove the politician and another will take their place (most likely selected by, funded by, or in cahoots with the interest). Remove the state and the already wealthy/powerful interest can simply take care of the problem itself.

I have also commented that libertarian analysis in this area stops short of the revelation that the same arguments can be applied to all aspects of the legal system, including the corruption of ‘force, fraud and theft.’ Once you put capitalism into your frame of reference, the problem becomes why exactly these violations of liberty, rights or what have you would emerge on such a large scale under a particular economic system (it begins with p).

Value

Libertarians – as well as other schools of thought – believe value is inherently subjective, perceived only in the eye of the beholder, and so forth. This is, in fact, what Marx thought of use-value:

A commodity is, in the first place, an object outside us, a thing that by its properties satisfies human wants of some sort or another. The nature of such wants, whether, for instance, they spring from the stomach or from fancy, makes no difference.

Of course subjective valuation is at the heart of consumption and other decisions. The difference is that Marx extended his analysis: he linked use-value to exchange-value and differentiated the two; he explored the relationship between use-value and the commodity; he defined the “social form” of wealth as separate to its use-value. Libertarians, on the other hand, being lazy, simply stopped at use-value, equated it to exchange-value, and built their entire theory around this single interpretation.

Capitalism/Human Nature

This is a big topic so I’m not going to claim to have explained both human nature and the history of capitalism in subsection of a post. What I will claim is that libertarians are almost certainly wrong.

The problem here is that they reason backwards from our current institutions and define all of history as either a diversion from, or tendency to, our current state. Humans were always greedy and selfish; it wasn’t until the various ‘unnatural’ barriers to trade were removed that this tendency was allowed to flourish. ‘Markets’ can be found throughout history, continually pushing at the barriers created around them; again, once they were unleashed, humanity developed. Here is Marx saying the same:

Economists have a singular method of procedure. There are only two kinds of institutions for them, artificial and natural. The institutions of feudalism are artificial institutions, those of the bourgeoisie are natural institutions. In this they resemble the theologians, who likewise establish two kinds of religion. Every religion which is not theirs is an invention of men, while their own is an emanation from God. When the economists say that present-day relations – the relations of bourgeois production – are natural, they imply that these are the relations in which wealth is created and productive forces developed in conformity with the laws of nature. These relations therefore are themselves natural laws independent of the influence of time. They are eternal laws which must always govern society. Thus, there has been history, but there is no longer any. There has been history, since there were the institutions of feudalism, and in these institutions of feudalism we find quite different relations of production from those of bourgeois society, which the economists try to pass off as natural, and as such, eternal.

Anyone who has taken history will know that they try to pound this tendency (ethnocentrism) out of you in your first classes. The fact is that western capitalism, like all of history, is a result of specific historical circumstances. Why was Britain one of the first to develop? It was surely in large part due to the resources, military and political power it gained from its empire; a similar argument can be made for the U.S. and its ‘treatment’ of the Native American people. As well as empire and slavery, there are other specific historical coincidences that might explain the rise of Europe. For example, there’s an argument to be made that the only reason the large supplies of silver extracted from Latin America did not obliterate Spain and Portugal in a sea of inflation was because China soaked up the demand with its introduction of the silver tax in 1581. Such arguments are, of course, up for debate. What is not up for debate is that historical context is irrelevant in discussing the rise of capitalism.

Similarly, while I do not subscribe to a strong version of historical materialism (personally I think it seems to lead to an infinite regression), there is obviously a lot of truth in the fact that people’s conditions determine how they behave. An English peasant would have had different beliefs and mannerisms to a member of the feudal class. More strikingly, certain sections of the Inuit refuse to say ‘thank you’ because it implies that you have done someone a favour, rather than simply your duty as a human being. Some civilisations used similar terms for ‘ripping someone off’ and ‘profit.’ Would we have the same attitude toward profit if we used the same word for it as ‘ripping off?’ Surely not.*

Expanding the scope of libertarianism to include property and capitalist relations – as well as their history – would start to raise some interesting questions, such as ‘why do we stop a poor person from eating by force?’ (try to take something from a shop without money and you’ll see what I mean). In fact, I expect a really critical look at capitalism from the perspective of individual freedom would simply collapse propertarian libertarianism into either Marxism, or, even more likely, anarchism (the latter being the true origin of the word ‘libertarian‘).

*These claims come from David Graeber’s Debt: The First 5000 Years.

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More Thoughts on Austrian Theory

A while back I wrote a short post on why I reject Austrian theories of the business cycle (ABCT). Austrians were not impressed. I still retain similar objections, though over time I have realised there are more reasonable adherents of the Austrian school (though being reasonable basically forces them to conclude demand-side recessions are a possibility). This post will hopefully be more comprehensive than my previous one, but again is only based on a few major observations/objections, and will echo some of my previous comments.

I have said a few times that I see Austrian economics as part of the marginalist tradition (as did Mises). Since I am critical of this tradition, a part of my objection is the application of the same criticisms to Austrians: the idea that ‘factors of production’ are rewarded according to their productivities is subject to all sorts of critiques; similarly, the Austrian treatment of capital is sometimes vulnerable to the problems  highlighted in the Capital Controversies. However, since I have already posted on this, and will likely do so again in the future, I will avoid this issue and instead criticise the Austrian school directly.

This post will be two pronged: first, I will explore the Austrian methodology in general; specifically, praxeology. Second, I will ask whether the theoretical implications of Austrian economics -regardless of praxeology – can be sustained.

Praxeology

Praxeology is the notion that economic theory can be built up a priori from the action axiom, or, as Mises stated it:

Human action is purposeful behaviour  Or we may say: Action is will put into operation and transformed into an agency, is aiming at ends and goals, is the ego’s meaningful response to stimuli and to the conditions of its environment, is a person’s conscious adjustment to the state of the universe that determines his life. Such paraphrases may clarify the definition given and prevent possible misinterpretations. But the definition itself is adequate and does not need complement of commentary.

It is worth stating that Hayek, and other Austrians, probably rejected this, at least as a rigid rule. So the critique applies mostly to Miseans. I have two points to make about it:

First, I think the axiom itself is flawed. While it is fair to say human action can be a purposeful response to stimuli in order to obtain certain ends, that is not the same as saying that this is always the case. Action can be purposeful; it can also be knee-jerk, confused, accidental, arbitrary or even meaningless. Sometimes the action itself is the end. This poses a problem for the ‘try to disprove the action axiom‘ test, which asserts that by trying to disprove the axiom you validate it through your purposeful behaviour (yes, it is an intellectual ‘I know you are but what am I?’). But all this does it show that action can be purposeful. By trying to disprove it, I am acting purposefully, but this doesn’t mean all of my actions are purposeful.

Second, even if we accept the action axiom, we run into problems. It’s simply not at all clear how to get from a tautological statement to elaborate theories of the central bank. Blogger ‘Lord Keynes’  has discussed this – it’s clear that Mises had to introduce other assumptions and propositions to build his theory. Mises even admitted this directly with the disutility of labour:

The disutility of labor is not of a categorical and aprioristic character. We can without contradiction think of a world in which labor does not cause uneasiness, and we can depict the state of affairs prevailing in such a world.

Ultimately, I see no need to invoke praxeology when talking about theory. We can discuss the logic of whether low interest rates cause bubbles, or look at the evidence. We can examine other propositions of Austrian theory. But why do we need the human action axiom? The substantive theory is  where we must turn to determine whether or not Austrians are correct.

The Natural Rate of Interest

Hayek’s original theory of the business cycle, first fully expounded in Prices and Production, rested on an equilibrium between saving and borrowing different goods.* The market would set the equilibrium rate at which different goods were borrowed, meaning the savings were matched to investment and there was no excess credit expansion. However, Piero Sraffa – in what is widely regarded as a devastating review of the book – observed that in a monetary economy, the money rate of interest would be an aggregate of all the ‘natural rates’ between different goods. Hence  there was no reason to believe it would correspond to an equilibrium between every, or perhaps even any, particular good.

This issue comes up again and again, and while the overwhelming majority of Austrians appear to have conceded Sraffa’s criticism that the is no natural rate of interest. However, many seem to think it doesn’t matter – and this is not unique to Austrians. For me, the natural rate of interest matters: if there is no ‘natural’ or ‘correct’ rate of interest, how do we measure a deviation from the ideal?

It is true that fluctuations in the base rate do affect house prices – being directly linked to mortgages as they are – but nevertheless, Austrian theory doesn’t seem to deal well with housing bubbles. This is because they generally involve people continually buying and selling the same houses to each other and hence have small amounts of capital misallocation; in fact, there is a shortage of housing in many developed countries, while existing houses remain highly priced. This doesn’t make sense under an Austrian framework, which would require overinvestment in houses and hence liquidation of existing surplus stocks.

For me, interest rates are nothing special. They represent a cost for businesses, to be factored into their decision-making along with other costs. As Joseph Stiglitz says, is it a problem when business’ supply costs are too low? Does it lead them to expand too much? It seems to me that when banks are lending money for the wrong things, it’s a regulatory rather than monetary problem (insofar as it is a monetary problem, I would say it’s caused by high interest rates, but that’s for another time).

Furthermore, this ‘naturalistic’ problem with Austrianism isn’t limited to the rate of interest. There always seems to be some supposedly neutral laissez-faire, baseline state, which is never defined. Surely limited liability laws affect the decisions of businesses? What about the practical problems with property rights and contract law: the limited resources of the legal system (and hence dismissal of small cases); implicit contracts; rental laws, car crash liabilities, insurance claims and much more? All of these will contain somewhat arbitrary decisions, and all will impact the workings of a capitalist economy, possibly leading to capital misallocation. Overall, it is difficult to find a solid foundation for the supposedly ‘natural’ baseline on which Austrian theory seems to be built.

Overall, I remain unconvinced. I expect Ludwig Lachmann and similar economists are well worth reading, particularly for their stances on expectations and entrepreneurial strategies. But nothing I’ve seen from ‘mainstream’ Austrians has yet convinced me that it is worth delving into either 1000 page tomes by Mises or Rothbard, or practically unreadable (economic) works by Hayek, in order to try to further my understanding of their theories. There are just too many issues – conceptual, logical or evidential – with what I know so far.

But then, the internet is surely the place for Austrians to prove me wrong.

*It is worth noting that Austrians appear to rely on an exogenous money model with their talk of equilibrating savings and investment, and their idea that credit expansion results from central bank expansion. As I have documented, this is not how banking works. However, some Austrians have incorporated this insight, while others are against FRB altogether, so it’s not a problem for all of them.

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Whichever Way You Paint It, The Supply Curve Is Flat

The conventional ‘upward sloping’ supply curve is known by everyone from an econ101 student to a professional economist. The curve posits a positive relationship between price and quantity supplied – in order to increase the quantity supplied, a higher price must be offered. What is less commonly known, however, is that an upward sloping supply curve is actually incredibly hard to justify, both in theory and in practice.

Behind the curve lies the proposition that production costs per unit increase as output increases. This makes the ‘upward slope’ a necessity: since an item costs more to produce, a higher price must be charged as production increases. Microeconomic theory posits that this relationship holds in both the short and long run. However, all signs say this can’t be true.

The Short Run

The neoclassical idea is that firms can only increase one factor in the short run, which gives birth to the increasing marginal cost argument – returns to production diminish as more and more is ‘squeezed’ out of the fixed input. Is this how production behaves?

I have previously commented on Piero Sraffa’s excellent critique of the idea of increasing marginal costs in the short run. Sraffa’s argument was two pronged, depending on how we define a ‘firm’ or ‘industry.’

Sraffa argued If we define an industry narrowly, such as a single firm, it turns out firms generally have a lot of spare capacity and can quickly employ previously idle resources to expand all inputs at once. This belies the traditional justification for decreasing returns – if we expand inputs simultaneously, we should expect roughly constant increases in output as a result.

Sraffa went on to argue that we could define an industry broadly enough that it’s reasonable to say a factor is fixed in the short run. This would be because, for a large industry, a new factor would have to be converted from other uses before it could be employed. Hence, diminishing returns may be possible. However, at this point it is no longer possible to neglect the collateral effects caused by changes in firm’s expenditure and output: the partial equilibrium method becomes contradictory, and the various curves – demand, supply, average cost – cannot move independently, which is a key assumption of the theory. So the theory as a whole is no longer appropriate.

So the idea doesn’t hold up in the short run, except in the extremely small number of cases that lie between the ‘narrow’ and ‘broad’ definitions. But what about the long run?

The Long Run

If you learn producer theory from the bottom up, one of the assumptions you start with is that inputs and outputs are infinitely divisible; in other words, they are like clay. They are also homogeneous, and available at a set price. Based on these assumptions, it is reasonable to assume that in a short run – when one factor is fixed – there may be increasing marginal costs. At this point I would defer to Sraffa’s above critique.

However, when we move to the long run, it’s incredibly hard to justify increasing MC even within the confines of the theory. Textbooks will generally assume the standard production function, which looks like this:

The downward sloping portion – for which costs fall as output rises – will generally be justified by ‘Economies of Scale (EoS).’ But what causes EoS? Bulk buying is one example, but this can’t apply because prices are taken as a given. Another is indivisibilities – if you buy a big machine it takes a while before you fully utilise it – but this quite clearly contradicts the assumption of perfectly divisible inputs. Yet another, the increasing returns to the division of labour, contradicts the assumption of homogeneous inputs.

Similarly, the upward sloping portion is then justified by ‘Diseconomies of Scale (DoS).’ Examples of this are generally few and far between – DoS is, after all, the strange proposition that firms simply become incompetent at some level – but again they tend to contradict our assumptions. One example is managerial difficulties – who is the manager if labour is homogeneous?

In fact, it turns out that few, if any, of the explanations for either EoS or DoS hold up under the available assumptions. If you increase a homogeneous  perfectly divisible mass of inputs a certain amount, there is no reason to expect anything other than a constant, proportional increase in put: in other words, constant returns to scale.

The Evidence

Unsurprisingly, it is true that the overwhelming majority of firms report constant or falling returns to scale. Walking down a high street in a capitalist country, it’s hard to deny that firms have the available goods to accommodate an increase in demand without a rise in cost; factories are designed in a similar fashion. Furthermore, in the long run a firm is likely to respond to an increase in demand by opening up more branches, rather than simply increasing prices.

So what’s the problem? The proposition that demand determines outputs and supply determines price is logically, intuitively and empirically reasonable in any time period and for most industries. Why can’t economists just tilt their supply curve 45 degrees to the right?

Well, at this point a few things become apparent. The theory of the firm becomes indeterminant: one of economist’s beloved negative feedback loops that allows the economy to self-equilibrate is gone, as firm size is not limited by production costs. Hence, the marginal theory of the firm goes from explaining everything – from firm size to income distribution – to explaining very little. This also makes explicit the idea that output in the economy is driven by demand, both in the short and long run, which contradicts conventional macro theory, where demand only matters because prices are sticky.

Overall, a flat supply curve turns the conventional story told in neoclassical economics, where the economy is self-equilibrating, bar a few frictions, to one where many key variables – wages, output, firm size – go from being at the equilibrium or ‘natural’ level, into one where they are largely arbitrary. It’s easy to see why economists would resist this.

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Libertarianism and Tax Avoidance

Tax avoidance intermittently comes into the spotlight in contemporary political debate. The left decry businesses dodging tax as immoral, whereas the right generally disagree. A common view among libertarians is that we must emphasise the difference between tax avoidance and tax evasion. The former is legally minimising the amount of tax you owe, whereas the latter is actually breaking the law to pay less tax. As usual, this means libertarians think they can draw a definitive line as to where policy should be and embrace a purely logical belief system, while their opponents are just moralising. And, as usual, this isn’t the case – turns out libertarians just have a different value system embedded beneath their argument.

The line between tax avoidance and tax evasion is whether or not the methods used are legal. Hence, the only way you can believe tax avoidance is OK while tax evasion isn’t is if you believe law is the appropriate moral benchmark by which to judge whether actions are ‘right’ or ‘just.’ But this is a completely anti-libertarian position: why should the guy with the bigger gun be able to tell someone else what to do? Or the tyrannical majority? Surely laws should be judged based on what they achieve or symbolise, rather than just being accepted because they are laws?

As it happens, I agree with this position; laws can be unjust (apartheid, slavery) and given the opportunity to disobey an unjust law, people should, whether individually or en masse. So if people/institutions are not morally obliged to obey the law just because it’s the law, surely the question of paying tax becomes a judgment call? This puts libertarians right where they don’t want to be: in the hazy world of morality. And the only position I can see them endorsing is that one should pay as little tax as possible.

So, whereas most people’s value systems tell them that if a corporation pays £8.6m over 14 years to a country where it made £3bn in sales over the same period, that’s unfair. Libertarians make out – perhaps because they really believe – that these people are just being emotional and illogical  But really the difference is not one of nature, but merely of degree.

P.S. readers may notice a big similarity between this post and my post on Milton Friedman and corporations. In fact, similar problems can be found throughout libertarianism – it seems they do believe strongly in the rule of law with laws they approve of. In this way, many libertarians actually have a strong authoritarian bent.

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Debunking Economics, Part XVII: Response to Criticisms (1/2)

Naturally, mainstream economists have been critical of Steve Keen’s Debunking Economics. I will do a brief series within a series to try and respond to some of these criticisms. In this part, I will respond to some of the main critiques of neoclassical theory that have generated controversy: demand curves, supply curves and the Cambridge Capital Controversies. In the next post, I will respond to criticisms of Keen’s own models and his take on the LTV, as well as anything else that has attracted criticism.

Note that this post will assume prior knowledge of Keen’s arguments, so if you haven’t yet read my summaries above (or better still, Keen’s book), then do it now.

Demand Curves

It seems there are some problems in this chapter. Keen mixes up some concepts and misquotes Mas-Collel. Having said that, he is broadly right. This is frustrating for someone on his ‘side,’ because it means mainstream economists can dismiss him when they shouldn’t.

Keen presents a quote from Mas-Colell where he assumes a benevolent dictator redistributes income prior to trade, and asserts that this assumption serves to ensure market demand curves have the same properties as individual ones. In fact, Mas-Colell is using this assumption to ensure that a welfare function, not a price relationship, will be satisfied. It remains true that a PHD textbook still assumes a benevolent dictator redistributes resources prior to trade, and subsequent economists have also used this assumption, which is not a great indicator of the state of economics. However, it was not an assumption used to overcome the Sonnenschein-Mantel-Debreu conditions.

More importantly (wonkish paragraph), it seems Keen lost some nuance in the translation of his critique to layman’s terms. He spends a lot of time talking about the Gorman polar form. This is about the existence of a representative consumer for a set of indirect utility functions (‘indirect’ because it calculates utility without using the quantities of goods consumed), but Keen makes out it is about the aggregation of preferences required for demand curves. Gorman is in many ways similar to, but not relevant to, the discussion of the aggregation of demand curves. Keen also argues that consumers having identical preferences is the same as them being one consumer, but this needn’t be the case: just because you and I have the same preferences, doesn’t make us the same person

Despite this, the competing wealth and substitution effects do create the conditions described by Keen. However, they only apply under general equilibrium – under which wealth effects are present – and not partial equilibrium – under which they are assumed away. Keen does not distinguish between the two.

In summary, Keen is correct that neoclassical economists could not rigorously ‘prove’ the existence of downward sloping demand curves. Keen himself says that it is reasonable to assume that demand will go down as price does, and classical economists were also content with this an observed empirical reality. Neoclassical economists themselves ended up having to defer to empirical reality when faced with the SMD conundrum and thus they had gained no insight beyond the classical economists, except to prove that their preferred technique – reductionism – does not work. For this reason, I interpret the SMD conditions primarily as a demonstration of the limits of reductionism (though some fellow heterodox economists might disagree).

Supply Curves

The proposition here is pretty simple: a participant in perfect competition will have a tiny effect on price. This is small enough to ignore at the level of the individual firm, which is neoclassical economist’s main defence. However they ignore that, as Keen says, the difference is both “subtle and the size of an elephant.” Once you aggregate up a group of infinitesimally small firms making incredibly small deviations from maximising profits, you get a result that is far away from the one given by the neoclassical formula. Result? We must know the nature of the MC, MR and demand curves to know both price and quantity, just as with a monopoly. The neoclassical theory – at this level – has no reason to prefer perfect competition to a monopoly, and a supply curve cannot be derived. From what I’ve seen, the critics ignore the effect of adding up tiny mistakes, instead focusing on how tiny they are on an individual level.

Economists have some other defences, but I interpret them as own goals. For example, there is the argument that, under perfect competition, firms are price takers by assumption. They cannot have any effect on price, by assumption. But this basically amounts to assuming the price is set by an exogenous central authority, which is odd for a model of perfect competition.

Another argument is that setting MC=MR itself is an assumption. This is a strange path to take for a theory that prides itself on internal consistency and profit maximisation. It acknowledges that MC=MR will not quite maximise profits, so amounts to the assumption that firms are not profit maximisers. There is also the similar argument that firms don’t take Keen’s problems into consideration in real life, so they don’t matter. This is a huge own goal, given most textbooks argue that it doesn’t matter what firms do in real life. I’m quite happy to acknowledge it does matter how they actually price – but that would involve abandoning the marginalist theory of the firm and using cost-plus pricing.

So, now that we have all finished discussing how many angels can dance on a pinhead (turns out it was slightly fewer than economists thought), let’s just start using more realistic theories of the firm and forget the mess that is marginalism.

Cambridge Capital Controversies

There are swathes of literature on this and I cannot hope to explore them all. The main thing I have noticed, and want to discuss, is that economists only seem to focus on capital reswitching when discussing this, and defer to empirical evidence to suggest it is negligible. I have a few problems with this:

(1) Empirical evidence is competing and some evidence suggests reswitching is more common than economists would like to think. Furthermore, it is incredibly hard to observe and therefore cannot be dismissed so easily.

(2) Most importantly, the Capital Controversies were not just, or primarily, about reswitching. Sraffa showed a number of things: demand and supply are not an adequate explanation for static resource allocation; the distribution between wages, profits and other returns must be known before prices can be calculated; factors of production cannot be said to be rewarded according to ‘marginal product’. For me these are more important, and are applicable to many models used today, such as Cobb-Douglas and other production functions, and the Solow Growth model.

With all 3 of the examples I have discussed, economists have tried to defer to empirical evidence to dismiss the problems with their causal mechanics. But generally economists do not regard empirical evidence about causal mechanics as important (the primary example being the theory of the firm), instead insisting on rigorous logical consistency. Surely, in order to be completely logically consistent, economists should at least be willing to experiment with the potential effects of SMD and reswitching in general equilibrium models and see what happens? Robert Vienneau has various discussions of this.

The common thread between these is that economists seem incredibly adept at assuming their conclusions. Of course, you can get around any critique with an appropriate assumption, but as I’ve discussed, theories are only as good as their assumptions and assumptions should not be used simply to protect core beliefs and come to palatable conclusions. Having said that, Keen’s book isn’t perfect (which is to be expected if you try and take every aspect of economics on in one book), and there are worthwhile criticisms out there. Nevertheless, Keen’s critique as a whole remains in tact, and leaves very little of what is taught on economics courses left in its wake.

P.S. Feel free to use the comments space to discuss any critiques of areas I have not covered/said I will cover.

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