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.
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).
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.