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Does the mainstream face historic challenges?

Recently, newly confirmed US Treasury Secretary and former Federal Reserve Chair Janet Yellen laid out, in a letter to her staff, the challenges that American capitalism now faces. She said: “The current crisis is very different from that of 2008. Its scale is just as big, if not even bigger. The pandemic has wreaked utter havoc on the economy. Entire industries stopped their operations. Sixteen million Americans still rely on unemployment insurance. Food bank shelves are getting empty.”

All this has already happened, but what does the future have in store for you? On the future, Yellen says the United States now faces “four historic crises: COVID-19 is just one of them. In addition to the pandemic, the country is also facing a climate crisis, a crisis of systemic racism and an economic crisis that has been going on for fifty years.”

She did not explain what this crisis, which has lasted fifty years, consists of. But despite that, she said she was confident that mainstream economic theory can find the solutions. “Economic theory is not just something you find in books. Nor is it simply a collection of templates. In fact, I moved from academia to government because I believe that economic policy can be a powerful tool for improving society. We can – and must – use it to tackle inequality, racism and climate change. I still try to see my science – the science of economics – the way my father saw his: as a means of helping people.”

They are beautiful words! But was the dominant economy really designed to “help people”, to improve their living conditions, as well as to guarantee their livelihoods? Digging deeper, is orthodoxy really offering a scientific analysis of modern economies, an analysis that can generate policies capable of solving those “four historic challenges”, as Yellen claims?

Now, the failure of mainstream economics to predict, explain or deal with the global financial crisis, as well as the subsequent Great Recession of 2008-9, is well documented. As I already showed on the blog The next recession, the evidence hardly supports Yellen's claims. The state of alienation of economists in the mainstream it is deep and has no cure.

The economic theory of the system itself cannot deliver what it promises. It, in its two branches of microeconomics and macroeconomics, is founded on assumptions that are not in line with reality. “Mainstream” indeed cannot be taken as a scientific analysis of modern (capitalist) economies.

First, it is founded on utility theory and marginalism; adopts a way of reasoning about the economic system that it calls “general equilibrium analysis”. Now, one wonders, where does “wealth” in this society come from, how could it be measured? The classical economists, Adam Smith, David Ricardo, etc. recognized that there was only one reliable and universal measure of value: the amount of labor (hours) expended to produce goods and services. But this labor theory of value was replaced in the mid-nineteenth century by the theory of utility or, more precisely, by the theory of marginal utility.

Utility then became the most accepted explanation for value. However, Engels was able to observe his misery: “The theory of fashion is now that of Stanley Jevons. It says that value is determined, on the one hand, by utility and, on the other hand, by the limit of supply (that is, by the cost of production). Now that's just a confusing and tortuous way of saying that value is determined by supply and demand. It is simply vulgar economics – not science”.

However, the original marginal utility theory quickly became untenable even for economists of the mainstream because the subjective value (according to which each individual values ​​the same good differently according to his inclination or according to the circumstances) cannot be observed, measured or even aggregated. The psychological basis of marginal utility was soon abandoned. This notion was then maintained as a mere explanatory convention. To learn more about the fallacious assumptions of mainstream value theory, see Steve Keen's excellent book, Debunking Economics (Debunking Economic Theory) or even Ben Fin's more recent critique of microeconomics and macroeconomics.

Engels called economics mainstream of “vulgar” because it cannot be considered as a scientific and objective analysis of the capitalist mode of production. It was never, for him, more than an ideological justification for capitalism. Here's how Fred Moseley characterized it: “The marginal productivity theory provides crucial ideological support for capitalism in that it justifies capitalists' profit by arguing that profit is produced by the capital goods owned by capitalists. Thus, everything is fair in capitalism, as there is no exploitation of workers. In general, everyone receives an income equal to their contribution to production”.

In contrast, he further says: “the main alternative theory of the origin of profit is Marx's theory. She concludes that there is exploitation of workers, that conflicts between workers and capitalists are always present, that crises and depressions occur recurrently, etc.). It is too subversive to be acceptable to mainstream economists. But these are ideological reasons, not scientific ones. If the choice between Marx's theory and marginal productivity theory were made strictly on the basis of scientific criteria, such as materialistic rigor, logical consistency, empirical explanatory power, Marx's theory would win easily.

The logical result of the development of ordinary economics is the theory of general equilibrium. There it is argued that modern economies tend towards balance and harmony. The founder of general equilibrium theory, Leon Walras, characterized a market economy as a giant lake. Ripples sometimes occur, for example when a smaller or larger stone is thrown into it. Eventually, in the absence of exogenous shock, the ripples would disappear; the lake would thus become tranquil. Supply might eventually exceed demand in a market through some shock, but markets would quickly adjust to balance supply and demand as a whole.

Walras was – well aware that his “theory” was an ideological defense of capitalism. See what his father wrote to him in 1859, when Marx was still preparing The capital: “I fully approve of your work plan to stay within less offensive boundaries towards the owners. It is necessary to do the science of political economy in the same way as one does the science of acoustics or mechanics”.

More recently, in 2017, Nobel laureate Esther Duflo, in a speech addressed to members of the American Economics Association, assessed that economists should give up on big ideas; instead of theory, they should proceed like plumbers: “install the pipes and fix the leaks” – he proclaimed without blushing!

But it is worth asking: do economies and markets really tend towards equilibrium when affected by “shocks”? To answer that question, just look at the swings in the stock markets over the past week. An atrocious doubt would soon come to the honest investigator. In fact, modern economies look like oceans with giant and endogenous waves, subjected to the tides caused by the action of the gravitational law of profit, constantly shaken by storms that it itself creates as it regulates the atmospheric climate.

In fact, there is no tranquility or balance, but a continuous turbulent movement that is endogenously generated. Marxist economics, which does not want to hide reality, seeks to examine the “dynamic laws of motion” that affect capitalism over time. In contrast, economic theory mainstream it suspends the immanent temporality of capital; sees fluctuations as "disturbances" caused by "external shocks", which only occasionally disturb "free markets".

Of course, some economists from the mainstream People who don't want to appear “dumb” admit that marginal utility and general equilibrium theories are absurd. Occasionally, scientists working in the field of "natural science" attack the assumptions of this standard theory. The most recent critic is the British physicist Ole Peters. Here is what he asserts peremptorily: everything we are supposed to learn from modern economic theory is wrong. For, according to him, conventional economic models assume something he calls “ergodicity”. Becoming is not trajectory dependent, it is not open to the non-probabilistic possible. When meeting the average of all the possible outcomes of a given situation, one already discovers what will happen.

Peters points out that conventional utility theory, according to which we always do a cost-benefit analysis when we make any decisions, assumes that we act appropriately to maximize our wealth. (NT: the criticism that follows therefore admits that the use of this explanatory convention makes sense and that it is scientifically admissible).

The solution to apprehend the markets in this perspective was to borrow from Physics, the mathematics commonly used in thermodynamics to model economic results that are obtained using the “correct average”. The problem, says Peters, is that it fails to predict how humans actually behave. The mathematics employed, according to him, is flawed. Expected utility is calculated as an average of all possible outcomes for a given event. What remains to be added is that a single point outside expectation can, in effect, distort the entire perception. Or, put another way, what you might expect on average has little adherence to what most people will actually experience.

Peters says that economic reality, more often than not, behaves according to “power laws”. The markets, the evolution of wealth, the movement of employment, etc. they do not tend towards the mean or towards equilibrium, as postulated by Walras. Instead, inequality can rise extremely high, unemployment can rise continuously, etc. Points outside statistical regularity can have decisive impacts on the behavior of economic variables.

However, it must be agreed that recognizing uncertainty and chance, and inserting these events into mathematical models, does not go very far either. It is necessary to base economic “models” on the reality of capitalist production, that is, on the fact that capitalist production is the exploitation of labor to obtain profit. It is necessary to consider the regular and recurrent crises as resulting from investment and capitalist production, that is, the laws of motion of capitalism.

A Marxist economist from the beginning of the XNUMXth century, Henryk Grossman, already accurately presented the central flaw of the economic theory that is being criticized here: it is based on static analysis, on comparative statics. Now, capitalism does not advance gradually, sometimes receiving punctual shocks, always harmoniously towards superabundance and the society of leisure. On the contrary, it is increasingly driven by crises, inequalities and the destruction of the planet.

In the face of all the evidence, the economy mainstream it just invents possible exogenous causes or “shocks” to explain the crises, because it doesn't want to admit that they are endogenous. For her, the Great Recession of 2008-9 was a fortuitous occurrence, a “one in a million chance”, or even an “unexpected shock”. It was a “black swan”, an unknown-unknown, something that, in order to be explained, may require a dazzling new mathematical model. Likewise, the COVID-19 pandemic apparently figures as an “unexpected exogenous shock” – not as a predictable consequence of capitalism's mad pursuit of profits; not the uncontrolled invasion of remote areas of the world where these dangerous pathogens reside. Now, orthodoxy does not want a theory of causes endogenous of crises.

In the field of macroeconomics, modern Keynesian theory also has to be regarded as insufficient. Modern Keynesianism (or 'bastard Keynesianism' as it was called by Joan Robinson) bases its analysis of the crises of capitalism as if they result from “shocks” that disturb the equilibrium. It employs so-called Stochastic and Dynamic General Equilibrium (DGSE) models to analyze the impact of these “shocks” on the economic system.

Among others, Keynesian economic journalist Martin Sandbu launched a modest campaign against this approach. “There is little doubt” – he said – “that conventional macroeconomics is in need of a profound overhaul. The question that remains is whether this standard approach, DSGE modeling, can be improved upon or whether it should be scrapped entirely.” As he himself agrees in addition: “DSGE macroeconomics does not really allow us to consider the large-scale financial panic seen in 2008. It does not allow us to opt, either, for some of the main conflicting explanations for the slow recovery and for a level of economic activity that remains well below the pre-crisis trend”. Sandbu wants economic analysis to move towards “a more expansive and liberal form of DSGE”.

Recently, he praised the idea of ​​so-called multiple equilibria as a standard feature that should be adopted in macroeconomic models. “It allows that there can be multiple self-reinforcing states that the economy can fall into, not just a single equilibrium around which it fluctuates. For with multiple equilibria there is no single central tendency. At the very least, there are several. While it is possible to provide the probability distribution associated with each possible equilibrium, predicting which one the economy will find itself in is an entirely different beastly matter."Sandbu presents this multiple equilibrium approach as a method that makes it possible to obtain better results in economic analysis: “it becomes clear that by far the most important policy issue is equilibrium selection: how to get the economy out of a bad state of self-reinforcement or to avoid ruptures that take it out of a good state”.

Now, this does not seem to be very different from what is presented in traditional general equilibrium models. And, even worse, now having “multiple equilibria” as a possibility in the representation of modern economies – considers Sandbu – “it becomes even more difficult for economists to know how to advise”.

If so, then we cannot expect that orthodox economics can actually meet the four historical challenges pointed out by Janet Yellen. What were they again? The capitalist needs to deal with future pandemics; it needs to solve the climate crisis; it needs to end inequality and racism; needs to overcome the crisis that has lasted 50 years since the 1970s. Now, it is only possible to hope that Janet's speeches made to financial institutions on Wall Street, bastions of international financial capital, which earned her more than US$ 7 million in recent years, have come up with solutions to the four historic challenges. But, readers, don't hold your breath waiting for any convincing answer.

*Michael Roberts is an economist. Author, among other books, of The Great Recession: A Marxist View.

Translation: Eleutério Prado.

Originally published in The next recession blog.


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