Saturday, May 7, 2011

Why Are So Many Economists Wrong?

The question is posed by a commentator on the last post, with respect to the New Keynesian N. Gregory Mankiw. The answer is that he, like the New Classical and monetarist economists, starts from fundamentally wrong assumptions about the world and the economy. In fact, these assumptions are basically the following axioms:
(1) the ergodic axiom
(2) the neutral money axiom (at least neutral in the long run)
(3) the gross substitution axiom.
These axioms are all wrong. A mainstream economist would have to reject them and start from scratch to come to the same conclusions independently as Keynes or Post Keynesians.

For why these axioms are wrong, see Paul Davidson, Financial Markets, Money, and the Real World (Cheltenham, 2002), p. 43ff.

As I noted in the last post, these are the traits of real world capitalist economies:
(1) a monetary production economy,
(2) fundamental uncertainty;
(3) subjective expectations;
(4) contracts which do not normally allow flexibility if economic variables change;
(5) inflexible or “sticky” wages;
(6) money with a zero or very small elasticity of production, and
(7) money and financial assets with zero elasticity of substitution with producible commodities.
If someone starts from principles that do not describe the real world, then one’s deductive arguments will go badly wrong and will not apply to the real world.


  1. This is more of a political question than economic, but I hope you can answer it: how much of modern economics is theoretical after the fact justification for wealth disparity, and how much of it is a genuine belief that neoclassical economics will create the most wealth for the most people?

  2. Let's see if I have been reading this blog right for the past few months.

    A mainstream economist believes that the future possibilities can be mathematically estimated in likelihood, even though such things can not account for, say, a technology coming up in the future that can break the game entirely.

    These economists also believe that money has absolutely no utility of its own account, even though it has psychological properties and special use from its "very small elasticity of production".

    Most of all, that inelasticity of production of money means that people will not necessarilly shift to buying things that become cheaper in terms of money. Money and financial assets do not have any genuine substitute, because not many other things share their properties.

    No matter how low prices fall, people often still want to hold on to their money and financial assets, rather than spend it, because of uncertainty about the future and the "calming" effects of holding on to their money.

    But Greg Mankiw believes that people will start spending once the prices have fallen far enough. So the very possibility that they might not is just not considered.

    All in all, mainstream economics has assumed it can definitively tell whether structural adjustment will take place after a recession begins, because they think people will definitely respond to falling prices with increased demand for goods and reduced demand for financial assets.

  3. Vladimir Gagic asks a "When did you stop beating your wife?" style question.

    Economics is not about creating the most wealth for the most people. It's not about anything.

    All that matters is what other people's values are. An economist is simply told by the statesman, the firm, or anybody what their values are and what they wants. Thereafter, the economist simply gives him a diagnosis of whether he can get what he wants, given the values of the questioner.

    He is basically like an auditor of a business, who can tell you what the position of the business is, but not how it is to be run. Or even in the most paternalistic possible case, an economist is like a medical doctor who may strongly recommend that a pregnant woman take rest, but can't help it if she doesn't take his advice.

    Furthermore, Mr. Gagic, you are trying to psychologically diagnose your opponents into disproving them. By asking whether economists have a confirmation bias for "after the fact justification for wealth disparity", you are basically asking, "What is wrong with economists?" before even answering, "Is something wrong with economists?"

    If you have been satisfiably convinced that they are out for malicious motives, then you can ease yourself out of addressing their arguments. Such a thing reminds one of Dialectics - where the opponent is not worth debating, because his "class interest" is to make his points. With such an unfalsifiable position, why address anybody at all? Why not just deem them all shills and stop there?

    Such thinking is typically American - WHO said, not WHAT was said. Americanism and Americanist thinking always involves looking at people and personal character, and never at ideas and critical thought. And although you might not be American, you could not have made any less of an Americanist non-question.

  4. "Economics is not about creating the most wealth for the most people. It's not about anything."

    I would have said that economics is precisely about finding out what system maximises wealth creation.

    For third world nations the problem of economic development is especially acute too.

  5. Vladimir Gagic,

    "how much of modern economics is theoretical after the fact justification for wealth disparity, and how much of it is a genuine belief that neoclassical economics will create the most wealth for the most people"

    For most mainstream economists, I think they really do believe that neoclassical economics is correct: their belief in it is sincere.

  6. I agree. Mainstream "economists" sincerely believe theo/neoclassical economics is correct. "Heterodox" economists know it is not.

  7. Theo-classical economics - I like it!

  8. Although I do enjoy reading heterodox economics blogs - such as Steve Keen's or Tyler Cowen's or Bob Murphy's or this one - I must say that branches of heterodox economics

    a) often have more in common with orthodox economics than they admit
    b) often have less in common with other heterodox branches
    c) are sometimes parallel to a movement of political activism.

    On the last point, I stress a little. Perhaps the only serious difference between heteros and orthos is that the former are more willing to have explicit political affiliation?

    Gunnar Myrdal was primarily an advocate of the Swedish Social Democratic Party's policies. Ha Joon Chang also writes from the perspective of anti-globalization activists who seek to protect the Third World from supposed First World predation. The Austrian School started with either apoliticals or people of unconventional politics, but is now a part of the Ron Paul movement.

    Although their conclusions are likely value-free, all these people tend to be hardcore political idealists.

    That need not be a problem. But as we see in the Star Wars movies, Jedi Knights who are political idealists either quit or are removed from the Order. They all walk down a dangerous path.

  9. Prateek Sanjay,

    You could advocate Post Keynesian economics and be socially and religiously conservative or an old-style Tory.

    There is no necessary connection between this macroeconomic theory and your political affiliation, just as some old-style Tories regarded themselves as Keynesians in economics.

  10. Wow, so you keynesians nowadays argue if "axioms" like that the future is known and can be calculated are true or not? Cool!

  11. "Wow, so you keynesians nowadays argue if "axioms" like that the future is known and can be calculated are true or not?"

    Umm, no, idiot.
    The fundamental uncertainty of the future was a point made by Keynes in 1937, and has been an important part of Cambridge Keynesianism and Post Keynesian theory ever since.

    Even the neoclassical Frank Knight came to much the same conclusion, though the mainstream neoclasicals never accepted his work.

    The Austrian Ludwig Lachmann was following in Keynes's (and Shackle's) footsteps when he applied these ideas about uncertainty to see that expectations are subjective.

  12. So, what's about the ergodic axiom, wise man?

  13. Post Keynesians are not "arguing" over the falsity of the ergodic axiom. They have known it is false since 1937.

    The argument is with the neoclassicals.

    If you knew a goddamn thing about your own "school", you would readily agree on the falsity of the ergodic axiom, and stop spamming my blog with your rubbish. From an "Austrian' economist on

    "Davidson is right that Keynes has here scored heavily against neoclassical economics. But the uncertainty of the future hardly suffices to establish the validity of the Keynesian system. For one thing, Austrian economics also emphasizes the uncertainty of the future. It is constantly stressed by Mises, who goes so far as to claim that the uncertainty of the future is a praxeological law, deduced from the action axiom."

    David Gordon, "The Keynes Solution?," Mises Daily, October 16, 2009

    Want me to do your work for you?

    Austrians and Post Keynesians part company on the consequences of radical uncertainty. Post Keynesians maintain the failure of Say's law and stress the other traits of real world capitalism that do not lead to an optimum use of resources.

    A serious argument would be to ask me to justify the "validity of the Keynesian system".

    E.g., how could you justify Keynesian stimulus if there is no solution to the problem of induction:

    Or just because a system displays the property of non-ergodicity, can the state of that system by influenced by an intervention?

  14. LK, apologies, I have misunderstood your post. I thought "he" in second sentence referred to the "New Keynesian N. Gregory Mankiw" rather than the "commentator on the last post". Feel free to delete my comments here if you wish so.

  15. The "he" in the second sentence does refer to the "New Keynesian N. Gregory Mankiw", but as pointed out here and in numerous other posts it is precisely because Mankiw accepts the neoclassical axioms that makes him wrong. His so-called "New Keynesian" macrotheory is a travesty of Keynes' thought.

    The debate about the nature of uncertainty is and about starting axioms is between heterodox economists (like Post Keynesians) and neoclassicals, whether they are New Classicals, monetarists, supply siders, or New Keynesians.

  16. Theo-classical economics - I like it!

    The phrase is William Black's of New Economic Perspectives and the UMKC. It's an insult to theologians though, who made real contributions to thought. As did the preKeynesian (neo)classicals or Ptolemaic astronomers. But for crapmeisters, charlatans, morons like Mankiw, Friedman and the mainstream that successfully carried out a Copernican revolution in reverse? Not strong enough.

  17. Mr. Sanjay, while I don't recall asking you anything, if you insist on doing so, then you should have bothered to read "this question is more political than economic." And I don't see how offering the alternative of genuine belief in the validity of neoclassical economics is a loaded question. Your simple criticism of my question, it seems, is only insecurity on your part.

    Nonetheless, your very self-satisfied answer that economics "is not about anything" answers my question: yes, you are still beating your wife, and yes, neoclassical economics is nothing more than a convenient justification of wealth inequality.

  18. Mr. Gagic, I simply prefer to call out bad arguments when I see them, and your question was a thinly veiled argument. As for why I bothered, that's an endless black hole into which we can go, with both sides asking, "Why did you bother"

    You already answer your own question with, "yes, neoclassical economics is nothing more than a convenient justification of wealth inequality", so you sought no answer. And as I said, this is another spin on dialectics, where you try to find class interests behind other people's arguments rather than looking at the arguments. This fallacy is one of confirmation bias.

    Moreover, you attempt psychological diagnosis with "insecurity on your part", which is again a form of avoiding rational discussion and then bothering about personalities and not ideas. Geometry is not worth learning, because Euclid was a pedophile.

  19. Hi Lord Keynes
    Robert Murphy at has a post attacking MMT. I wonder if you'd like to comment

  20. Neoclassicals also make use of comparative statics to model the economy, and exclude banks and other institutions entirely. Moreover, they favor an "instrumentalist" philosophy of science.

    The PKs use dynamic modelling based on complexity theory, and include institutions in their models.

    New Keynesian economics, even what is practiced by Kroog and Stig, could not be more different from non-neoclassical Post-Keynesian economics if it tried.