3 Nov 2013

Steve Keen's "Debunking Economics : The Naked Emperor Dethroned?"

I finally got round to reading the Revised and Updated edition of Steve Keen's "Debunking Economics : The Naked Emperor Dethroned?"

It's powerful stuff. Steve Keen really does do a comprehensive demolition job on the standard neoclassical economic models that have dominated economic thinking and policy for decades - models that failed to predict the crash of 2008, and indeed still haven't come up with a realistic explanation of what happened.

The dominant neoclassical view claims that unregulated financial markets will naturally generate situations that optimise well-being. They are ideas that originated with Adam Smith's proposal that a society composed of individuals each acting out of self-interest leads to the highest possible level of welfare for society as a whole - the idea of the 'invisible hand'.

As Keen points out (p268), "The vision of a world so perfectly coordinated that no superior power is needed to direct it, and no individual power sufficient to corrupt it, has seduced the minds of many young students of economics". He should know - because  he was one when he started out as a student.

But he then goes on to say that  "what enabled [him] to break away from that delusional analysis was what Australians call "a good bullshit detector"."  And much of the book goes through virtually all the claims of neoclassical economic theory, demonstrating that his "bullshit" detector is fully operational.

What is particularly impressive is that in many cases, Keen doesn't even have to use his own arguments to demolish the theories - the proofs are often provided by neoclassical economists themselves. But the neoclassical authors who pointed out that the mathematical modeling at the heart of the theory does not hold up when moved into the real world tend to be brushed under the carpet.

Specifically, the first part of the book is called "Foundations : The logical flaws in the key concepts of conventional economics.  Here's the summary of its four chapters - already very devastating.
  • Chapter 3 ('The calculus of hedonism") reveals that economics has failed to derivc a coherent theory of consumer demand from its premise that people are no more that self-interested hedonists. As a result, economic theory can't justify a crucial and seemingly innocuous element of its analysis of markets - that demand for a product will fall smoothly as its price rises. Far from being innocuous, this failure cripples neoclassical theory, but neoclassical economists have both ignored this failure, and responded to it in ways that make a mockery of their claims to being scientific.   
  • Chapter 4 ("Size does matter") shows that the economic theory of 'the firm' is logically inconsistent. When the inconsistencies are removed, two of the central mantras of neoclassical economics - the 'price is set by supply and demand' and 'equating marginal cost and marginal revenue maximizes profits' are shown to be false. Economic theory also cannot distinguish between competitive firms and monopolies, despite its manifest preference for small competitive firms over large ones.
  • Chapter 5 ('The price of everything and the value of nothing') argues that the theory of supply is also flawed, because the conditions which are needed to make the theory work are unlikely to apply in practice. The concept of diminishing marginal returns, which is essential to the theory, is unlikely to apply in practice, 'supply curves' are likely to be flat, or even downward sloping, and the dynamic nature of actual economies means that the neoclassical rule for maximizing profit is even more incorrect than it was shown to be in the previous chapter. 
  • Chapter 6 ('To each according to his contribution") looks at the theory of the labor market. The theory essentially argues that wages in a market economy reflect workers' contributions to production. Flaws in the underlying theory imply that wages are not in fact based on merit, and that measures which economists argue would reduce unemployment may in fact increase it. 
The second part of the book is called "Complexities : Issues omitted from standard courses that should be part of an education in economics", and contains the following five chapters.
  • Chapter 7 ("The holy war over capital") shows that the theory of capital is logically inconsitent. Profit does not reflect capital's contribution to output, and changing the price of capital relative to labor may have 'perverse" impacts on demand for these 'fators of production.'
  • Chapter 8 ('There is madness in their method') examines methodology and finds that, contrary to what economists tell their students, assumptions do matter. What's more, the argument that they don't is actually a smokescreen for neoclassical economists - and especially journal editors, since they routinely reject papers that don't make the assumptions they insist upon. 
  • Chapter 9 ('Lets do the Time Warp again') discusses the validity of applying static (timeless) analysis to economics when the economy is clearly dynamic itself. The chapter argues that static economic analysis is invalid when applied to  a dynamic economy, so that economic policy derived from static economic reasoning is likely to harm rather than help an actual economy. 
  • Chapter 10 ('Why they didn't see it coming') tracks the development of macroeconomics into its current sorry state, and argues that what has been derided as 'Keynesian' macroeconomics was in fact a travesty of Keynes's views. It explains the otherwise bizarre face thtat the people who had the least inkling that a serious economic crisis was imminent in 2007 were the world's most respected economists, while only rebels and outsiders (like Keen) raised the alarm. 
  • Chapter 11 ('The price is not right') deals with the economic theory of asset market, known as the 'Efficient Markets Hypothesis'. It argues that the conditions needed to ensure what economists call market efficiency - which include that investors have identical, accurate expectations of the future, and equal access to unlimited credit - cannot possible apply in the real world. Finance markets cannot be efficient, and finance and debt do affect the real economy. 
  • Chapter 12 ('Misunderstanding the Great Depression and the Great Recession') returns to macroeconomics, and considers the dominant neoclassical explanation of the Great Depression - that it was all the fault of the Federal Reserve.
Keen also illustrates how much of the theory is totally without empirical support. It appears to be an entirely hollow edifice that simply does not stand up when subjected to serious scrutiny.

And yet it is orthodox neoclassical theory that is used by virtually all goverments to determine their policies - or rather lack of policies. Since any government intervention is by definition an interference in the perfect operation of the markets, it has to be banned. And the fact that no neoclassical economists were able to explain the 2008 crisis is still an embarrassment for the entire profession. 

I would be very interested to know if there are any neoclassical economists out there who have read the book and can still look at themselves in the mirror. There is a strong case to be made that their stupidity and refusal to question their own dogmatic beliefs is behind a lot of the problems that we face today.

Note added February 2014 : If you would like to hear Steve Keen talking - there's a BBC radio interview with him from June 2012 that you can find here.

1 comment:

  1. economist are for hire. and sometimes in the hiring there is a conflicting interest, That is why you have to do your own research and not simply learn from others, Particularly in economics and money creation there is a lot of over complication to hide a simple concept, If the concepts were simple so everyone could understand there will be a revolt. So there is an ulterior motive to keep deliberately complicated.