Tuesday, July 3, 2012

Economic textbook theory under fire

Special Report - Crisis forces "dismal science" to get real

There's quite a lot in this article but the gist is that it's getting hard to ignore the gulf between economic theory as taught and the real world. Perhaps someday we'll realise that blowing property bubbles isn't so clever. 'Roger Farmer, a professor of economics at the University of California in Los Angeles, was at a dinner at the Bank of England to celebrate the "Great Moderation", a term coined to describe an era in which some politicians claimed monetary policy had ended boom and bust. "We had entered a new era of economic prosperity," he recalled in a paper this February. That night, British building society Northern Rock went under, heralding the start of Europe's crisis and a global backlash against economists.'

Posted by quiet guy @ 08:25 AM (1667 views)
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14 thoughts on “Economic textbook theory under fire

  • Great article, thanks for posting. I like this bit:

    Up to one in four people can’t find work in parts of Europe, and the reality of people who are unemployed without choosing to be is one of the biggest holes in mainstream theory, for Bofinger and others. In orthodox teaching, supply and demand in the labour markets should fix unemployment leaving just those people who choose not to work in the dole queue. < / i>

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  • close Italics

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  • voiceofreason says:

    Just found a large proportion of the neo-classical economics bashers (i.e. economic Voices of Reason) attended this “Just Banking” conf in Edinburgh in April.
    http://www.justbanking.org.uk/category/speakers/
    Ian Fraser, Richard Werner, Steve Keen etc etc

    Long may the be heard.

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  • mark wadsworth says:

    close italics again, hopefully.

    Economics as a study took a very wrong turn about a century ago once a small group realised they could get away with classifying land as capital and launching the myth that banks create wealth.

    Land is not capital (it is a government protected monopoly privilege and a kind of privately collected taxation) and banks do not create wealth (above and beyond the very real value of the convenience of direct debits, cash machines, electronic payments etc). And taxes on income have huge deadweight costs. Once you understand all this and go back to e.g. Alfred Marshall it all becomes a lot clearer.

    All this Home-Owner-ist economic thinking is however deeply engrained, and there are plenty of people who blame recessions on the unemploed, which is like blaming the 1914-18 War on people who died in the trenches.

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  • Out with the old and in with the new.

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  • voiceofreason says:

    Mark, one could draw interesting parallels between land and the electromagnetic spectrum.
    EM spectrum licenses are auctioned off at vast profit by the govt, the spectrum is govt protected.
    No-one can privately own it, there is a finite supply.

    Imagine of the same principles of auction/license were applied by the govt to land.

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  • mark wadsworth says:

    VOR, I have pointed out many a time that land is the prime residual accumulation point for rents, but there are plenty of other things where the same logic applies by analogy, from radio spectrum and airport landing slots via taxi driver permits all the way down to very trivial things like fancy number plates.

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  • MW – If you haven’t already read it the following is interesting regarding where economic theory went wrong:

    http://michael-hudson.com/2011/10/simon-patten-on-public-infrastructure-and-economic-rent-capture/

    e.g.

    “Free trade policy was not appropriate for conditions that called for steering economic evolution along the most productive lines. And what British (free trade) economists treated as universal actually reflected its class structure, especially its hereditary groundrent stemming from the Norman invasion….(Economic development) required investment in capital, which in turn required protective tariffs and public infrastructure investment…….

    Defenders of property and opponents of tax reform found (the) focus on rentier revenue disturbing, above all its application to land ownership, and the monopolies and trusts created by Wall Street. These vested interests applauded the free-market marginalists who took property relations for granted, and especially endorsed John Bates Clark’s rationalization of property income as “earned.” Clark in America and a marginal utility school in Europe….treated all income as reflecting—by definition—the recipient’s contribution to production. The result was a circular reasoning to confirm their desired outcome and starting viewpoint: if all income was “earned,” there was no such thing as a free lunch (economic rent)..

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  • mark wadsworth says:

    Icarus, clearly, people like Hudson know more about the nitty gritty of all this than I do and can bandy about all sorts of specific examples, but what it boils down to is my comment at 4.

    Interestingly, the Hud is mainly a bank basher, he sees LVT mainly as a means to deflate credit bubbles from which only bankers benefit, whereas from my point of view, cutting the banks down to size is just another bonus of LVT but not the main reason.

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  • MW – he sees LVT as the main means of instituting a rational, productive economy without economic rent and ‘debt overhead’ that ‘loads down’ the economy with unnecessary costs and transfers wealth/debt-overhead to unproductive bankers and monopolists.

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  • MW,
    LVT alone won’t cut the banks down to size. Hong Kong and Singapore both have more land taxation than us, but they are dominated by finance. In the case of Hong Kong you still need to borrow large sums of money to acquire the initial lease, then further huge sums to finance the building of tall skyscrapers. LVT is right for many reasons, but I can’t see it having a huge impact on the banks.

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  • mark wadsworth says:

    D: “you still need to borrow large sums of money to acquire the initial lease”

    Yes this is quite true, what HK has is therefore a halfway house between proper LVT (land costs you nothing but you pay tax each year) and UK style freeholds (land costs a fortune up front but you pay nothing after that), a thirty year lease behaves more like freehold than a site subject to LVT.

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  • It occurred to me many years ago after graduating from a ‘traditional’ university with a first in economics and a far east Asian language that the economic fundamentals as taught in textbooks when applied to human capital were way off piste.

    My logic was thus: since the inception of the course that I had graduated from, only about 60 people had successfully completed the degree. Therefore the barriers to entry for the human capital market I was competing in had severely limited supply. Demand for the human capital I claimed to be a part of should have been healthy as there were then (as now) plenty of companies in the UK with significant demand for people with knowledge of economics and fluency in far east Asian language.

    My job search was a rude awakening. This was 1995 and unemployment was as high as it is now. In fact to complicate the issue, job centres had never seen graduates before and were ill equipped to recommend lines of work to us. All of my friends in London meanwhile seemed to have fallen on their feet. It was a miserable time to be a graduate looking for work in provincial Britain.

    Later I realised that this was a failure of my expectations having been guided and having naively aligned my goals with classical economic theory of human capital scarcity. I was only 22 years old. I also later discovered that regardless of how talented some young people are, they will never reach their potential because of limitations of their circumstances and lack of opportunities due to their geographical location.

    This never comes into economics, which for me, is why it is called the dismal science. It models the rational consumer but has never found one, never seen one and will probably never even look for one.

    Here ends the first lesson. Carry on as you were.

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  • Paul, thanks for sharing your thoughts and background on this – if it isnt too intrusive a question what do you do for a living now?

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