Anwar Shaikh on the contrasting approaches of classical and neoclassical economics

9780199390632In this extract from Anwar Shaikh’s work Capitalism, he draws a striking contrast between the theoretical approaches of his own adopted classical economics, and neoclassical approaches, which dominate the mainstream. He highlights how the classics (and Marx, who he counts as part of this group) more satisfactorily address the real nature of capitalism, starting from its observed patterns and behaviour. Neoclassical economics starts from an idealized vision, a long way from the reality of the economy, in order to act as an apology for capitalism with all its flaws, and then adds “imperfections” to bring the theory closer to the real world. As Shaikh says, this is certainly a strange approach.

“Classical political economy attempted to get underneath the tempestuous surface of capitalism to identify the central tendencies of the actual system. Neoclassical economics took the opposite tack. From the very start, it was focused on the task of constructing a vision of perfect capitalism, optimal, efficient, and thoroughly idealized – all under the guise of “analytical refinement.” Real competition was replaced by perfect competition, the aggressive cost-cutting firm turned into a passive price-taker, and the turbulent movement of real markets was substituted with the smooth path of equilibrium-as-bliss. In the midst of the Great Depression of 1873-1896, Jevons and Edgeworth were refining the list of requirements for “perfect competition,” while Walras was weaving these elements into the general equilibrium model which still dominates orthodox macroeconomics. It is a particular historical irony that Walras, a French socialist who looked to the state for “proper guidance” on the installation and maintenance of “free competition”, would become the patron saint of conservatives who defend corporate capitalism and revile the state…[E]ven those who seek to return to the task of analyzing the actual system generally begin from the Walrasian framework in order to introduce selective “imperfections” here or there.

What a strange manner of proceeding! First, one invents a fictitious idealized world, a veritable Garden of Eden where even the snake of scarcity works for the general good. Most of the effort is then dedicated to explicating the properties of this paradise, although sometimes it becomes necessary to address the clamorous multitudes outside the gates. Then the intellectual problem becomes one of positing particular “imperfections” that can be used to account for otherwise inexplicable behaviors of the obdurate masses. This is the modus operandi of all orthodox economics after Keynes, with differences among the schools arising from disputes about specific attributions of imperfections. Proceeding in this manner ensures that orthodox theory can never be deemed to be wrong: it is only a matter of finding the right set of imperfections to explain each particular “deviation” from the ideal. I do not subscribe to this procedure because I reject its very starting point. I would argue that real macro dynamics is just as different from Walrasian general equilibrium as the classical theory of real competition is from perfect competition. The difference between classical and neoclassical approaches is not about abstraction itself, but rather about the method of abstraction. Abstraction-as-typification begins from the real in order to identify typical patterns and their underlying drivers; abstraction-as-idealization begins from the ideal and inevitably ends up with a vision of the real as a catalogue of imperfections.”

Anwar Shaikh (2016), Capitalism: Competition, Conflict, Crises, Oxford University Press, p.540-541.

Anwar Shaikh on economics and the real world

The video below features Anwar Shaikh discussing the basic framework he uses in his 2016 magnum opus Capitalism: Competition, Conflict, Crises. Shaikh describes his approach as working in the tradition of classical political economy, and draws in particular on the ideas of Adam Smith, David Ricardo, Karl Marx and John Maynard Keynes, integrating them into a coherent form. He emphasis the importance of profitability under capitalism as a motivating and regulating force, and what he terms ‘real competition’ in the marketplace, in contrast to theories of so-called perfect or imperfect competition. He also explains how his theory can explain the failure of Keynesian policies to deal with the stagflation of the 1970s, which led to the widespread abandonment of demand management as a tool to achieve full employment.

The high wage economy: marrying social justice with economic success – Part 1

Production_LineA persistent goal of many progressive economists and policymakers is to enable a widely-shared prosperity, thus bringing together social justice and economic efficiency, while sustaining individual freedoms. Some economists argue that low labour costs in the form of wages and, more broadly, minimal labour market regulations and taxes which fund the welfare state, are necessary to achieve “competitiveness” among firms so that the price of output can be kept low in order to encourage sales, while sustaining profits. This is especially so for developing countries with relatively low levels of productivity, which simply can’t compete with higher wage, higher productivity countries in the rich world. Continue reading

Exploring the economics of good and evil

Economics-Good-EvilThis post is inspired by Tomas Sedlacek’s excellent book Economics of Good and Evil. I have already posted several, for me at least, thought-provoking extracts from the book, and there are more to come. Here I want to discuss some of the issues which arise from considering how economics is impossible to separate from ethics, though many of its modern practitioners would think otherwise. Even if they do acknowledge this truth, the ethics of modern economics are generally unspoken or presupposed. They exist, but are not often considered open to debate, except by those inclined to more heterodox perspectives.

The goods

What is counted as good in modern economics? To start with, most policymakers prioritise GDP growth, or perhaps growth in productivity, given their role in driving material prosperity and creating jobs. Increasing quantities of goods and services produced by a growing economy are part of the result. But it is surely rather short-sighted to assign ‘good’ only to the material aspects of production. Some ecological economists argue that the priority given to continuous growth in economic output are so damaging to planetary ecosystems and resources that we should aim for something like zero growth, or even ‘degrowth’. From their perspective, continued increases in GDP are ultimately unsustainable, and a radically different kind of economy is the required response. Space should be made for the poorest countries to grow, but the richest should radically change tack. Continue reading

Wynne Godley and economics – forecasts, policy and the drivers of prosperity

I have just finished reading Alan Shipman’s fascinating biography of the late economist Wynne Godley, who passed away in 2010. Godley worked in the UK Treasury in the 60s, before moving to Cambridge University and heading the maverick Cambridge Economic Policy Group (CEPG). He became known for his prescient economic forecasts of the UK and later the US, predicting the demise of the ‘Barber Boom’ in the 1970s, the mass unemployment of the 1980s unleashed by Margaret Thatcher’s professed adherence to monetarism, the end of the ‘Lawson Boom’ and return to recession in the late 80s and early 90s, and finally the Global Financial Crisis (GFC) of the 2000s, which followed the build up and subsequent unwinding of unsustainable macroeconomic imbalances in the US, which he had identified as early as 1999.

Through his career, Godley’s approach to economics developed into what are now termed ‘stock-flow consistent’ macroeconomic models. His final book, Monetary Economics, co-authored with Marc Lavoie, develops models of increasing complexity of a hypothetical economy, in which flows of income, expenditure and production interact in a comprehensive and logically consistent way with stocks of assets and liabilities.

One of the key lessons of Godley’s analysis is that incorporating banks or a financial sector into macroeconomic models yields important insights. Thus, the so-called ‘Great Moderation’ period of steady economic growth, moderate unemployment and low inflation which preceded the GFC in economies such as the US and UK, in a way concealed the unsustainable accumulation of private debt, which financed consumption and a boom in asset prices, particularly housing.

The subsequent financial crisis and deep recession were therefore not an ‘exogenous’ shock which arose randomly from outside the system, but were ‘endogenous’, arising from within the economic system itself. Godley, along with economists such as Steve Keen, modeled the dynamics of debt accumulation and predicted an inevitable crisis, as debt accumulation went into reverse, private saving rose, and unemployment rose sharply, even as central banks reduced interest rates towards zero.

Fiscal policy, in the form of tax cuts and public spending increases, made a comeback in many countries, at least until the premature turn towards austerity. Godley and Keen had both predicted that public deficits would soar as governments let the automatic stabilisers operate, and borrowed and spent on top of that, to try and combat the recession. Such was the level of private debt that, as the private sector scrambled to pay it down by curtailing spending, these deficits proved insufficient to prevent recession. In their absence, it would likely have proved even deeper.

Keynesianism and the Golden Age

Godley’s economic models have today spawned an expanding literature applying his stock-flow consistent approach to both the economy as well as the environment. Many of those inspired by his work, as well as the man himself, would be classified as post-Keynesian economists, broadly speaking the heterodox or more radical followers of Keynes. They argue that economic growth, and aggregate supply, are usually constrained by aggregate demand, of which investment is the main driver, as it provides both a source of spending and of capacity on the supply-side. They hold to the vision that sufficiently ambitious public policy can create and sustain full employment, moderate inflation, and widely-shared rising living standards. They tend to take great inspiration from the post-war ‘Golden Age of Capitalism’, which witnessed around 25 years of such outcomes.

The Golden Age ultimately came to an end as a combination of rising unemployment and inflation, or stagflation, apparently discredited the Keynesian consensus, and the Bretton Woods system of fixed but adjustable exchange rates unravelled. The monetarist creed which followed saw policymakers shift their attention to combating inflation with monetary policy and, in theory, fiscal austerity. Unemployment soared in the UK and manufacturing output collapsed.

Left economists of all persuasions, from Keynesian to Marxist, decried these developments. The post-Keynesians argued that their own ideas for economy policy could be used to solve these problems, while some Marxists viewed them as inevitable under capitalism, even if they were hugely damaging to society, as they could encourage a restructuring which would restore business profitability, and create the conditions for a new period of economic growth to take place. Strangely, these latter arguments are in some ways close to conservative ones, although Marxists tend to see socialism as a better answer to the problems created by capitalism, while conservatives would continue with the creative destruction unleashed by capitalist production, often favouring little in the way of the social protections or industrial interventions favoured by those to their political left.

From Keynesianism to industrial policy

Wynne Godley’s economic framework ultimately eschews ‘fine-tuning’ or short-term policy interventions in favour of medium-term strategies which can sustain the goals of most Keynesians, mentioned above. They require management of the public budget, incomes policies to sustain low inflation, and sometimes even import controls such as tariffs or quotas to manage the balance of payments, and prevent a boost to demand at less than full employment ‘leaking’ into foreign demand in the form of imports, rather than encouraging the growth of domestic production and employment.

Also implicit in this framework is the potential for industrial and technology policies to increase the international competitiveness of domestic firms, and thus to encourage a faster growth of net exports given the growth of world demand. The more competitive such firms are internationally, the more of this demand they can capture and serve and the faster the growth of net exports, all else being equal. Another Cambridge post-Keynesian and colleague of Godley’s, Nicholas Kaldor, made arguments along these lines to justify the need for an industrial policy.

Industrial policy can not only create a boost to foreign demand, but it also potentially encourages faster structural change and the adoption of new technologies, which are part of the workings of a successful capitalist economy able to raise productivity and living standards over time. This falls more into the category of microeconomic analysis, but taken together with the ideas of Godley and others, it shows that ‘macro’ and ‘micro’ need to be integrated, rather than kept artificially separate, as is often the case in mainstream analysis, which even drops the case for considering emergent macro properties completely with its arguments for ‘microfoundations’ of macroeconomics.

Marx, Shaikh and competition

For Keynesians of all kinds, aggregate demand, whether domestic or foreign, is seen as a key driver of growth in output and employment, but for modern classical and Marxist economists, Anwar Shaikh being one prominent example, competition between firms and industries drives investment and growth in the search for greater profitability.

Godley was nicknamed the ‘cassandra of the fens’ for his gloomy forecasts for the economy. Although his predictions of recession often turned out to be right, he was perhaps too pessimistic about the prospects for subsequent recoveries in the absence of Keynesian fiscal reflation. Many post-Keynesians, who have historically often prioritised macro over micro analysis, neglect the role of the profit motive and competition in driving economic growth. ‘Accumulate, accumulate, that is Moses and the prophets’, proclaimed Marx, and Shaikh, who has integrated many ideas from classical and Marxist thought as well as some from the post-Keynesian tradition in his own magnum opus Capitalism, makes a strong case for the imperative of profit-making and competition as the central regulating mechanism under capitalism.

For Shaikh, firms and industries compete in the long run by investing in new technologies to increase productivity and cut costs, enabling them to cut prices and expand market share, with the aim of achieving greater profitability. Over the long term, crises or recessions are inevitable from time to time, even if they can be temporarily prevented or postponed with state interventions.

Thus economic growth, despite its often disruptive form in both good times and bad, derives from the intrinsic motives within the capitalist system, and the disruption can only be temporarily ameliorated. Despite this, growth can be seen as being constrained by demand or by supply. It is just that Keynesians tend to see the former as being the dominant tendency and requiring sustained intervention by the state.

As part of an industrial policy, public investment in modern infrastructure and research into and development of new technologies can ‘crowd in’ private investment by opening up new opportunities for firms to take advantage of. The state can therefore ‘create’ new markets for the private sector. This idea is contrary to the conservative view that public investment or borrowing more generally will tend to crowd out private investment. The state can thus expand both demand and supply.

Keynesianism and politics

There is no doubt that Keynesianism offers an attractive political program for the left, with its hope that state intervention can create ‘jobs for all’, poverty reduction and well-funded social policies, not least in the form of a strong welfare state. History seems to suggest that these outcomes cannot be sustained indefinitely, only periodically, under capitalism, while waves of creative destruction and structural change are perhaps more of a constant.

Such changes can prove a threat to sustaining liberal democracy, as the aftermath of the GFC has shown. Keynesianism purports to be able to do so, in the presence of sufficient political will and mass support for progressive parties. But the classical and Marxist canons and their interpretation of economic history show this vision to be at best incomplete, even in the absence of a path to socialism.

The Chinese economy: development, finance and reform

800px-Chinese_draakEven before the Covid-19 outbreak, the Chinese economy was slowing, after more than three decades of rapid economic expansion. Thirty years of recorded growth at around ten per cent per annum is unprecedented in human history. This has enabled hundreds of millions of people to be lifted out of poverty, and the material transformation of a poor country to one that is classified by the World Bank as upper-middle-income.

Despite all this, there is a broad consensus, including among Chinese government officials, that the country’s development model needs to change if it is to continue its transformation and become a rich country. Many economists argue that this will involve a rebalancing of the economy, in order to continue to grow and develop in a way that is more sustainable both for China itself, and for the rest of the world, given that as the world’s second largest economy behind the US, internal changes now have a major impact globally. Continue reading

Ha-Joon Chang: why free trade may not be best

ha-joon-chang“When they hear someone criticizing free trade, free-trade economists tend to accuse the critic of being ‘anti-trade’. But criticizing free trade is not to oppose trade.

Apart from the benefits of specialization that the theory of comparative advantage extols, international trade can bring many benefits. By providing a bigger market, it allows producers to produce more cheaply, as producing a larger quantity usually lowers your costs (this is known as economies of scale). This aspect is especially important for smaller economies, as they will have to produce everything expensively, if they cannot trade and have a bigger market. By increasing competition, international trade can force producers to become more efficient – insofar as they are not developing country firms that would get wiped out by vastly superior foreign firms. It might also produce innovation by exposing producers to new ideas (eg., new technologies, new designs, new managerial practices).

International trade is particularly important for developing countries. In order to increase their productive capabilities and thus develop their economies, they need to acquire better technologies. They can in theory invent such technologies themselves, but how many new technologies can relatively backward economies really invent on their own?…For these countries, therefore, it would be madness not to take advantage of all those technologies out there that they can import, whether in the form of machines or technology licensing (buying up the permit to use someone else’s patented technology) or technical consultancy. But if a developing country wants to import technologies, it needs to export and earn ‘hard currencies’ (universally accepted currencies, such as the US dollar or the Euro), as no one will accept its money for payments. International trade is therefore essential for economic development.

The case for international trade is indisputable. However, this does not mean that free trade is the best form of trade, especially (but not exclusively) for developing countries. When they engage in free trade, developing countries have their chances of developing productive capabilities hampered…The argument that international trade is essential should never be conflated with the argument that free trade is the best way to trade internationally.”

Ha-Joon Chang (2014), Economics: The User’s Guide, Pelican Books, p.412-4.

To imitate or innovate? Firm behaviour and economic performance

innovative-manufacturing-headerSuccessful developing countries that have made the transition to advanced country status are relatively few in number. Those that have ‘made it’ in the wake of already rich countries have tended to adopt polices which encourage firms and sectors to ‘catch up’ over a sustained period.

When economies are far from the technological frontier they can achieve more when firms learn to use and adapt already existing technology rather than innovating themselves. Historically this has taken place in countries from the US and Germany to South Korea and Taiwan. One would expect firms to imitate technology more at an earlier stage of development, assuming that there are economies, sectors and firms ahead of them and closer to or at the frontier, while as they approach the frontier, innovation should become more important.

A recent article in the journal Industrial and Corporate Change looks into this process at the firm level. Ching T. Liao explores the differences between those firms that imitate others and those that innovate, and the effect this has on productivity. Continue reading

What sort of big government? Corporate welfare versus the common good in the US

For me, the argument is over. Big government is all-pervasive and inevitable in today’s democratic capitalism. Markets and states are or should be complements, not alternatives, in any society which is both wealthy and continuing to develop and improve the lives of its citizens in the widest possible sense.

This is not an argument for socialism, although there are some on the right who see big government as an evil leading inevitably to a totalitarian and repressive state. This remains a possibility, but it was big government that saved a system on the edge of collapse during the financial crisis, however imperfectly. Crises may be inevitable under capitalism, but it remains the job of government to improve economic and social performance by harnessing the dynamic potential of markets so as to serve the common good.

In today’s US, an unlikely president is unashamedly trying to subvert and dominate the system for his own ends. The process may seem incoherent, but perhaps it mostly boils down to serving a thirst for power and attempting to fill what some have called an ’emptiness’ at the heart of the man.

If one takes Trump’s recent State of the Union address as an accurate description of his political achievements and the state of the US, rather than analysing what he has actually done, one could be forgiven for thinking that all is well there. It is not.

This post is not an analysis of Trump’s achievements in office, rather a discussion based on three books which take a critical view of US capitalism and society, reaching beyond the current political cycle. Although each takes a slightly different perspective and more or less covers a different period in US history, the thread which links them is the idea that its economy and society are being held back by an excessive concentration of power. Continue reading

Don’t Be Evil. Rana Foroohar on Big Tech

The FT’s Rana Foroohar discusses the ‘evil’ side of ‘Big Tech’. She is pushing her new book, but it is an interesting interview which touches on a range of issues relevant to the economics, business, politics, finance and culture of this increasingly all-pervasive phenomenon.

Foroohar has also written on the dangerous and distorting power and influence of ‘Big Finance’, which has become known as financialisation and has generated a large and growing literature among political economists, particularly those writing in the Marxist and post-Keynesian traditions.