Oh no, not Keynes again! New economic thinking urgently required

26 04 2010

Book Review

The Economic Crisis and the State of Economics Edited by Robert Skidelsky and Christian Westerlind Wigstrom, Palgrave Macmillan, 2010

The Institute for New Economic Thinking, funded by the billionaire George Soros, held its first Conference in early April 2010. Just in case we were not already aware of its intellectual underpinning, the event took place at Kings College, Cambridge, where Keynes developed his General Theory, sessions took place in the Keynes lecture theatre and many of the participants and speakers were neo Keynesians.

Much of the substance of the discussion that took place is prefigured in a new book of essays, The Economic Crisis and the State of Economics, edited by leading Keynesian Robert Skidelsky. Although written last year in response to the recession, its themes have now become central to the range of economists lined up in Soros’s new Institute. The three main themes which emerge from the selection of essays in the book are, first, the future is uncertain and cannot be predicted, secondly, no economic model can be trusted to work and thirdly, economics cannot be a science because it is driven by often irrational human behaviours. A fourth, although often tacit conclusion, is that the state has to be prepared to intervene in order to make up for the inadequacies of the market.

The main target of the essays is the Efficient Market Hypothesis (EMH), associated with the Chicago school of economists, the view that markets operate efficiently and that state intervention can only be damaging to the market mechanism by distorting market rationality. The general view expressed in this book is that the financial crisis has destroyed both the practical and intellectual basis for the EMH. The peculiar aspect of this debate is that, although it is true that the EMH has been popular amongst some economists in the past, it has had very little to do with the real world outside of academia. In the real world the 20th century saw ever increasing state involvement in the economy at every level.

The free market, outside of state control, subsidy and regulation, is a myth. In that sense the EMH is a straw man for the Keynesians to tilt at. If you have any doubt about the irrelevance of the EMH in the real world then just look at how the world’s leaders responded to the financial crisis. Governments everywhere stepped in with massive subsidies to keep the financial system afloat. Would leaders who were supposedly ideologically wedded to the principles of the free market have acted in such a concerted way to bail out the markets?

Economics and rationality

So if the demolition job on the EMH is of little value, is there any interest in what the Keynesians are saying? Yes, because what they are trying to do is to suggest that rationality is not possible in the economic sphere. John Kay, in his essay, Knowledge in Economics, says that ‘the test of an economic theory is whether it is useful rather than whether it is true’. P91 Paul Davidson, in Risk and Uncertainty, says that believers in the EMH, and indeed anybody who accepts the views of the classical economists Smith and Ricardo, are guilty of thinking that ‘the future is merely probabilistically risky but not uncertain’ P20. Davidson argues that the future is not predictable and therefore planning is pointless. All governments can do is be prepared to step in when things go wrong, which they inevitably will.

The Keynesians are expressing in their abandonment of rationality the viewpoint of those who feel that the world is out of control. Paradoxically perhaps there is a rational aspect to this viewpoint. The global market is indeed out of control, but only in the sense that markets always are and always have been. Markets are the antithesis of rational planning. It is only after production has taken place, money spent and resources used up, that you take the product to market and find out if there is a buyer. Enormous effort and time is wasted on products which turn out to have no buyer, leading to waste, bankruptcy and redundancy. That is how the market regulates the economy, through destruction.

It is because of the essential irrational nature of markets that the state has emerged over a long period to regulate and support the economy and limit the damage done to society as a whole when markets cease to function effectively. The challenge facing us all, especially in the aftermath of the global recession, is to work out what a more rational economic world would look like and how it would operate. After all, most production is essentially rational, in that it is about the meeting of human needs in one sphere or another and requires conscious activity in order to be effective. The key element that is missing, which the Keynesians recognise, is the absence of enough information about what is happening in the economy which would enable people to make rational decisions. But that is not a problem of economics but of politics.

How can we organise an economy in which people are sufficiently engaged in and have control over the consequences of investment decisions and their outcomes? This would be a good subject for the Institute for New Economic Thinking to consider.

After the recession-the return of Keynes or the end of economics?

21 10 2009

images[1]Robert Lucas, the University of Chicago economist, joked last year that “everyone is a Keynesian in a foxhole’. At first glance it certainly seems that the idea of government intervention to maintain economies in trouble has made a comeback. In the past year various governments have nationalised banks, introduced major stimulus programmes, prevented industries from collapsing, subsidised employment and printed money in order to combat the financial crisis.

Yet as Sean Collins has argued in his excellent review of Keynes: The Return Of The Master by Robert Skidelsky, whom I shall be debating next week at  this event  , the ragbag of anti-crisis measures put together around the world was not the product of any widespread conversion to Keynesianism. It was instead an ad hoc programme of state measures aimed at one thing-staving off financial collapse and its perceived consequences.

The Keynes they like is not the proponent of permanent state intervention to guarantee full employment. He is instead the man who said ‘in the long run we are all dead’. In so far as Keynesianism means anything today it represents the short term managerial approach to running economies which characterises the UK and other developed countries. Why has there been so much state intervention from governments which have been arguing for ‘light touch’ regulation for the past ten years? Because there is no alternative on the horizon.

The recession has effectively destroyed, at least for the time being, the belief in free markets that has governed most of the developed world since the discrediting of Keynes in the 1970s. As Sean Collins argues however, we should not go along with the thesis that the past thirty years have been about actual free markets. During this period the state has continued to intervene in the economy, although in different ways.

Nevertheless we have reached a point where economics itself has been discredited. As Daniel Yergin argues there are so many explanations for the recession that no coherent narrative has emerged. This vacuum is being filled by another legacy from Keynes. His belief in both the power of psychology and the essential uncertainty of the capitalism economy have become more influential in response to the recession. Both of these points are highlighted by Skidelsky in his book.

The falling back on psychological explanations for the crisis amongst behavioural economists is a rejection of real economics. The crisis has in roots in economic stagnation in the west, the consequent financialisation of western economies and global imbalances created by the relative dynamism of the BRICs. To ignore these causes and point to crowd psychology reduces the problem to one susceptible by state manipulation of people’s activity. In this sense it fits with the short termism we spoke of above. It represents an inability to face reality and think through what it would mean to create more dynamic western economies.

The elevation of uncertainty as a major problem is also wrong. Keynes, writing in the 1930s was obsessed with the threat of capitalist collapse. Faced with the Depression and looming global conflict this was not an unreasonable fear. It is to Keynes’ credit, in contrast with many who followed after him, that he understood that economics is about politics. His argument for full employment was that it was necessary to stave off revolution.

In fact one thing the recession has shown us is that capitalism is in general very stable and quite predictable. We are in the midst of a major recession but as I have noted before there has been very little social response. This is because capitalism is at root a system of social relations. No matter how bad the economy may get, as long as there is no organised alternative it will bounce back.

Emphasising the uncertainty and risks involved in capitalism today can only have one effect, one which Skidelsky himself recognises,’uncertainty imposes a kind of permanent fearfulness about the future which puts a damper on economic progress’. Skidelsky also criticises some of the behaviouralist economists, like Shiller, for ‘panic’ in the face of apparently irrational human behaviour in the run up to the recession.

There may be opportunities, due to the crisis within economics, to debate what kind of economy we need. This would entail rejecting the panic and uncertainty brigade and arguing for a longer term more strategic approach to the economy, more planning, more debate about where we want to go and above all more leadership.