Debunking Economics: Steve Keen
I watched the ABC’s 7.30 Report yesterday (8.10.08), in which Steve Keen, Professor of economics at the University of Western Sydney, was interviewed about his views on the present global financial crisis. This reminded me of a book I read about four years ago by Steve Keen: Debunking Economics. The Naked Emperor of the Social Sciences. Pluto Press 2001. I read it very carefully from beginning to end, making numerous annotations, but had forgotten most of it.
I recommend the book strongly to anybody who is interested in economics, but particularly to those who believe that they have all the answers about the economy, without being blessed with the necessary background knowledge.
Steve Keen wrote the book to correct the misleading teaching of economics at universities. According to him (p.5), many students do only introductory courses in economics and then take their wisdom into their careers as managers, politicians etc. “They might learn, for example. that ‘externalities’ reduce the efficiency of the market mechanism. However, they will not learn that the ‘proof’ that markets are efficient is itself flawed. One needs an understanding of quite difficult areas of mathematics to realize the intellectual weaknesses of economics. ” However, Keen does not target economics in general, but the mainstream ‘neoclassical economics’.
A few quotes from the book:
p.2: “Economists blame these crises on particular economic policy failings by the relevant governments… Yet many non-economists harbour the suspicion that perhaps these crises were in some sense caused by following the advice of economists” This perspective was recently supported by none other than Joseph Stiglitz, a renowned economist, Chief Economist and Vice-President of the World Bank (he gives the examples of the collapse of the Russian economy after rapid privatization, and the Asian crisis, where the IMF’s enforcement of austerity seriously worsened a crisis which had been initiated by the international capital markets).
p.4: “Virtually every aspect of conventional economic theory is intellectually unsound; virtually every economic policy recommendation is just as likely to do general harm as it is to lead to the general good”.
p.7:”though weather forecasts are sometimes incorrect, overall meteorologists have an enviable record of accurate prediction” whereas the economic record is tragically bad.
p.8:”the intellectual discipline of economics shows no tendency to reform itself.”
p.11: the book’s message, that the economic mantra (”individuals should pursue their own interests and leave society’s overall interests to the market”) is wrong, is not new. Many books have made the same point in the past. What is new about this book is that it makes that point using economic theory itself.
Keen ‘debunks’ almost every assumption of neoclassical economics, including equilibrium assumptions. For each argument, he goes back to the basics, such as Jeremy Bentham’s utilitarianism, which really is at the basis of neoclassical economics with its claim that human behaviour is the product of innate drives to seek pleasure and avoid pain.
Of particular interest in the context of the present financial crisis is his detailed discussion of causes of crashes, e.g., those responsible for the Great Depression (the economic guru of the time, Irving Fisher, was dead sure that stock markets had permanently stabilized just weeks before the crash, an assumption based on his equilibrium theory, later distilled into the efficient markets hypothesis. He personally lost $100 million in the crash. He changed his ideas incorporating nonequilibrium assumptions. When the crash was over, people happily returned to his efficient market hypothesis, although it had been proven wrong).
I leave it at that and, again, recommend the book.
See also: http://knol.google.com/k/klaus-rohde/free-markets-and-free-trade-ecology-and/xk923bc3gp4/25#
October 10th, 2008 at 4:04 pm
From Wikipedia The efficient-market hypothesis states that it is impossible to consistently outperform the market by using any information that the market already knows, except through luck.
I am not sure how the great depression, stockmarket crashes, bank crises or anything of that sort prove the hypothesis wrong. Rather, the fact that the market beat Irving Fisher to a pulp goes closer to proving this hypothesis right rather than disproving it. I believe that the 1929 stockmarket crash, taken in isolation, can plausibly be viewed as an ordinary, if large, market correction. I don’t think that nor the depression that followed proves anything about “neoclassical” economics other than the fact that “bad” things can still happen no matter which theories you subscribe to.
I make a much bigger distinction between “self-adjusting systems” and “systems in equilibrium” than you do. A sytem that needs to be continually self-adjusting will obviously appear out of equilibrium for all intensive purposes. This does not mean it is not appropriately self-adjusting according to various market theories.
October 10th, 2008 at 5:05 pm
As John Maynard Keynes succinctly commented, “Markets can remain irrational longer than you can remain solvent”. I would add that the longer markets remain irrational, the bigger the pain and adjustment when reality eventually bites.
October 11th, 2008 at 6:41 am
The efficient market hypothesis (as originally developed by Irving Fisher) was used to make predictions about how the market would perform in 1929. These predictions were falsified by the crash. Irving Fisher then developed the Debt-Deflation hypothesis (explicitly based on nonequilibrium assumptions) to explain the crash, and Steve Keen apparently believes that the latter interprets the facts more correctly (high debts plus deflation lead to severe inbalances and a crash: very relevant today).
Concerning Keynes: indeed, if you are willing to accept anything, any disturbance whatsoever, as merely correcting an acceptable and unavoidable inbalance, you are welcome of course to do so and include it in your personal definition of equilibrium dynamics, but the consequences for many may be fatal. I am reminded of the St. Kilda sheep: they fluctuated from one extreme (severe overpopulation) to the other (almost total population collapse) again and again, briefly passing through the point of equilibrium on their ways up and down. If you calculate the “average”, a nice equilibrium indeed. I thought that humans had intelligence to avoid such disasters.
By the way, Adam Smith is not the father of excessive speculation, he wanted to limit it. The real father is Jeremy Bentham.
October 11th, 2008 at 6:48 am
I forgot: the reasons why Steve Keen refutes conventional “neoclassical” economics are not just the facts that crashes occur and have never been correctly predicted by neoclassical economists, but by his examination of the fundaments (basics) of the theory. I quote again:
“Virtually every aspect of conventional economic theory is intellectually unsound; virtually every economic policy recommendation is just as likely to do general harm as it is to lead to the general goodâ€.
What is the point of a theory if it cannot make correct predictions (not even approximately correct predictions)?
You should read the book.
October 11th, 2008 at 11:58 pm
What is the point of a theory if it cannot make correct predictions (not even approximately correct predictions)?
Can you understand this? If someone works out a way to predict the market, they can then invest in the market in such a way as to make money while the premises behind their predictions remain true. If his way of predicting the market becomes common knowledge among investors, the premises are guaranteed to stop being true as the net result of the average investor attempting to make money with this new information. Thus economics can never have an open scientific basis, because as economics facts become disseminated it changes the very truth they have just disseminated.
Predicting the market is like predicting whether a prisoner 1 will snitch not knowing whether their partner in crime snitched on them. The market is the net result of millions of dillemmas piled on top of each other. Thus, of the things experts on the economy can tell you, they really can’t objectively prove anything. Thus a book demonstrating that the theories of economists are based on false premises, and are therefore dangerously wrong misses the point. If a government wants advice on how to run an economy, who do you suggest they ask other than economists?
October 12th, 2008 at 6:45 am
“Can you understand this? If someone works out a way to predict the market, they can then invest in the market in such a way as to make money while the premises behind their predictions remain true.”
And this is what Irwin Fisher did prior to 1929. He made his millions believing in his own theory, but then unfortunately lost them.
“If a government wants advice on how to run an economy, who do you suggest they ask other than economists?”
Indeed, and this is the point Steve Keen makes: governments should ask economists, but the right ones. - The models used in neoclassical economics are wrong because they are based on static equilibrium assumptions. More realistic models are nonequilibrium dynamic ones. He discusses one example in detail, a chaotic model. It leads to cyclical fluctuations well in accordance with what you see in the economy. So, the answer is: governments should ask economists who are not trapped in traditional ways of thinking. After all, eminent economists like Stiglitz for instance, disagree with the advice governments have received from mainstream economist. - It is unlikely that they can be sure about the future, but their predictions will at least be more realistic, i.e., closer to what will happen.
October 12th, 2008 at 9:29 am
See also my previous post and listen to this interview with George Soros:
http://www.pbs.org/moyers/journal/10102008/watch.html?ref=reddit
October 12th, 2008 at 10:13 pm
So, the answer is: governments should ask economists who are not trapped in traditional ways of thinking.
So, what’s to say that what happened to Irwin Fisher won’t happen to one of these new age economic thinkers?
Economics tends to make fools out of “experts”. It’s the nature of the beast. Economists won’t repeat the mistakes of Fisher: They will make completely new mistakes, and be brought to account. It takes a brave man to stand behind their economic predictions.
October 31st, 2008 at 9:46 am
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December 17th, 2008 at 3:30 am
Tokyo: Japan is ready to offer $106 billion to the International Monetary Fund if it needs extra funds to help emerging economies, a Japanese government source said on Thursday, as a central bank board member warned the financial crisis has