Essentials of Heterodox and Post-Keynesian Economics

Marc Lavoie

University of Ottawa

The global financial crisis has had an impact on…

• Students of economics• Some reporters• Trade unions• Central bankers• The IMF

But little impact on …

• The European Commission• Most academic economists and their

economics departments

Where has economics been going?

• “Indeed, the typical graduate macroeconomics and monetary economics training received at Anglo-American universities during the past 30 years or so, may have set back by decades serious investigations of aggregate economic behaviour and economic policy-relevant understanding.”– Willem Buiter, 2009 (former member of the

Monetary Policy Committee of the Bank of England) 

Where could it go?

• Stop the growing hegemony of neoclassical economics in economics departments.

• Stop repressing dissent.• Change the curriculum.• Less emphasis on techniques, more emphasis on

history and institutions • Introduce more competition in the field of economic

ideas: bring in heterodox schools of thought

Outline

• 1. Heterodox economics versus orthodox economics

• 2. Post-Keynesian economics• 3. Who’s afraid of neoclassical

economics?

PART I

Heterodox economics versus orthodox economics

Heterodox vs Orthodox economics

• HETERODOX ECONOMICS

• NON-ORTHODOX ECONOMICS

• POST-CLASSICAL ECONOMICS

• RADICAL POLITICAL ECONOMY

• REAL-WORLD ECONOMICS

• NEW PARADIGM ECONOMICS

• ORTHODOX ECONOMICS

• DOMINANT PARADIGM

• NEOCLASSICAL ECONOMICS

• THE MAINSTREAM

• MARGINALISM

• OLD PARADIGM ECONOMICS

Heterodox schools in economics• Post-Keynesians• Sraffians (Neo-Ricardians)• Old Institutionalists• Marxists, Radicals• Development Structuralists (Latin-American school, Furtado,

Prebisch)• French Regulation School, Social Structure of Accumulation (SSA)• Neo-Schumpeterians• Circuitists• Social economics and Humanistic economics• Anti-Utilitarism (MAUSS)• Economists of « conventions »• Feminist economics• Green economics (Ecological Economics)• Old behavioural economics• And no doubt many others (Ghandi economics, Henry George,

Gesell, Polanyi, system dynamics, agent-based, Neo-Austrians(?)...

Macro-economics

Heterodox authors

Neoclassical school

Marxists CambridgeKeynesians

OldKeynesians

Monetarists

New Keynesians

New Classicals

RadicalsFrench

RegulationSchool

Post-Keynesians

KEYNES

Dissenters in economics

Heterodoxy Orthodoxy

Dissenters Mainstream

Examples of orthodox dissenters

• Milton Friedman• Amartya Sen• George Akerlof• Paul Krugman• Joseph Stiglitz• Oliver Williamson• Ronald Coase• William Vickrey ? • Herbert Simon ?• Keynes ?

What do all these heterodox schools have in common?• Differences between schools of thought and their

relative ranking have a lot to do with the sociology of the profession.

• Some of the discrepancies are due to specialization in certain fields (cf. T. Lawson).

• Still, in my opinion there are broad features that characterize heterodox and orthodox schools.

• These are called the presuppositions of research programmes by philosophers of science: they are things that cannot be questioned

Paradigm

Presupposition Heterodox schools Orthodox schools

Epistemology/Ontology Realism Instrumentalism

Method Holism, organicism Individualism, atomicism

Rationality Reasonable rationality Hyper rationalityOptimizing agent

Economic core Production, growth, income effects

Exchange, scarcity, substitution effect

Political core Regulated, tamed, markets

Unfettered market optimism

Presuppositions of the heterodox programme vs those of the mainstream

Instrumentalism vs realism

• Friedman’s as if doctrine• « Good models have to necessarily be artificial, abstract,

patently unreal » (Lucas, 1981)• « Of course, that model does not not represent reality and that

is not its purpose » (Bliss, 1975)• « It is better to be precisely wrong rather than roughly right »• Ex.: The use of the Gaussian copula function to price CDO

(collaterized debt obligations) was based on an index of CDS (credit default swaps) market prices instead of looking at true default rates.

Rationality

• “ Orthodox macroeconomists came to conflate being rational with thinking like an orthodox economist. What this implied was that agents knew the one and only true model of the economy (which conveniently was stipulated as identical with neoclassical microeconomics)”. (Philip Mirowski, 2011)

• ‘A systematic deviation from an “insane” standard should not automatically be called a judgmental error’ (Gerd Gigerenzer, 2008)

Scarcity versus production

• Economics is the study of scarcity (Robbins, 1932)• « Neoclassical economics is the study of an upward-

sloping supply curve with a downward-sloping demand curve » 

• Vs• « Economics is the study of the process by which

society brings its available resources into production, and the distribution of that production among its members. » (John Weeks, 2012)

Distrust in unfettered markets

• « On the one side are those who believe that the existing economic system is, in the long run, a self-adjusting system, though with creaks and groans and jerks and interrupted by time lags, outside interference and mistakes … . On the other side of the gulf are those that reject the idea that the existing economic system is, in any significant sense, self-adjusting »– Keynes, CW, xiii, p. 487 (1934)

Holism: Some crisis-related macro paradoxesParadox of thrift (Keynes 1936) Higher saving rates lead to reduced

output,

Paradox of costs (Kalecki 1969, Rowthorn 1981)

Higher real wages lead to higher profit rates

Paradox of public deficits (Kalecki 1971)

Government deficits raise private profits

Paradox of tranquility (Minsky 1975) Stability is destabilizing

Paradox of debt (I. Fisher 1933, Steindl 1952)

Efforts to de-leverage might lead to higher leverage ratios

Paradox of liquidity (Dow 1987, Nesvetailova 2007)

Efforts to become more liquid transform liquid assets into illiquid ones

Paradox of risk (Wojnilower 1980) The possibility of individual risk cover leads to more risk overall

Paradox of profit-led demand (Blecker 1989)

Lower wages lead to slower growth despite all countries being profit-led

Edward Fullbrook(2013): new paradigm

• Start from real data not apriorism

• Real-world rationality

• Holism• No market clearing• Disequilibria

• Pluralism• Math-formalism

upside-down• Radical uncertainty• Economy is a

subset of biosphere• Facts and values

are inseparable

Summing up this part….

• Heterodox economics is distinct from orthodox economics.

• The various heterodox schools of thought have a lot in common, especially on the methodology side.

• Different schools of thought often focus on different fields, so that their similarities are not always obvious.

• But just as there are battles between New Classical and New Keynesian economics, there are disagreements between various heterodox schools.

Part II

Post-Keynesian economics

Phases in the creation of PKE

• 1930s-1950s: The Beginnings: – Keynes 1936 Robinson 1956

• 1960s-early 1970s: The Capital controversies, the response to monetarism– Sraffa, Pasinetti, Garegnani – Kaldor, Davidson

• Mid 1970s-1980s: The Romantic Age– Kregel-Eichner, syntheses, institutionalization

• 1990s: The Age of Uncertainty– Methodology

• 2000s: The Age of Policy

PKE adopt the five general heterodox presuppositions

Specific post-Keynesian presuppostions

• The relevance of the principle of effective demand (demand-led economies)

– Both in the short and the long run– The supply adjusts to demand (inversed Say’s law), but

see Kalecki and Robinson on capacity constraints– The autonomy of investment from inter-temporal decisions

of households (investment causes saving)

• The importance and irreversibility of time– Historical time– Dynamics, the traverse– The long run is a consequence of a series of short runs,

there is no independent long run trend– Path dependence, multiple equilibria– Tracking financial stocks through time

Auxiliary post-Keynesian features

• Fundamental or radical uncertainty• A monetary production economy• Alternative microeconomics (little reliance on

substitution effects)• Diversity of methods and theories• Institutions make a difference (Monetary and fiscal

policies do have an impact on real quantities)

qqfc qth

AVC = DUC = mc

TUC

mc

AVC

The shape of cost curves

The various PK strands: 5-way typology

• Fundamentalist or Financial Keynesians: – Money, finance, liquidity preference, uncertainty, methodology– Davidson, Minsky, Kregel, Chick, Dow, Fontana

• Kaleckians: – Pricing, growth, cycles, employment, income distribution– Sawyer, Bhaduri, Dutt, Blecker, Fazzari

• Sraffians: – Relative prices, technical choice, input-output models, capital theory – Garegnani, Kurz, Pasinetti, Steedman

• Institutionalists: – Institutions (firms, banks), pricing, behavioural economics– Fred Lee, Peter Earl, Galbraith 2x, MMT (Wray)

• Kaldorians: – Growth, money, international trade, productivity growth– Godley, Thirlwall, McCombie, Palley

– Some authors go across the strands: Arestis, Nell….

Part III

Who’s afraid of neoclassical economics or why do neoclassical

theories always seem to be supported by empirical evidence?

Theoretical constructs rejected by PK economists

• NAIRU or the natural rate of unemployment• The loanable funds theory and the natural rate of interest• Crowding-out effects (except for possible psychological effects)• Say’s law• Inflation is a monetary phenomenon• Aggregate employment determined in the labour market• Higher saving leads to higher investment• The government debt constraint is similar to that of households• The efficient market hypothesis, in its various incarnations• That unemployment is only due to sticky prices• Bank reserves cause bank loans and deposits• Unit cost curves have a U-shape

Another theoretical construct rejected by PK economists

• The well-behaved neoclassical production function• For instance the Cobb-Douglas production function• This was at the heart of the Cambridge capital

controversies of the 1960s and 1970s• It was shown that standard results of neoclassical

theory obtained with such aggregate production functions did not hold in a model with two or more sectors (say, two sectors producing investment and consumption goods respectively)

L/K L/K

L/K

w/pw/p

w/p

LD

(a) (b)

(c)

LS

LD

LD

Cambridge UK vs Cambridge Massachusetts

The response of neoclassical economists

• « Placing reliance upon neoclassical economic theory is a matter of faith’ (Ferguson, 1969)

• Regressions based on the Cobb-Douglas seem to work, when properly specified. It works, therefore it exists (Empirism)

r

Real wagew/p y

R

y0

y1

y2

k0Rate of profit Capital-labour ratiok1

True relationship (Leontief) yt= (1/vo)kt

Pseudoneoclassicalproduction function

Shaikh

kk2

The counter of post-Keynesians• The coefficents of the regressions are supposed to

yield the output elasticies of labour and capital, which depend on technology, as in the Cobb-Douglas

Y = T.LaKb

• In reality, because macro data must be deflated, what is truly being computed by these regressions are the wage and profit shares in national income.

• This has been demonstrated by John McCombie (2001) (see the recent book of Jesus Felipe and John McCombie (Not Even Wrong, 2013)

This puts in jeopardy all of neoclassical economics because…

• « The neoclassical production function is the cornerstone of neoclassical theory and is used in virtually all applied analyses » (Prescott 1998)

• NAIRU measures, labour demand functions and wage elasticities; investment theory; measures of multifactor productivity or total factor productivity growth; estimates of endogenous growth; theories of economic development; theories of income distribution; estimates of cost functions; measures of potential output; theories of real business cycles; estimates of the impact of changes in the minimum wage, social programs, or in tax rates.

Further issue: publication bias

• Data fishing, data mining, data massaging• Now famous example: the Reinhart and Rogoff

(2010) AER study on the negative impact of public debt ratios above 90%

• Herndon, Ash and Pollin (2014) found there were coding mistakes, omitted entries, unconventional weighting.

• « Reviewers and editors [of academic journals] may be predisposed to accept papers consistent with the conventional view » (Tom Stanley, 2005)

Meta-regression analysis: regression on regression results

Meta-regression analysis …

• Shows that more than half of the fields of research suffer from severe publication bias.

• Falsifies the claim that larger government deficits lead to reduced household spending (Ricardo equivalence theorem)

• Falsifies the claim that there exists a natural rate of unemployment towards which the economy converges. Also falsifies the claim that expected inflation leads to a one-on-one increase in the rate of inflation. Thus, the NAIRU, which is at the heart of current monetary policy, is falsified.

The role of post-Keynesian economists (and young economists in general)• The crisis has clearly demonstrated, if such a

demonstration was needed, that there is something wrong with mainstream economics (Financial Times: “The credit crunch has destroyed faith in the free market ideology”).

• In view of these failures, it is our social duty to keep developing an alternative view of the economic system.

• It is our duty to sustain and clarify the heterodox traditions that question the efficiency of unfettered markets.