John Buell

Why Academic Economics Matters

Is academic economics responsible for the Great Recession that still haunts most of the world? Paul Krugman thinks the blame shouldn’t fall on mainstream economists. They had long accepted the theory that the proper fiscal stimulus could have averted a deep slump. Nonetheless, Krugman has come under harsh criticism — not from the right this time — but from a band of Left and other heterodox economics. They suggest that he shares certain key assumptions with his right wing critics, that these shared assumptions have blinded him to the fundamental causes of the crisis, and that consequently his policy responses, while preferable to the right’s do nothing stance, is still far from adequate. Indeed, Krugman’s attempts to square some progressive reforms with a conventional format has had the inadvertent effect of helping to cement conventional understandings of markets and a conservative political agenda.

Though Krugman has labeled these theoretical issues a sideshow and others may find the issues too “wonkish,” to use a favorite Krugman term, Krugman’s most famous mentor, Paul Samuelson, once hit the nail on the head: “I don’t care who writes a nation’s laws, or crafts its treatises, if I can write its economics textbooks.”

In an effort to avoid being overly wonkish myself, I will provide a brief commentary on Krugman’s most recent defense of his own approach to the crisis and its theoretical foundation. My comments are in brackets. Krugman purporting to summarize his critics: “the failure of economists to predict the global economic crisis (and the poor policy response thereto), plus the surge in inequality, show the failure of conventional economic analysis. So it’s time to dethrone the whole thing — basically, the whole edifice dating back to Samuelson’s 1948 textbook — and give other schools of thought equal time. [Heterodox economists seek only a place in the curriculum and access to journals. For decades editors of the mainstream journals have refused even to submit for review submissions not anchored in the market fundamentalist tradition. Lets see if the hegemony of market fundamentalism would stand in a genuine free market of ideas.]

Krugman: “It is true that economists failed to predict the 2008 crisis (and so did almost everyone). [Virtually all neoclassical economists failed, but several scholars working in alternative traditions ridiculed by Krguman did in fact either predict the crisis or advance concerns about growing economic instability. Krugman generally does not acknowledge them by name and seems uninterested in the paradigms and tools that led them to issue warnings.]

Krugman: “But this wasn’t because economics lacked the tools to understand such things — we’ve long had a pretty good understanding of the logic of banking crises.” [Krugman et al. understood the role of bank runs and the importance of deposit insurance, but he has a limited understanding of modern banking. It is not just shadow banks but other large depository institutions that initiated loans, increased the money supply, and encouraged booms in asset prices. Much of this should have been apparent even as far back as the dot com bubble, but was not in part because of the limited understanding of banks as mere intermediaries between what Krugman rather moralistically termed “patient savers” and “impatient investors.”]

Krugman: “What happened instead was a failure of real-world observation — failure to notice the rising importance of shadow banking. [What you see is in part a function of the lens you employ.]

The whole subject of prediction of the crisis deserves more attention than it has received from Krugman. Like his mentor Paul Samuelson, Krugman believed that the problem of depressions has been solved. If growth became sluggish and unemployment started to grow, reductions in the Fed’s interest rate could stimulate demand. Only in a severe downturn in investment where the interest rate has fallen to near zero does the interest rate mechanism fail to operate. This is the liquidity trap, of which Krugman often speaks. In those circumstances a fiscal stimulus — spending by the federal government — is necessary. Depressions and even prolonged recessions however, are not an intrinsic part of this model. Krugman’s greatest failure is not that he did not predict this recession but that his models do not build the possibility of major collapse into them. They picture an economic system that is largely linear and predictable and that moves rather seamlessly from one equilibrium to another. His quaint view of banking and his linear system dynamics each reinforce the other.

To his credit, Krugman does acknowledge the severity of the current crisis and advocates far more constructive fiscal response than any of his prominent colleagues. But nonetheless he can explain the current crisis only by resort to random external factors, such as an asset bubble. But why such bubbles occur or what is the role of and dilemmas created by uncertainty and speculation in modern market economies are not part of his scheme. In this regard he resembles an earlier generation of economists who could explain seventies stagflation (the simultaneous occurrence of inflation and high unemployment) — an anomaly for those who think in linear equilibrium terms — by reference to the OPEC cartel’s rapid price increases

Krugman reminds me of those ancient geocentric astronomers who tried to preserve an earth centric universe by adding ever more epicycles to the planetary orbits. But unlike the case of astronomy, when these efforts fail or are deemed inadequate, the “science” of economics may revert even more dogmatically to a pure market fundamentalism even while policy in practice unhesitatingly employs the power of government to enhance the interests of the most wealthy. Progressive and economic dissidents can and should work with Krugman in behalf of his humane concerns about health care, the minimum wage, and the long term unemployed. But mainstream economics needs more than a few fixes around the edges. It requires some countervailing prods from left and heterodox voices.

John Buell lives in Southwest Harbor, Maine and writes on labor and environmental issues. His books include Politics, Religion, and Culture in an Anxious Age (Palgrave MacMillan, 2011). Email Jbuell@acadia.net.

From The Progressive Populist, June 1, 2014