Bookblogging: Dead Ideas Introduction

by John Quiggin on July 15, 2009

Discussion on the first post in this series went really well, so I’m carrying on. Here’s the proposed introduction.1 Again, comments, both favorable and critical are very welcome and the best will be rewarded with a copy of Dead Ideas from New Economists (I’m back with the original title at present).

Updated As Chris Bertram points out, my second (or higher-order) hand attribution of the “Thesis, antithesis, synthesis” triad to Hegel was incorrect. As with Mundell’s impossible trinity, these terms weren’t used by Hegel (apparently they were borrowed from Fichte by Hegel’s popularisers). I’ve changed the text a bit and added a bit more about Marx and idealism/materialism, still trying to keep it at a level that will be good for a broad audience and avoid the risk of bringing in yet more errors. There’s lots more in the thread I will take into account in later parts of the book, coming soon. Thanks everyone, and keep the comments coming,


Introduction

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. JM Keynes

Most economics textbooks present the subject as a monumental scientific edifice, constructed by adding building bricks of empirical research to a solid and unassailable logical foundation. In reality no subject works this way, not even natural sciences like physics and chemistry. As philosopher Thomas Kuhn showed in his The Structure of Scientific Revolutions, periods of ‘normal science’, where a discipline is characterised by agreement on the methods of inquiry and the questions that need to be resolved, are interrupted by occasional ‘revolutions’ where one paradigm, such as that of Newtonian physics is displaced by a new and superior alternative, such as Einstein’s relativity theory.

In the terminology commonly associated with the great German philosopher Georg Hegel, economic thought is a dialectical process in which an idea (the ‘thesis’) meets its contradiction (the ’antithesis’) producing a synthesis which transcends its origins. This synthesis in turn encounters new contradictions and the process continues. There are plenty of examples of mechanical and simplistic application of the dialectical framework, but used carefully it can provide some powerful insights.

In Hegel, as in Keynes’ statement quoted above, it is ideas that drive economic developments. Karl Marx famously ‘turned Hegel on his head’ arguing that the economic interests of contending classes drive ideas and not the other way around.

The reality of the interaction between ideas, economic systems and economic power is far too complex to be reduced to a simple aphorism. At all times and places, ideas that start from the assumption that existing institutions are natural and providential and proceed to derive conclusions that are favorable to the interests of the powerful will receive a ready hearing, and such ideas are likely to be dismissed as absurd when the wheel of power turns. But economic realities are stubborn. Ideas that are inconsistent with reality will sooner or later be falsified, and economic systems based on those ideas will run into trouble.

It might be thought, more than 200 years after Adam Smith’s Wealth of Nations set out the classical framework that still guides much economic thought, that economics might have progressed beyond the stage conflict over basic ideas. But economic ideas do not develop in a historical vacuum. Big changes in economic thinking depend on major events such as economic crises, and such events occur only rarely.

The Great Depression of the 1930s was such a crises and it produced a revolution in economic thinking still associated with the name of its originator, John Maynard Keynes. Responding to what he perceived as the absurdity of a classical economic theory proclaiming that a market economy would inevitably return to full employment ‘in the long run’, Keynes observed tartly that ‘in the long run we are all dead’. In his General Theory of Employment, Interest and Money, Keynes developed a model of the economy in which high levels of unemployment could represent a persistent equilibrium. The classical full employment model was reduced to a special case of Keynes ‘General Theory’.

In the hands of Keynes’ successors, such as John Hicks, the Keynesian model of the aggregate economy became the new subject of ‘macroeconomics’, contrasted with the classical model of individual makrets, now christened ‘microeconomics’. Hicks produced a graphical synthesis of Keynesian and classical macroeconomic ideas, taught to generations of students as the IS-LM model after the two curves on which it relied. In the process, Hicks relied heavily on some of Keynes’ ideas, but ignored or discarded others, much to the dismay of more purist Keynesians such as Joan Robinson.

Whether or not it was entirely true to Keynes, the Hicks synthesis produced a theoretical framework to justify policies Keynes had long advocated, of using public works programs and other fiscal policy (that is, changes in tax rates and public expenditure) measures to stimulate demand for goods and services during periods of recession. Conversely, as Keynes argued in How to Pay for the War, the government should use budget surpluses in periods of strong economic growth to restrain demand and reduce the risk of inflation.

The combination of Keynesian macroeconomics and neoclassical microeconomics provided both an ideological justification for the ‘mixed economy’ that emerged after World War II and a set of practical policy tools for its economic managers. The mixed economy was, arguably, the first and most successful example of a ‘Third Way’ between the traditional antagonists of socialism and unrestrained capitalism. The increased macroeconomic role for government went hand in hand with the postwar expansion of the welfare state, already anticipated by such developments as the New Deal in the United States, and the anti-depression policies of social-democratic governments in such far-flung countries as Sweden and New Zealand.

The contrast between the privations of the Depression and war years and the prosperity of the 1950s and 1960s was striking, and transformed the political landscape in the developed world. The laissez-faire doctrines of economic liberalism were discredited, seemingly forever. While conservative parties continued to employ the rhetoric of the free market, the social-democratic reforms adopted in response to the Depression formed the basis of political consensus.
For the next thirty years, the combination of Keynesian macroeconomics and the liberal and social democratic versions of the welfare state were associated, at least in the developed world with strong economic growth, full employment, enhanced equality and improvements in public services of all kinds. It was these developments, and not the posturing of the Reagan era, that guaranteed the defeat of Communism.

During these decades, the victory of the Keynesian revolution was universally recognised and generally perceived as final, despite the grumbling of a relative handful of neoclassical critics, centred on the University of Chicago, and, on the left, an even smaller handful of post-Keynesians and Marxists who derided the new synthesis and its tools as ‘hydraulic Keynesianism’ and ‘a permanent war economy’.

But by the late 1960s, a counter-revolution was brewing. Inflation rates were rising, and the most compelling analysis of the problem was provided by Chicago economists such as Milton Friedman, who argued that expansion of the money supply would inevitably cause inflation, whatever fiscal policy responses Keynesians might propose.

The economic chaos of the early 1970s, including the breakdown of the ‘Bretton Woods’ postwar system of fixed exchange rates, the OPEC oil shock was seen as vindicating Friedman. The biggest blow to Keynesianism was ‘stagflation’, the simultaneous occurrence of high unemployment and high inflation. In the standard Keynesian model of the day, which postulated a trade-off between unemployment and inflation (the famous ‘Phillips curve’), this could not occur. Friedman’s model, which took into account expectations of inflation that were incorporated into wage bargains, appeared to explain stagflation.

In the space of a few years, Friedman’s ‘monetarist’ macroeconomic policies had largely displaced Keynesian demand management. But the counter-revolution did not stop there. In macroeconomic theory, Friedman’s relatively modest (and empirically well-founded) changes to the Keynesian IS-LM model were succeeded by a full-scale return to the orthodoxy of the 19th century, under the banners of ‘rational expectations’ and ‘new classical’ macroeconomics.

Friedman’s macroeconomic success prompted widespread acceptance of the free-market views on microeconomic issues he had long advocated both in academic research and in popular works such as Free to Choose and Capitalism and Freedom. Other advocates of the free market such as FA von Hayek enjoyed a similar vogue. The new version of free market ideology that emerged from the 1970s has been given various (mostly pejorative) names such as neoliberalism, Thatcherism and economic rationalism. I prefer the more neutral term ‘economic liberalism’.

Speculative activity in financial markets had been seen by Keynesians as a crucial source of economic instability. During the Bretton Woods stringent controls were imposed on national financial markets and international capital flows. During and after the monetarist counter-revolution, these controls broke down, ushering in an era of financial deregulation. Over the ensuing decades, the financial sector, a minor and tightly controlled industry during the postwar years, experienced an explosion in the volume and complexity of trade, the profitability of the industry and the lavish rewards to industry participants.

This development called for, and received theoretical support from the economics profession in the form of the efficient markets hypothesis. Building on the relatively innocuous observation that the efforts of stockmarket ‘chartists’ to predict the future movements of stock prices from their past behavior were futile, the efficient markets hypothesis was developed to the point where it was seriously suggested, in the wake of the September 2001 attacks, that the best way to predict terrorist attacks would be to open a futures market.

The general acceptance of the anti-Keynesian counter-revolution was predicated first on the necessity for a way out of the economic chaos of the 1970s and early 1980s and then on the widespread prosperity it delivered from the 1990s onwards. Although problems became steadily more evident, they were ignored as long as profits kept rising and economic growth kept on keeping on.

The economic crisis that began in the US housing market in 2007 and had engulfed global financial markets by late 2008 showed clearly enough that there was something wrong with the dominant economic paradigm. While old-fashioned Keynesians on the left, and advocates of the Austrian School on the right, had pointed to growing economic imbalances as a source of impending disaster, economic liberals continued until well into 2008 to argue that any problems were minor and easily contained.

While it may be satisfying to observe that so many experts got the crisis wrong, it is not really useful. The big question is “What economic doctrines have been refuted by the crisis and what new doctrines (or improved versions of older doctrines) should replace them?”. This book aims to answer the first of these questions, and to provide at least some suggestions on the second.

1 I’ve been out of order so far, but, after correcting with this post, I plan to offer excepts in the order I want them to appear.

{ 87 comments }

1

A. Y. Mous 07.15.09 at 11:28 am

Very interesting. But is it necessarily a compulsion that you have to talk economic theory only from Adam Smith onwards? A lot of dead people before Smith was even born!

Plus, on a 1-10 scale, how much of your book lies between Los Angeles and Amman? From the two excerpts, I see it going to eleven. Half a circle maketh not a sphere.

Still, as I said, interesting.

2

dpinkert 07.15.09 at 1:18 pm

I agree this is very interesting. But was “monetarism” (insofar as it is a doctrine about monetary policy) really so dominant for such a long period of time? I thought it was largely abandoned during Volcker’s stewardship at the Fed.

3

Hidari 07.15.09 at 1:29 pm

It would help economic ignoramus’s like me a lot if a precise definition of the Efficient Markets Hypothesis (EHM) was given, giving special care to define the word ‘efficient’ in such a way that even I can understand it. And for that matter, ‘markets’.

For example:

‘This development called for, and received theoretical support from the economics profession in the form of the efficient markets hypothesis. Building on the relatively innocuous observation that the efforts of stockmarket ‘chartists’ to predict the future movements of stock prices from their past behavior were futile…..’

Just to let you know, I don’t understand that second sentence at all, and I don’t know what ‘chartists’ means in this context. I also don’t understand why the unpredictability of markets should lead one to believe that they are efficient.

Sorry to be dumb here, but if the book is for the ‘lay’ reader then you can’t assume any real background knowledge of economics.

4

F. Blair 07.15.09 at 1:34 pm

“Building on the relatively innocuous observation that the efforts of stockmarket ‘chartists’ to predict the future movements of stock prices from their past behavior were futile”

Is this really true? I though that the EMH — as opposed to some comment about the randomness of prices — really began from a much more germane observation, which is that only a very small percentage of money managers outperform the market over time. If you’re trying to figure out whether the market is the best available guide to prices (as opposed to a perfect guide), figuring out whether there are better guides — that is, individuals who can do a better job of allocating capital — seems like the relevant question.

5

Paul 07.15.09 at 1:56 pm

The thought of pondering economic theory makes me almost catatonic. Economists and accountants are a threat to civilization ! :-)

6

Bunbury 07.15.09 at 2:48 pm

Hidari,
It is actually quite difficult to state the EMH precisely but this site rounds up a few attempts and so gives a flavour of what’s involved. They let some words , “economic profit” for example, do a lot of work.

A Chartist is someone who attempts to make market or investment decisions by looking at charts of economic indicators — in other words and after a jargon transplant, an Econometrician. The reasoning behind the second sentence is that if Chartists were able to make predictions then there would be prices that do not reflect information available just by looking at the history of the price. Thus an efficient market would have to be unpredictable. On the other hand if it were unpredictable it would be efficient in the sense that you couldn’t predict it. Here predict is means predict under or over performance.

There are several strengths of definition of the EMH and presenting it as above neatly focusses on the weak form without getting bogged down in quibbles. It does miss out on a more natural motivation for the EMH: there are a lot of smart and well motivated people looking for ways to make money out of the market and they have very similar information so why should you know any better?

7

Chris 07.15.09 at 2:55 pm

The general acceptance of the anti-Keynesian counter-revolution was predicated first on the necessity for a way out of the economic chaos of the 1970s and early 1980s and then on the widespread prosperity it delivered from the 1990s onwards.

I think you may want a different word here instead of “widespread”. In the US at least, IIRC substantially all the economic growth of that period was captured by the top quintile, and real wages for the majority stagnated, with rising consumption allowed only by looser credit and greater consumer indebtedness, eventually culminating in the current crisis. Since the working and middle classes ended up worse off than in the postwar period (except for the fruits of technological advancement), “widespread prosperity” seems seriously misleading.

If you mean that the prosperity was *geographically* widespread (rather than demographically, which unless you have different statistics than I’ve seen, it wasn’t, although to be fair I don’t know if the US was typical during this time period), then maybe “worldwide” would convey that more clearly.

P.S. To me the overall sense of the passage is pointing in the direction of a synthesis of the most-confirmed-by-experience parts of Keynesianism and Friedmanism (given the invocation of Hegelian dialectic as the only way economics progresses). If that’s not what you intend to present, then the reader’s expectations may be disappointed (unless of course my interpretation is idiosyncratic).

8

Hidari 07.15.09 at 3:14 pm

‘The reasoning behind the second sentence is that if Chartists were able to make predictions then there would be prices that do not reflect information available just by looking at the history of the price.’

Sorry to be stupid here, but after looking at that sentence with an increasing headache for ten minutes I still don’t understand it.

Is there a missing assumption here? Is the ‘hidden’ assumption that new information is always being ‘introduced’ to the market? Therefore if one could infer the current/future price of X from its past price then by definition it’s not keeping ‘up to date’ so to speak, with the new information?

If that’s the case then at least I understand why efficiency precludes deterministic inferences from past performance.

But I still don’t understand why it’s inherently unpredictable? Surely any new information, in a ‘perfect’ market would also be instantly known by the Chartists as well? Isn’t that what almost all the definitions linked to presuppose?

9

nnyhav 07.15.09 at 3:17 pm

If working toward a general equilibrium theory of economic theories, shouldn’t one say so?

10

matthew kuzma 07.15.09 at 3:22 pm

“Conversely, as Keynes argued in How to Pay for the War, the government should use budget surpluses in periods of strong economic growth to restrain demand and reduce the risk of inflation.”

There’s an idea that has been ignored for too long. I can’t imagine how hard this would be to sell, politically, but I think it’s the only adequate response to deficit spending. If governments ought to respond to economic hard times by spending on a scale large enough to steer the economy, at precisely the same time as their own sources of income are depressed, the only way to expect them to operate sustainably is if they also sock money away during the economic booms.

11

Hidari 07.15.09 at 3:33 pm

Stop Press!
OK i just looked up the Wikipedia.

‘In finance, the efficient-market hypothesis (EMH) asserts that financial markets are “informationally efficient”, or that prices on traded assets (e.g., stocks, bonds, or property) already reflect all known information, and instantly change to reflect new information. Therefore it is impossible to consistently outperform the market by using any information that the market already knows, except through luck.’

OK! You can’t buck the markets because anything you might know, ‘everyone’ immediately knows, and so it will immediately be reflected in the prices, and ‘Information or news in the EMH is defined as anything that may affect prices that is unknowable in the present and thus appears randomly in the future.’

OK now I get it.

12

geo 07.15.09 at 5:01 pm

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else.

Is Keynes right about this? I’ve always found Marx’s classic formulation of historical materialism more plausible: “In every epoch, the ideas of the rulers are the ruling ideas.” I understand him to mean by this that, however ideas come into the world, they need to be propagated in order to have any effect. This takes money (or whatever is the currency of social power at the time). In contemporary industrial societies, the manufacture of consent is a sophisticated and expensive affair, aiming at influence over education, media, and scientific research as well as government. Only one social group, business, has the resources and organization to undertake it, hence the overwhelming dominance of pro-business ideology, at least in the United States. Of course, there are intrinsic limits: even the Business Roundtable can’t prevent widespread popular belief that 2+2=4. But they can — and so far have managed quite nicely to — prevent the idea that, say, cooperation may be sometimes more desirable than competition, or that truly drastic economic inequality is inimical to political freedom, from gaining any traction.

13

Katherine 07.15.09 at 5:09 pm

I’m sure I’m jumping ahead here (and/or misunderstanding and/or oversimplifying), but didn’t Stieglitz (and someone else) win a Nobel Prize for proving that you couldn’t have a state of perfect information? Or something?

14

Akshay 07.15.09 at 5:22 pm

Nice intro!

I would suggest that you can’t simply neglect Marx in either the intro or the book; the GFC has a strong political-economic dimension. The sight of accumulation, verelendung, political control by corporations, capitalism-succumbing-to-crisis, ideological subservience and manipulation, etc. certainly reminds this reader of him. I therefore think one of the answers to your second question should be to return economics to its broader roots as *political* economy.

Similarly, where does your own tradition of Social Democracy come from? Since you are presumably going to push it in the conclusion of the book, you might want to use the introduction to plant the ‘gun’ you will use in Act III. At the moment your rhetoric suggests a return to ‘true’ Keynesianism will be necessary. But doesn’t democratic socialism have other roots than Keynes? The US might have been Keynesian once, it was never Social Democratic.

A minor pedantic point, but about the very first paragraph: There is a vast secondary literature pro and contra Kuhn. See, for instance, the Stanford Encyclopedia of Philosophy entry on Scientific Revolutions. I would ask a philosopher to check, and if necessary amend, your two-line summary about what has been “shown” in this debate. IMHO, Special Relativity is a bad example of a ‘Kuhnian’ revolution. It would more easily provide fodder for the contra Kuhn camp. (To make a long story short, Classical Mechanics has not been ‘displaced’)

15

engels 07.15.09 at 6:28 pm

Is Keynes right about this?

Without venturing anything substantive on this very interesting issue, I’m not sure your Keynes quote and your Marx quote contradict each other. I take Keynes to be pointing to the tremendous influence that the ideas of philosophers and economists have, even over people who claim to be guided by common sense and uninterested in theory–such people invariably turn out to be unacknowledged followers of an old, well-entrenched theory. I don’t think Marx would really go along with this in general but in this particular quote all I think he is saying is that the theories and ideas that become dominant in any given society are those of (that serve the interests of) the ruling class. One could happily endorse both these points, I think: practical men of business in America today are usually the slaves of a defunct economist, but the fact that the defunct economist in question happens to be Milton Friedman may be explained by the Marxian/Chomskyan processes you talk about… But I haven’t actually looked at the context for either quote so I could be I am being dumb.

16

engels 07.15.09 at 6:44 pm

Keynes does say ‘The ideas of economists and political philosophers, both when they are right and when they are wrong,’ so it is not as if he is claiming that ideas rise to prominence on their intellectual merits or something, in a way that would have to exclude the possibility of ruling class interests playing a role, even a determining role. But I should probably read Keynes before spouting off any more.

17

JoB 07.15.09 at 6:44 pm

John,

I guess mainly what geo said @ 11 (possible the best remark here in days).

But also this:

This is the second excerpt and the second time you start of with a quote of Keynes; not only is that one-sided but it also plays into the perception that the title can be whatever as the content will be neo-Keynesian (which is rather fashionable these days anyway).

I’d venture to suggest you’d better start your introduction with the dead ideas of post-Keynesianism. You could work in geo’s thought, maybe setting the scene in Davos (I’m sure there just has to be a transcript out there of a panel discussion that is so ridiculous now with the benefit of hindsight that it’s hilarious in a ‘how-was-she-called’ does Palin type of way). Work with the promises of eternal bliss of deregulation – the promises of American dreams – the automatism of automatic market-propelled equality (in fact, it has to be possible to start with a Blair quote) and then go back to deviled old notions & let the reader conclude herself how ridiculous it was to write off all of that.

Come to think of it, Kuhn is part of your problem. The paradigm shift thing is exactly a notion that supports the kind of theoretic revolution that neo-liberals propagated; just ignore the progression of thoughts & start with a clean slate. It also happens to be what allows the ruling few (those present in Davos minus the court jesters now Nobel prizer) to insitigate a ruling idea that’s beneficial to those that rule & gives them the semblance of ‘good’ moral agency.

PS: Chris, yes but no: the worldwide benefits do not derive from the ideas John is going to try to refute. Not everything surrounding free market theory is one pot of baddies & globalization of trade certainly produced many goodies like this. But I’d be surprised if somebody would demonstrate that financial deregulation benefited developing world – if that would be so, why would China have a distinct advantage in Africa.

18

bert 07.15.09 at 6:55 pm

re #11
I went to a book event by Gillian Tett (“Fools Gold”) last night.
Discussing the financial elite, and in particular the princes of the capital markets, she namechecked Pierre Bourdieu. Interesting.

19

Chris Bertram 07.15.09 at 7:17 pm

You’ll want to drop the thesis-antithesis-synthesis bit John, that *wasn’t* Hegel’s language, in fact.

20

SamChevre 07.15.09 at 7:25 pm

Over the ensuing decades, the financial sector, a minor and tightly controlled industry during the postwar years, experienced an explosion in the volume and complexity of trade.

That “tightly controlled” portion needs to be explained, or something–because it doesn’t fit my knowledge of the world.

Banks were more controlled in some respects, less controlled in others. (Regulated interest rates, regulated service areas, but not much attention to risk concentration.)

Insurance was far less regulated.

Both those regulatory regimes disintegrated/failed spectacularly when interest rates became unstable (roughly, 1975-1985) but at least in the US, both banking and insurance are much more regulated than was the case in 1975.

It’s my impression that stockbrokers/underwriters/public companies were also less regulated (short-selling, insider sales, research/sales/underwriting entanglements), but that isn’t my area of expertise.

It seems that two key factors were more economic climate issues than regulatory issues. First, trading and information costs and time lags were much greater, producing a fair amount of friction (which tends toward stability). Second, interest rates and commodity prices were relatively stable.

21

John Quiggin 07.15.09 at 8:54 pm

Chris B, I guess I’d prefer to keep the language and drop the attribution to Hegel. Does someone else deserve the credit, or is it one of these cases where the basic idea is in Hegel, but the most compelling encapsulation is not. In economics there is the Impossible trinity, not to mention the Keynes-attributed quote that the market can stay irrational longer than you can stay solvent.

22

bert 07.15.09 at 9:38 pm

If the question of the title is still open, can I say that I prefer the suggestion made in the previous thread: “Zombie Economics”. (You may or may not like the echo of “voodoo economics”, a dismissive country-club-Republican criticism of the Laffer curve.)
I’m not sure a general readership will queue up for a book full of dead ideas, whoever they’re from. And as others have suggested, the spoonerism may be a little arcane. But that’s just my subjective take.

By the way, my comment at 6.55pm was a response to Scialabba. Whenever soc1al1sm is discussed, comment numbers tend to be a work in progress, I’ve found.

23

Chris Bertram 07.15.09 at 9:45 pm

I think it was devised by a Hegel populariser (I can’t remember who exactly) and then taken up by Marx.

24

Tim Dymond 07.15.09 at 9:49 pm

Regarding people’s unfamiliarity with certain terms (e.g. chartist, EMH etc) – I know you will explain these throughout the book, but have you considered including a glossary that people can readily refer to while they are reading? If you want to be more literary you could also have a ‘dramatis personae’ list of the book’s characters (economists, politicos and whoever else) as I imagine there will be a lot names bobbing up in the text. That way you may not have to detain yourself too long introducing them in each chapter.

25

gcwall 07.15.09 at 10:59 pm

The most dramatic change that I have observed taking place over the past several decades is the abandonment of pure research for research that serves a particular end. If this is the case than arrogance has created an aristocracy that attempts to manipulate reality to serve its purposes rather than a scientific approach that informs from discoveries deduced from activities that produce empirical data out of real interactions within an economic system. The abandonment of what is real for what a particular class wants the masses to believe is real creates an environment in which only the most powerful and influential can survive. It might be better to refer to modern economics as survival economics for a particular class of individuals that creates arbitrary paradigms designed to enhance its control of the economy over the welfare of society regardless of the harm or expense to the majority or a second tier lower class.

26

Jock Bowden 07.16.09 at 12:23 am

Hidari/JQ

Hidari’s quote from Wikipedia is the clearest and most succinct statement of EMH so far.

John, I wonder if it is necessary to muddy the waters by introducing references to Chartism, which, let’s face it, is a bit like astrology. The idea of EMH is to demonstrate in a very abstract sense that an individual cannot consistently outperform the market, as an individual can never have access to all the information that has gone into setting the price of a security at any point in time. The corollary being, if that investor has inside information that the market does not, then that investor has more information than the market and thus could then outperform the market.

27

Jock Bowden 07.16.09 at 12:27 am

JQ

Promising start. But I wonder about the wisdom of incorporating notions of Kuhnian paradigm change and Hegelian dialectics.

As you say, Kuhn’s paradigm concept was built for the physical sciences, not the social sciences. Remember, the central concept in Kuhnian paradigm change is the incommensurability between the old paradigm and the one that has replaced it. Correct me if I am wrong, but are you saying in the twentieth century the paradigm changes went from pre-war ‘the absurd classical economic theory’ (whose only practitioner you mention – Adam Smith – thrived in the 18th not 20th century, then to Keynes, then to Friedman’s monetarism synthesised with 19th-century-based ‘new classical’ macro, which you choose to call “economic liberalism”?

If so, you might want to rethink mixing Hegelian/Marxian dialectics with Kuhnian paradigm change. If you are going to use dialectics and its marxian cognates of thesis > antithesis > synthesis, the reader will want to know why you are not using the economic theory that goes with it – marxian crisis theory. This is especially confusing as you claim the “the traditional antagonists of socialism and unrestrained capitalism.” These terms are just dumped in, unexplained, and unhistoricized”. It leaves the reader bewildered as to the differences – if any – between “antagonists/thesis-antithesis/paradigm change”

You could clean this sentence up, as at present it is hard to get what you mean:

In the language of Hegel, it is a dialectical process in which an idea (the ‘thesis’) meets its contradiction (the ’antithesis’) producing a synthesis which transcends its origins.

Are you saying it is the ‘synthesis’ which transcends its origins? If so, I am not really sure how that happens. Are you saying the thesis was Keynesian macro aggregate demand management, the antithesis was neoclassical micro, and the synthesis was Hicks’ IS-LM model? The new antithesis was Friedman monetarism, and the new synthesis was “economic liberalism”?

I have a few more suggestions, but I’ll wait for your response just to make sure I am not missing something completely.

28

P O'Neill 07.16.09 at 1:37 am

Is there going to be a refuted doctrine for exchange rates? You mention the demise of Bretton-Woods. And floating exchange rates certainly opened up the lucrative trading revenue from exchange rate speculation. But monetarists always seemed schizophrenic about exchange rates, some viewing it as “just another price” while others argued for fixed exchange rates against a real anchor — the goldbugs that Krugman talks about. Yet actual policymakers seem to prefer something in between: currency unions or highly managed floats if they do leave the exchange rate somewhat flexible. Yet the Wall Street Journal did years of exulting about currency boards although it’s been quiet recently now that the painful adjustment costs that they impose are more obvious (see Latvia). So what does seem refuted is either independently fixing the exchange rate or completely ignoring it. I suspect that there are juicy classical/monetarist quotes out there advocating both of these positions.

29

Walt 07.16.09 at 4:05 am

The “thesis, antithesis, synthesis” terminology is usually attributed to Fichte.

30

Robert 07.16.09 at 6:55 am

I probably am weak on how to write for the target audience. But I have lots of problems with what I’ve seen so far. It seems focused on surface ideas. For instance, if I were to offer an idea in contrast to the EMH, I would talk about Joan Robinson’s contrast between theories set in historical and logical time. Paul Davidson, by writing about non-ergodicity, offers a formal characterization of historical time.

In general, I don’t expect John to be fair to Post Keynesians. For example, I don’t see how Monetarism ever was more “compelling” than Post Keynesianism in the analysis of stagflation, however much the profession disagreed.

I have trouble with talk of paradigms in economics. Sometimes people are talking about different ways of understanding actually existing capitalist economies. And sometimes people are talking about different ways of organizing economies. I can see why one might argue the distinction is not hard and fast. But if one wants to be using the idea for both, as seems to be the case in John’s extract, I think one should be making a conscious decision.

As far as refuted ideas of the sort John seems to be interested in, I have another. Some have been suggesting – I wish I could recall better who – that the way to align the incentives of corporate managers with stockholders is to give them stock options. One might here go back to Enron and such corporate scandals, before the global financial crisis, for refutation.

31

Robert 07.16.09 at 7:08 am

What I am recalling as a model for John is John Cassidy, “The Greed Cycle”, The New Yorker, September 23, 2002. (My name links.) The refuted idea is put forth in a 1990 Harvard Business Review article by Michael Jensen and Kevin Murphy.

32

John Quiggin 07.16.09 at 8:01 am

Are you saying the thesis was Keynesian macro aggregate demand management, the antithesis was neoclassical micro, and the synthesis was Hicks’ IS-LM model? The new antithesis was Friedman monetarism, and the new synthesis was “economic liberalism”?

Yes to the first and no to the second. The synthesis of new classical and Hicksian IS-LM was micro-based macro (RBC and New Keynesian) to which I’ll be coming soon.

I’d say (also responding to Robert above) that economic liberalism was the (ideal of) the policy system for which new classical macro and free-market micro were the theoretical basis.

Now both the theoretical and the policy paradigms have failed, and we need a new synthesis (with the role of antithesis being played by Minsky-type post-Keynesianism, behavioral econ and some elements of Austrianism).

All of this is obviously mechanistic/schematic, and I don’t intend to present the arguments in this way, but I find it a useful way of thinking about things, whether it’s due to Fichte, Hegel or (pre-inversion) Marx.

33

Jock Bowden 07.16.09 at 8:11 am

JQ

You would be well advised not to include both Kuhnian and Marxist ideas together, as Kuhn was largely motivated by anti-Marxism. And if you include any Marxism, your thesis will get hammered from a Marxist perspective, as the ideologies you set up as antithetical, a Marxist does not.

34

Chris Bertram 07.16.09 at 9:13 am

#33 Whatever Kuhn’s motivations, very similar ideas are present in the Marxian tradition: for example Althusser uses the concepts of “problematic” and “epistemological break” as derived from Bachelard and Canguilhem.

35

JoB 07.16.09 at 9:13 am

In other wors, if you don’t drop Kuhn I won’t even read my free copy ;-)

36

Tracy W 07.16.09 at 9:18 am

Quiggin: It might be thought … that economics might have progressed beyond the stage conflict over basic ideas.

Who might think this, and whether they have good reasons for thinking this, are interesting questions. After all physicists have been sitting around with two conflicting theories about reality (relativity and quantum physics) for several decades now, astronomers briefly had ages for oldest stars older than their age of the universe and recently and famously recently changed their consensus even about the number of planets in the solar system.

On the other side, in economics the labour theory of value does appear to be dead in the water, and it’s generally agreed that it’s not obvious that centrally-planned economies are inherently more efficient than market economies.

In terms of macroeconomic policy, we’ve only had the system of national accounts since after WWII, which makes analysing whole economies pre-WWII rather difficult, and of course we can’t put a whole economy in a lab and perform experiments on it, so it’s hardly surprising that macroeconomists are still having conflicts over basic ideas.

In the process, Hicks relied heavily on some of Keynes’ ideas, but ignored or discarded others, much to the dismay of more purist Keynesians such as Joan Robinson.

It’s interesting that a guy like Keynes, who made a couple of vivid statements about the okayness of being wrong, for example “There is no harm in being sometimes wrong — especially if one is promptly found out. ” would wind up with ‘purist’ followers.

This development called for, and received theoretical support from the economics profession in the form of the efficient markets hypothesis. Building on the relatively innocuous observation that the efforts of stockmarket ‘chartists’ to predict the future movements of stock prices from their past behavior were futile,

Again, the Efficient Markets Hypothesis first came in three forms, the weak form of course was that chartism doesn’t work, but the semi-strong and the strong forms of the hypothesis are not innocuous. That’s why the EMH attracted so much empirical attention.

the efficient markets hypothesis was developed to the point where it was seriously suggested, in the wake of the September 2001 attacks, that the best way to predict terrorist attacks would be to open a futures market.

This statement is wrong. In the first post you made on this topic, I pointed out that the reasoning behind predictions markets is not dependent on the efficient markets hypothesis, at least not the EMH as defined by Fama, which is what I think most readers will think of when you start talking about EMH. To quote from the Statement on Prediction Markets (which I admit I forgot to provide a link to previously, see http://papers.ssrn.com/sol3/papers.cfm?abstract_id=984584, page 4 of the pdf):

These markets work for several reasons: First, almost anyone can participate. Second, people think hard when they have to back up their predictions with money; buy the right presidential contract and you win, buy the wrong one and you lose. Third, the profit motive encourages people to look for better information.

Nothing in there about the EMH. I can’t see any inherent contradiction between believing that markets provide a useful way of aggregating dispersed information and also disbelieving even the weak-form of the EMH. And as I’ve said, I’ve never come across anyone who says that they believe the strong-form of the EMH (which is not to say that they don’t exist). Given the relative economic performance of West Germany vs East Germany and North Korea vs South Korea, anyone who thinks that markets aren’t a useful way of aggregating dispersed information is either ignorant, insane, or has a remarkable alternative explanation in their back pocket that I would be very interested in hearing.

37

Jock Bowden 07.16.09 at 9:27 am

Chris Bertram

What you say is absolutely true and fascinatingly so. But I’m sure you’d agree that to throw them all around together in the same paragraphs requires very supple treatment, and things could go pear shaped extremely quickly.

38

Jock Bowden 07.16.09 at 9:32 am

OTOH, it would really neat to see someone use Bachelard to argue whether or not the Phillips Curve or even monetarism were “inside” the “Keynesian paradigm”.

39

JoB 07.16.09 at 9:51 am

By the way, is this the one and only Shock-Jock?

40

John Quiggin 07.16.09 at 11:06 am

“In the first post you made on this topic, I pointed out that the reasoning behind predictions markets is not dependent on the efficient markets hypothesis, at least not the EMH as defined by Fama,”

Tracy, there are loads of statements from both supporters and critics to back up my claim here (try Google). More importantly, the points you cite are exactly the premises from which the strong-form EMH is derived – thick markets in which large numbers of rational individuals trade based on the information available to them. More generally, as several commentators have pointed out, you are drawing an untenable distinction between the exact form of words used by Fama on the EMH and the logically equivalent formulations I’m discussing.

41

John Quiggin 07.16.09 at 11:11 am

Here for example is the CIA, which ought to know

The theories underlying PAM and other prediction markets are the Efficient Capital Markets Hypothesis (ECMH) and the Hayek hypotheses.[8] These hypotheses explain how information is aggregated such that market prices provide accurate estimates on the likelihood of future outcomes.[9] According to ECMH, capital markets are “extremely efficient in reflecting information about individual stocks and about the stock market as a whole,” such that no amount of analysis in an attempt to forecast future stock prices can beat the market

42

ron 07.16.09 at 1:12 pm

You will lose credibility with physicists if you maintain that: “….such as that of Newtonian physics is displaced by a new and superior alternative, such as Einstein’s relativity theory.”
First, Newtonian physics hasn’t been displaced. It still works very well for everyday applications. Quantum physics added to knowledge in the area of small particles (thus “quanta”).
Second, relativity is also not a departure. It is a special case, not a contradiction.
NASA (and virtually all scientists) would use Newtonian physics much more than the others.

43

Rob 07.16.09 at 1:18 pm

Given its an introduction its hard to say, but I think you need focus more on popular opinion versus what academia actually thought and what the Fed actually did. It was already mentioned that Monetarism was pretty much abandoned by Volker to stop the volatility of interest rates and inflation that money targeting brought. And while Greenspan was a Randite he followed a Neo-Keynesian monetary policy. Neo-classical RBC was dying by the mid 90s when it hit a dead end.

44

gcwall 07.16.09 at 1:36 pm

Economic theory is similar to cancer treatments, sophisticated in knowledge and research, but barbaric in methodology.

45

Salient 07.16.09 at 1:37 pm

In the terminology commonly associated with the great German philosopher Georg Hegel, economic thought is a dialectical process in which an idea (the ‘thesis’) meets its contradiction (the ’antithesis’) producing a synthesis which transcends its origins.

If you were to split this into two sentences, the second of which concisely defines “synthesis,” I think many more readers would understand where you’re going: “transcends its origins,” while retaining fidelity to the way this stuff’s normally talked about, sounds unnecessarily mystical.

Also, more generally, perhaps the introduction should begin with a couple paragraphs that lay out the need to explore this history, i.e., in order to track back and see where these New Economists went wrong. The first couple paragraphs could summarize some obvious problems with current economic paradigm, then point out that we have historical examples of similarly problematic thinking. The transition could be an assertion such as: we need to investigate what was wrong then, and how the paradigm then shifted, so that we may better understand what’s wrong now, and in what ways the paradigm could/should shift again.

[I’m not sure if you’re looking for these kind of stylistic suggestions, and I feel nervous that I might be being unintentionally offensive by providing them, and I am hoping no such offense is taken.]

46

Jock Bowden 07.16.09 at 1:51 pm

Salient

In the context of this particular discussion and its focus on Kuhnian paradigm change, I am not really sure we can say that past economists were “wrong”.

47

Salient 07.16.09 at 1:59 pm

In the context of this particular discussion and its focus on Kuhnian paradigm change, I am not really sure we can say that past economists were “wrong”.

Well, true, much for the same reason that we can’t say Newton was “wrong.” To be “wrong” implies there is some model which is “right” which is a misunderstanding of what a model is. I guess here “wrong” in my earlier statement would mean, roughly, “problematic” or “unsatisfactorily inaccurate.”

But, if I replaced “wrong” with a more accurate phrase, my sentence might have been too convoluted to be comprehensible. I’d rather say something imperfect but comprehensible, than something perfectly incomprehensible. :)

48

Justin 07.16.09 at 2:11 pm

I found the comment about the futures market in response to the difficulty of predicting a terrorist attack, not really making the point you were trying to about the hubris involved in the efficient markets hypothesis.

I’m sure there could be a better example somewhere to better demonstrate market triumphalism. My initial reaction to your example, was why not use a futures markets to predict something?

I’m not sure it is the best example, nor is it clearly linked to your point.

49

Salient 07.16.09 at 2:27 pm

“Friedman’s model, which took into account expectations of inflation that were incorporated into wage bargains, appeared to explain stagflation.”

I would say “better accommodated” instead of “appeared to explain,” at least if the former is true.

More generally, I think there’s an ambiguity that needs to be explicitly resolved, between how a model fits to data in order to predict phenomena, and how a model attributes causal mechanisms to those phenomena.

50

Chris 07.16.09 at 3:10 pm

#46: To be “wrong” implies there is some model which is “right” which is a misunderstanding of what a model is.

True, but isn’t neoclassical economics itself based on a misunderstanding of what a model is? Confusing the map (rational actor models) with the territory (actual economies)? I think that’s wrong in a sense deeper than that in which all models are wrong. Or maybe it would be even better described as “not even wrong”.

#47:I think there’s an ambiguity that needs to be explicitly resolved, between how a model fits to data in order to predict phenomena, and how a model attributes causal mechanisms to those phenomena.

A good point, especially regarding models developed *after* the phenomenon they “appear to explain”.

Of course people are going to try to fit their theories to the data, but unless the theory also holds up with data *other* than that used to create it, it’s not very useful and I don’t think its explanatory mechanisms should necessarily be taken seriously. It may be incorrectly taking for granted idiosyncrasies of the original situation that do not actually generalize, for example. Was Friedmanism overfitted to stagflation, or does it have explanatory power outside that context?

51

Tom Hurka 07.16.09 at 4:07 pm

More Hegel pedantry, I’m afraid.

The Ideas that Hegel thought drove history weren’t ordinary ideas in people’s heads: they were concepts that were embodied in social structures but not necessarily thought or understood at the time by people living in those structures. Remember his famous Owl of Minerva remark about philosophy: it comes on the scene when a historical period is coming to its end and *only then* understands it, i.e. conscious thought about an Idea typically appears only after the Idea has done its historical work.

Hegel certainly didn’t think material interests or anything economic drove history; in that way he differed from Marx. But he also didn’t think ideas, in the sense of thoughts in people’s, e.g. philosophers’, heads drove history. Capital-I Ideas drove history, and they were something completely different.

(I seem to remember Charles Taylor making this point. And anyway, why do you need to talk about Hegel?)

52

kid bitzer 07.16.09 at 4:26 pm

“And anyway, why do you need to talk about Hegel?”

this question should always be asked, whenever someone is talking about hegel.

53

geo 07.16.09 at 4:31 pm

The reality of the interaction between ideas, economic systems and economic power is far too complex to be reduced to a simple aphorism.

Darn. I keep hoping, though …

54

Hidari 07.16.09 at 4:43 pm

‘The new version of free market ideology that emerged from the 1970s has been given various (mostly pejorative) names such as neoliberalism, Thatcherism and economic rationalism. I prefer the more neutral term ‘economic liberalism’.’

Given the proviso that I don’t know much about economics, isn’t it generally agreed upon that the accepted term for what you are talking about is ‘neo-classicism’? I mean, as an ‘academic’ theory? The problem with ‘economic liberalism’ as a phrase, apart from the fact that it seems to be very vague, is that it doesn’t differentiate, so to speak, between the liberalism that follows from (e.g.) EHM, i.e. the very mathematical approaches you really want to be talking about (I think) and the liberalism that derives from the Austrian school. Policy wise, neo-classicists and Austrians have a lot in common, but not in terms of their basic assumptions and presuppositions.

Of course you may be planning to point out failures in Austrian economics as well, in which case my point is moot.

55

Rabbi 07.16.09 at 6:08 pm

I’d like to add my vote to the “delete Kuhn” faction. If your reader is not familiar with Kuhnian ideas and the controversies around them the comment is incomprehensible, and if they are it’s at best dubious.

56

engels 07.16.09 at 6:49 pm

Following on from others, I do think your argument would be clearer if you could pare down the number and range of references to historical figures–just within the first few paragraphcs you have Keynes, Kuhn, Hegel, Marx, as well as Newton and Einstein in passing–especially when, like Kuhn and Hegel, they are from outside of economics and don’t really seem needed to make your point. It also seemed to me that in the first couple of paragraphs you were trying to make two different points–about the power of ideas and the non-additive nature of progress in economics–at the same time with your reference to Hegel and this was a bit confusing.

But it is an interesting piece.

57

John Quiggin 07.16.09 at 7:58 pm

To Salient and others, stylistic criticisms are welcome as are substantive objections and of course compliments. I’m getting a lot out of this, including the message summed up by Engels which I will accept, I think.

Hidari, although there is no settled terminology, “neoclassical” is most commonly used to refer to the entire body of economics emerging from the “marginal revolution” in C 19, including (a little uncomfortably) the Austrian school, but not institutionalists and Marxists or Sraffa-style post-Keynesians). In this sense, the famous Cambridge capital controversy (in which all the main protagonists were Keynesians of one kind or another) was about the logical validity of neoclassical economics. I don’t plan to write at all about this controversy or to criticise neoclassical economics in the broad sense I’ve described – of course, I’ll welcome comments arguing that I should. I’m aiming at a much smaller (but still wildly ambitious) target; the version of neoclassical economics that became dominant in late C20 and was associated with the political movement I’m calling economic liberalism.

58

Tom Hurka 07.16.09 at 8:03 pm

Kid at #50:

But it’s fun to talk e.g. about Hegel’s explanation why women don’t have orgasms. (It’s because they’re not civil servants.)

59

kid bitzer 07.16.09 at 8:12 pm

oh, i just said it should always be asked, not that it could never be answered.

and in the case you cite, the answer “because it’s fun to ridicule him” provides complete satisfaction.

(provided that one is a civil servant).

60

nickhayw 07.17.09 at 12:38 am

To throw my hat into the ring, and in answer to your call in #55 for broader criticisms of neoclassical economics, please do! :) – you leap straight into Keynes and ‘in the long run, we’re all dead’ without setting the scene, and I’d venture that your average lay reader (without a background in 20th century [economic] history) might not be able to make sense of why Keynes was such a huge break from the neoclassicals/marginalists/Say’s law-devotees.

I for one would love to see an extra paragraph or two establishing the historical setting of the Great Depression, and a little more on the ‘bad ideas’ that caused that mess, or were bandied about at the time. Would provide a nice side-by-side for the current crisis, too, given the amount of talk in the media about the Great Depression (and how this one is ‘the worst since then’, etc.)

61

nickhayw 07.17.09 at 12:48 am

Oh, and what exactly do you take to be ‘the classical framework’, exemplified by (or starting with) Smith? An homogenous, one-sector model framework? Capital = corn = perfectly substitutable/perfectly elastic? An emphasis on perfect competition? A lay-reader certainly isn’t going to know anything about classical political economy, and I think it would help your case if you expanded a little on the continuities between the classicals and their marginalist successors (and, perhaps, the absurdity of maintaining classical conceits in a much-changed economic world?)

62

Not Really 07.17.09 at 2:22 am

> These[prediction] markets work for several reasons:

I have seen exactly zero convincing arguments that the self-styled “prediction” “markets” work at all, for any meaning of the word work (utterly weak, weak, semi-weak, semi-strong, strong, oooblah, whatever). And there was a clear example of said gambling sites being manipulated during the last US election cycle. So let’s not get too far ahead of ourselves there.

63

Robert 07.17.09 at 6:14 am

My name links to 11 principles of neo-liberalism, as expounded by Philip Mirowski, in the book I’m currently reading.

64

Hidari 07.17.09 at 8:39 am

‘To throw my hat into the ring, and in answer to your call in #55 for broader criticisms of neoclassical economics, please do! :)’

If you are interested in that, you might want to check out Paul Ormerod’s Death of Economics.

But generally speaking, John, I think it’s best to keep things tight and focus on the ideas that led up to our current situation. This also has the benefit of being able (implicitly? explicitly?) to attack Hayek, and the Austrians as well. To repeat, if you go back to their ‘roots’ these guys are really very different from the neoclassicals, but in terms of policy prescriptions it’s much the same kinda stuff.

What I’m basically trying to say is that it seems to me that you want to attack the policies that led to our current mess and not so much the abstract, academic, ideas that may have led to these policies. This seems wise, although of course you are going to have to touch on the first to deal with the second.

It might also be a good idea to simply list all the ideas that you are going to call ‘economic liberalism’ with quotes to prove that people actually said that they believed them (‘oh but goodness no one believes that!’ is a classic way of wiggling out of these kind of accusations). I think it’s important to to this because one of the depressing things about the current political stage is how many things are simply unargued and taken for granted.

For example, in the recent bank crisis/manufacturing crisis, it has simply been assumed by almost all sides of the political spectrum that ‘private is good, public bad’ and that even though (e.g.) GM has essentially been nationalised that this must be a short term move and that ‘we’ must ‘all’ try to move all these companies/banks etc. back into the private sector as quickly as possible.

Now this may be true or half true or false or whatever but it’s still an assumption that needs to be argued: by which I mean, empirical evidence must be provided that in some meaningful semi-objective sense, public firms perform ‘worse’ than private firms.

So bringing them into the open, numbering them and then simply going through them pointing out

1: yes people really did say they believed them
2: Providing the reasons as to why people said they believed them and then
3; Looking at the rational (logical) and then empirical evidence as to whether or not they are true or not, in other words, do the reasons provided in ‘2’ stand up?

So 1 could be the EMH, 2 could be the idea that private companies are ‘better’ than public ones, 3 could be the idea that financial deregulation is always a good idea, and so on and etc.

65

Tracy W 07.17.09 at 8:46 am

John:

I haven’t found said quotes. I did a search on Google – http://www.google.co.uk/search?hl=en&rlz=1T4GZEZ_en-GBGB237GB237&q=%22efficient+markets+hypothesis%22+%22prediction+markets%22&meta= on “efficient markets hypothesis” and “prediction markets”.

The first result that came up with was yours, which of course is what I am disagreeing with. The second was a collection of papers which had my phrases in my random. The third was finally relevant, but merely says “Much of the enthusiasm for prediction markets derives from the efficient market hypothesis”, firstly no support is provided for such claims, and secondly, much is not the same as all. The third paper is a general one about prediction markets merits and dismerits published by the CIA. If you check the CIA’s reference, it is to an article by Robert Shiller: “From Efficient Markets Theory to Behavioural Finance”.
http://www.unc.edu/~salemi/Econ423/Shiller%20From%20EM%20to%20BF.pdf, which doesn’t actually mention prediction markets as far as I can tell. Perhaps the CIA ought to know, but I advise some more skepticism in the future about whether people actually do what they ought to do.
The fourth link was apparently recently moved. The fifth one states that:

Economic support for the efficacy of prediction markets ultimately derives from Adam Smith’s “invisible hand”, Hayek’s “The Use of Knowledge in Society”, and Eugene Fama’s Efficient Market Hypothesis. Taken as a whole, they support the position that market prices fully reflect all available information about the product or asset under consideration.

Again this bases prediction markets on more than the EMH. (And, perhaps, I’ve found your believer in the strong-form of EMH for you, though if I was you I’d check with the blogger a bit more thoroughly.)

More generally, as several commentators have pointed out, you are drawing an untenable distinction between the exact form of words used by Fama on the EMH and the logically equivalent formulations I’m discussing.

Strong words, but you don’t back them up. Your statement is, to quote again:
“The EMH says that financial markets are the best possible guide to the value of economic assets and therefore to decisions about investment and production.”

I’m going to imagine two hypothetical people here.
My imaginary person one believes in the strong form of EMH. She however also thinks that all good decision making processes must be democratic as a matter of definition, and thus therefore the “best possible guide” to the value of economic assets has to be a democratic one as a result of her definition. Such an imaginary person could favour prediction markets as a guide to how people should vote in their democratic decisions, without believing that EMH is wrong.
My other hypothetical person rejects all forms of EMH, weak to strong, but is currently convinced by Andrew Lo’s “adaptive markets hypothesis”. They believe that financial markets are the best possible guide to the value of economic assets and therefore to decisions about investment and production, because they believe that no other method can aggregate information that well and efficiency of information aggregation is how they define best. Therefore they reject Fama’s EMH and accept your EMH.

Please note, I don’t agree with either of these hypothetical people, I don’t believe in the strong form of the EMH, and I don’t know any mathematical proof that financial markets are the best possible …, for any definition of the word best except the trivial one where “best” is defined as “using financial markets”, and on the whole I try to keep some awareness that I might be wrong in the absence of such proofs, although I also know that I struggle with self-consistency.

These sort of examples is why I keep saying that your EMH is logically quite different from Fama’s EMH. In part because your EMH uses the word “best”, which is terribly subjective. Simply telling me that I’m wrong is not going to convince me otherwise.

More importantly, the points you cite are exactly the premises from which the strong-form EMH is derived – thick markets in which large numbers of rational individuals trade based on the information available to them.

Nope. Going back to Fama’s 1970 paper, Efficient Capital Markets: A Review of Theory and Empirical Work”, available at http://www.ekonometria.wne.uw.edu.pl/uploads/Main/1970.Fama.EMH.pdf, he says that the weak form of EMH came from empirical observations:
“Rather, the impetus for the development of a theory came from the accumulation of evidence in the middle 1950s and early 1960s that the behaviour of common stock and other speculative prices could be well approximated by a random walk. Faced with the evidence, economists felt compelled to offer some rationalization.”, page 8 of the pdf, page 389 of the original journal article in The Journal of Finance, Vol 25, No 2.
I can see nothing in here where the strong-form of EMH is derived from a thick market with large numbers of rational individuals trade based on information available from them, the progression that Fama outlines is from empirical work to theories trying to make sense of such empirical work.

And I have never come across anywhere where the strong form of the EMH is derived from thick markets etc. Perhaps it is derived somewhere, but you’ll have to show me to convince me. (I would be interested in such a derivation from the mathematical point of view if nothing else).

Meanwhile, your post inspired me, last night in the library, to pick up a book on Keynes, specifically “Keynes” by Robert Skidelsky, Oxford University Press, 1996. He has a rather different account of the influence of Keynesian economics on the world of the 1950s and 1960s to yours. From page 112:

Keynesian policy may then be said to be in operation when budget deficits are deliberately incurred to raise the level of output. On this test there was no Keynesian policy during the height of the ‘golden age’ because, as R.C.O. Matthews pointed out in 1968, ‘the [British] government, so far from injecting demand into the system, has persistently had a large current account surplus’. The same was true for the United States until 1964. Similarly there is no active demand management policy in the most successful ‘golden age’ economies: Germany and Japan.

Skidelsky then goes on to speculate that the belief that Keynesian policy would work if required could explain the ‘golden age’. He then goes on to write:

In the 1960s Keynesianism was universalized … in a double sense: the use of fiscal policy to balance economies was extended to France, Italy, Germany and to a lesser extent Japan, and fiscal policy became more active and ambitious as fears of recession revived.

(page 114)

The record is clear: by the decade’s end the OECD inflation rate had doubled from 3 per cent to 6 per cent, without any improvement in real variables. The rising inflation which was the real legacy of the growth Keynesianism of the 1960s set Keynesian macroeconomic policy an impossible task in the 1960s.”

(page 117)

Is Skidelsky wrong in his history?

66

JoB 07.17.09 at 9:34 am

John, do you really want to keep the “non-additive nature of progress in economics”? – besides being besides the point, it is an idea that imho can easily itself be refuted. You risk to make just that mistake that was made in the 70s: disregard a couple of decades and start afresh. There’s a lot of value in the “Von-s” and denying that is hogwash. You also don’t mention the fact that it’s in the context of communist state failure and oil crises deficits that Keynes was abandoned (and then only somewhat, to be honest, outside of certain quarters in Chicago at least) and that there was good reason to steer clear of anything remotely similar to a Soviet state (& that Keynes for one would, most probably, have agreed with that – I have not read him but I have only seen him quoted not so much against market workings but only against the automatic bliss that would be coming from only free market workings).

67

Jock Bowden 07.17.09 at 1:00 pm

JQ

Thinking about this a bit more, how are you going to justify this tautological phrase “economic liberalism” as the paradigm that replaced Keynesianism? Nobody in academia, policy circles, or governments used this phrase, so why are you?

You would be better off sticking to “monetarism”.

68

financial economist 07.17.09 at 1:45 pm

Tracy, you might surprised to discover that the literature on the efficient market hypothesis did not begin and end in 1970. I think it’s odd how that one paper has such a totemic significance for you. John is completely right in how EMH is interpreted within the field. We teach MBAs that because of the efficient market hypothesis you should use the market’s implied discount rate in capital budgeting, which fits John’s point exactly.

Theoretically, the efficient market hypothesis is derived from rational utility-maximizing agents in general equilibrium, and everything John says follows directly from that. The market microstructure literature talks about the importance of thick markets to get anything like an efficient market.

69

Jock Bowden 07.17.09 at 1:58 pm

FE

I am not sure where you teach, but I do not know of any business school or economics undergrad program that does not move on from the EMH very early on.

70

James C 07.17.09 at 10:17 pm

I think “economic liberalism” is a pretty widely used and understood phrase.

But I’d like to see someone address Tracey W/Skidelsky’s point about the scarcity of budget defecits in the postwar Keynesian golden age, mainly because I was going to pose it myself.

71

John Quiggin 07.18.09 at 1:23 am

JoB – “Von-s” ? I don’t know what you mean here.

72

JoB 07.18.09 at 8:05 am

Mises, Hayek.

I hope that doesn’t offend you.

73

Robert 07.18.09 at 11:04 am

John Quiggin wrote, “Hicks relied heavily on some of Keynes’ ideas, but ignored or discarded others, much to the dismay of more purist Keynesians such as Joan Robinson.”

In 36, Tracy W. writes, “It’s interesting that a guy like Keynes, who made a couple of vivid statements about the okayness of being wrong, for example ‘There is no harm in being sometimes wrong — especially if one is promptly found out.’ would wind up with ‘purist’ followers.”

If Tracy is suggesting that Robinson never said she was mistaken, she is just ignorant.

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John Quiggin 07.18.09 at 11:57 am

I wasn’t offended, I just forgot that both these guys vonS

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Jock Bowden 07.18.09 at 3:42 pm

James

No it isn’t. There are no journals called “The Journal of Economic Liberalism” which most economics read and cite, which are devoted to solving economic problems using models from the “economic liberalism” as opposed to Keynesian, monetraist, or Marxist schools. There are no scholars who are Professors of “Economic Liberalism”. It is a tautological phrase, which JQ has only recently substituted for “neoliberalism” which he has used for the past five years. Why the sudden change?

There are already too many things wrong with this book – particularly historiography and epistemology – without adding this weird nomenclature.

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engels 07.18.09 at 3:51 pm

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Jock Bowden 07.18.09 at 4:05 pm

engels

If you have to direct me to an obscure website to justify its existence, then clearly the non-concept has problems. What “economic liberalism” is, is a projection of an ‘Other’. Would you be directing me to marginal websites to validate the existence of Keynesianism, neoclassical, monetarist or marxian economics? Of course not. And yet here, JQ is arguing this “economic liberalism” has been a “paradigm” for over 30 years!!

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andthenyoufall 07.18.09 at 4:30 pm

Jock – if you don’t click on the link, you will never appreciate the irony of the “obscure website” in question.

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Robert 07.18.09 at 4:35 pm

I prefer the term “neoliberalism”. But Jock is just ignorant.

“And if economics as a broad discipline deserves a robust defense, so does the free market paradigm. Too many people, especially in Europe, equate mistakes made by economists with a failure of economic liberalism.” The Economist, July 18-24, 2009, p. 11, emphasis added.

Meanwhile various “hapless Wiki-workers” (Mirowski 2009) on the “neoliberalism” entry cannot get it through their heads that the label was used by various neoliberals (e.g., Milton Friedman 1951) to describe themselves. Instead they pretend it is a pejorative invented by leftists and social democrats.

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Jock Bowden 07.18.09 at 4:43 pm

Robert

Dated yesterday. Here’s a little job for you. Bring me some journals and Prof Titles from over the oast 30 years, not past 30 minutes.

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engels 07.18.09 at 4:46 pm

This is starting to get a bit silly.

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Jock Bowden 07.18.09 at 4:48 pm

Starting??

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Righteous Bubba 07.18.09 at 5:03 pm

If you have to direct me to an obscure website

That’s probably the funniest response to lmgtfy there will ever be.

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Tim Wilkinson 07.18.09 at 6:21 pm

Andy McNab @81 etc –

move on from the EMH very early on
yeah, to deliver a couple of those caveats to go into the bottom drawer for production on challenge (those whorish academics need some sor of figleaf). Then straight back to the main bullshit.

What “economic liberalism” is, is a projection of an ‘Other’
or alternatively a description of a main strand in political theorising – you see, “Liberalism’ in the personal sphere is (in old fashioned terms) left wing – in the economic sphere, right (thanks largely to legal personality combined with limited liability). Monetarism properly so-called is a very specific doctrine, which doesn’t go anywhere near covering the Tory-sans-concern-for-the-unwashed ideas that Econ. Liberalism aptly enough describes, and certainly names.

Starting? Aravya.

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John Quiggin 07.18.09 at 8:06 pm

Jock, you’re on a final warning. Your contributions at this point don’t justify the disruption caused by your generally belligerent attitude. Anything more like the last few comments above and you’ll be banned.

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Tracy W 07.20.09 at 12:36 pm

Financial economist: Tracy, you might surprised to discover that the literature on the efficient market hypothesis did not begin and end in 1970. I think it’s odd how that one paper has such a totemic significance for you.

Hmm, two speculations about my psychology. This resort to ad hominem slightly increases my Bayesian estimate of the probability that I’m right. (For the record, I don’t see how the answers to the questions of where Fama’s EMH was derived from, and whether it is or isn’t logically-equivalent to Quiggin’s EMH, are affected by my potential levels of surprise, or whatever I place or don’t place totemic significance on, I just don’t think my inner states are that important to reality.)

John is completely right in how EMH is interpreted within the field. We teach MBAs that because of the efficient market hypothesis you should use the market’s implied discount rate in capital budgeting, which fits John’s point exactly.

John Quiggin’s claim was that the EMH had been “developed to the point where it was suggested … that the best way to predict terrorist attacks would be to open a futures market”.
I don’t see how the truth or falsity of any version of the EMH implies a particular view on discount rates – surely, even if the weak-form of the EMH is false, if you are going to be funding a project by borrowing on the capital markets, it makes sense to consider the capital markets’ implied discount rate in doing your budget? After all, that’s the one that potential lenders are going to be deciding whether or not to invest against. Calculating it might be a bit more difficult of course depending on the alternative theory you adopt. Or alternatively, you could believe in even the strong-form of the EMH and also argue on philosophical grounds that the discount rate should be something else entirely (eg environmentalist arguments for using a discount rate of zero for certain situations where a massive loss is possible at some point in the distant future).

Theoretically, the efficient market hypothesis is derived from rational utility-maximizing agents in general equilibrium

Two points:
1. As I quoted before, Fama said in his 1970s paper that the EMH came as an explanation of empirical results. According to him, the theory followed the empirical work, not the other way around.

2. I would like to see this derivation, assuming that it exists. My financial economics professor never mentioned it at all, and I notice that neither you nor John have provided a citation for this supposed derivation.

The market microstructure literature talks about the importance of thick markets to get anything like an efficient market.

Remarkably, the behavioural economics literature shows that a rather efficient market outcome can be achieved with very few participants. See for example Markets, Institutions and Experiments, by Vernon L.Smith, http://www.ices-gmu.net/pdf/materials/393.pdf, page 15 of the pdf, where six buyers and six sellers are enough to reach the “optimal equilibrium outcome”, or “Experimental Methods in Economics”, http://www.ices-gmu.net/pdf/materials/370.pdf, from page 5 of that pdf:

Since 1956, several hundred epxeriemnts using different supply and demand conditions, experienced as well as inexperienced subjects, buyers and sellers with multiple unit trading capacity, a great variation in the numbers of buyers and sellers, and different trading institutions, have established the replicability and robustness of these results. … These experiments establish that the 1956 results are robust with respect to substantial reductions in the number of buyers and sellers. Most such experiments use only four buyers and four sellers, each capable of trading several units. Some have used only two sellers, yet the competitive equilibrium model performs very well under double auction rules.

Robert: I was not suggesting that Robinson never said *she* was mistaken, I was merely saying that it was surprising that anyone would be a purist Keynesian, given Keynes’ own apparent openness to the possibility that he might make mistakes, which implies that being a purist Keyneisan would require ignoring some of Keynes’ own writings, a bit contradictory. But what do I know? Perhaps Robinson wasn’t a purist Keynesian anyway.

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Yves Smith 07.24.09 at 4:51 am

John, the thread is long and I’ve skimmed the comments but may have missed some observations, so forgive me if some of what I say is redundant.

As a layperson who has a pretty good handle on the financial economics literature. I find you are conflating that with EMH and Fama. Anyone how knows the history here will be perplexed with where you put in in a timeline and the role you assign it. You probably know the origins are Bachelier and what is now called the random walk. The key building blocks were MPT and CAPM, in the 1950s. EMH was so well advanced that Benoit Mandelbrot chose to investigate it in 1963-4 and essentially disproved it, but his disconcerting analysis (replicated in other markets besides cotton, which had the best data) was at first considered very seriously, then ignored. The first index fund was created in 1971. Black Scholes was 1973 and that was considered to be the crowning achievement of financial economics. Pretty much everything after that was a mopping up operation.

In other words, this reads as if you are casting economics though a macro lens and fitting the history of other disciplines into that story, and the “fit” is off. I think the success of micro was actually unwittingly cemented by Samuelson in 1947. The methodological binders he put on economics (ergodicity in particular) would relegate any lines of thinking that involved difficult-to-model or non-linear assumptions like instability to the sidelines. The neoclassicals spent 30 years building their edifice and taking ground in the journals. They just needed the Keynesian orthodoxy to stumble to have a chance to move their paradigm to the fore.

If you want to make macro the centerpiece, then talk about policy frameworks. That would legitimate that focus.

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