Sharp tests of economic theories are rare and hard to find, particularly in macroeconomics. Any examination of particular episodes in economic history necessarily involves counterfactuals, and these provide room for endless dispute. As an obvious example, assessing the impact of the Obama Administration’s 2009 stimulus requires an estimate of how things would have gone without the stimulus, and that is obviously hard to do.

Similarly, arguments about unemployment in the US get bogged down in disputes over whether it is structural or demand-driven and the extent to which policies such as the extension of unemployment benefits to 99 weeks have contributed. 

There is, though, one way in which the current Great Recession/Lesser Depression provides a sharp test of a critical proposition in economics. All forms of classical economics involve, in one form or another, the claim that the causes of unemployment are to be found in labour markets, and not in  macroeconomic variables such as the level of aggregate demand. That’s equally true of the Say’s Law version of classical economics criticized by Keynes, the New Classical macroeconomics of Robert Lucas and the attempts by Real Business Cycle theorists like Kydland and Prescott to explain cyclical fluctuations in terms of labor market shocks.

The crucial problem for all these theories is that labor markets and the associated institutions operate mainly at the national level. Even within the EU, different countries have very different labor markets. So, it is essentially impossible for labor markets in many different countries to move together, except as the result of macroeconomic influences operating at an international level[1]. That means that the occurrence of a sharp and sustained increase in unemployment, taking place in many countries at once, is inconsistent with classical economics.

This point seems trivially obvious, but as far as I can tell hasn’t been made, or at least not clearly. Once it’s conceded, it seems impossible to avoid a view of the world that is basically Keynesian in its analysis of the macroeconomy.  It is possible to hold such a view and reject Keynesian policies on pragmatic grounds, as in Friedman’s critique of ‘fine-tuning’. But the longer and deeper the recession the harder it is to sustain this view.

This seems like a good time to plug the fact that a paperback edition of Zombie Economics will be out soon (May 6) with a brand-new chapter on Austerity, bits of which have been seen here. On 9 May, I’ll be launching an Australian edition, where the added material is a chapter on Economic Rationalism. And a week or two ago, I received some copies of the Italian edition










fn1. Of course, you can cheat and label these macro influences “technology shocks”, then assume them to be internationally correlated. But in the ordinary meaning of technology, there is no plausible way in which economies as disparate as, say, the US and Greece can experience a common technology shock.

Advice For Writers

by John Holbo on April 27, 2012

I’m reading Chesterton on George Bernard Shaw (no, I’m not really sure why either):

“A quick eye for ideas may actually make a writer slow in reaching his goal, just as a quick eye for landscapes might make a motorist slow in reaching Brighton. An original man has to pause at every allusion or simile to re-explain historical parallels, to re-shape distorted words. Any ordinary leader-writer (let us say) might write swiftly and smoothly something like this: “The element of religion in the Puritan rebellion, if hostile to art, yet saved the movement from some of the evils in which the French Revolution involved morality.” Now a man like Mr. Shaw, who has his own views on everything, would be forced to make the sentence long and broken instead of swift and smooth. He would say something like: “The element of religion, as I explain religion, in the Puritan rebellion (which you wholly misunderstand) if hostile to art — that is what I mean by art — may have saved it from some evils (remember my definition of evil) in which the French Revolution — of which I have my own opinion — involved morality, which I will define for you in a minute.” That is the worst of being a really universal sceptic and philosopher; it is such slow work. The very forest of the man’s thoughts chokes up his thoroughfare. A man must be orthodox upon most things, or he will never even have time to preach his own heresy.”

Ah, graduate school, and trying to write my dissertation. I remember it well. (Shudder.) I don’t know whether I was a budding universal philosopher, but I did commit the sin of wanting to be a multifold heretic within the scope of a single paragraph, or sentence. I’ve tried to stop doing that.