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The Wonks That Warned Us!

The rebel economists who predicted the financial collapse are headed to Buffalo

Ideas matter. Just ask the millions of Americans who lost their jobs in the crash of 2008, which came about because of the idea that less government regulation of the financial system would make us all richer. Whose idea was that? Not some politician’s. The notion of the free, self-correcting, efficient market was the creation of economists.

You know about this notion even if your brain seizes up at the mere mention of economics. Every day, politicians try to outdo one another in claiming how strongly they believe in free enterprise, and how much they hate government, taxes, regulation, and the heavy-handed intrusion of bureaucrats—despite the fact that it took over $2 trillion of public money, and emergency action by governments around the world, to stop the crash of 2008 from becoming the Great Depression of 2008.

Today, a year after the crash, and because of it, the economics profession is in turmoil. Nobel Prize-winning economist Paul Krugman, who is a sharp critic of the dominant pro-market, anti-government trend in economics (called “Neoclassical” theory), wrote recently that “the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth.”

That’s casting too wide a net. Not everybody who makes a mathematical model to describe human behavior gets dazzled. But what is certain is that the economics profession has been dominated by the disciples of the late free-market guru Milton Friedman and others of the Chicago School, so named because of their prominence on the faculty of the University of Chicago, where mathematical modeling first flourished. For decades, there has been an overshadowed (and at times bitterly ridiculed) alternative group of economists who have long been warning that the Neoclassical orthodoxy was missing the boat and leading us astray.

This group of critics is known by various names: heterodox economics, Post-Keynesian economics, Minskyites. And for two days in October, some of th ese folks, thinkers who are the world’s leading critics of the Neoclassical, math-centered, market-worshipping economics empowered by Ronald Reagan and George W. Bush, will be meeting at Buffalo State College at the fourth bi-annual Cross Border Post-Keynesian Conference.

Finance vs. the “real” economy

What’s so weird about the claims of the Free Marketeers is that there really has not been a free market in ideas. The Neoclassical way of looking at the world is a near-monopoly. In the last chapter of his famous work The General Theory of Employment, Interest and Money, the late economist John Maynard Keynes (whom the Neoclassicists revile) wrote, “I am sure that the power of vested interests is vastly exaggerated compared to the gradual encroachment of ideas.” In the US, the power of vested interests was made more powerful by giving political voice to the ideas of Neoclassical economists.

Only because of the crash of 2008 are some alternative voices being heard. One of them belongs to the late Hyman Minsky. Minsky, who died in 1996, warned 40 years ago about the inherent instability of the world of finance. Minsky saw a trend toward riskier and riskier behavior by financial speculators, whose formerly isolated world would burst; when it burst, it would affect the “real” economy of producers and consumers. That’s what happened in 2008. In fact, many in the financial press have been labeling the global financial crisis a “Minsky Moment.”

But Minsky was not mainstream. About 95 percent of economists in academia are in one of two closely related schools of thought. There are the Free Marketeers, who believe that markets always work, and then there are the Neo-Keynesians, who believe that markets can fail due to imperfections or rigidities. Both essentially use the same sophisticated mathematical model to generate their outcomes, with the key point being that the model is designed to explain “equilibrium,” which is defined as an economy at full employment.

Free Marketeers argue that market economies will always generate a full employment situation, and deviations from it are the result of outside influences—notably, government intervention or oil price spikes. Their conclusion is that government interventionist policies disrupt the economy; markets, if left alone, will always return to equilibrium. Neo-Keynesians argue that there are institutional rigidities and market imperfections—minimum wages, union contracts, non-competitive markets, insufficient information—that can prevent an economy from reaching full employment equilibrium. These Neo-Keynesians argue that government policies (fiscal or monetary) should be used to help guide the economy back to full employment.

In essence, both schools accept that the economy can experience disruptions, but one camp argues they’re caused by external interventions, and the other says there are real-world internal factors that prevent markets from rapidly reaching equilibrium, so intervention is necessary.

What about the rest of the economics discipline? The fringe is made up of folks who call themselves Institutionalists, Marxists, Austrians—and Post-Keynesians.

Minsky was a Post-Keynesian. Most of the folks who are convening at Buffalo State College are Post-Keynesians. Their approach differs in that they do not accept the equilibrium model because they think that accepting it requires unrealistic assumptions about human behavior and institutions in order to derive nice mathematical results. In fact, Minsky’s model, which is formally known as the “Financial Instability Hypothesis,” is described as a model of disequilibrium— because Minsky set about explaining a process that generates crises, not equilibrium.

The Minsky Moment

In his recent summary of what went wrong, one of the recommendations that Paul Krugman makes is for mainstream economists to start incorporating “the realities of finance into macroeconomics.” He should have just said that it’s time to make Minsky mainstream.

Minsky saw that finance is the cause of instability. He essentially describes a process of debt accumulation by businesses (and households) based upon expectations of future profits or earnings. He categorized businesses as hedge, speculative, and Ponzi-financed units based on their level of debt relative to earnings. As economies experience booms, businesses, with increased expectations of profits, take on more debt to finance expansion. “Success,” Minsky wrote, “breeds a disregard for the possibility of failure.”

What we saw in actual practice over the past decade was that success caused more and more firms to move to speculative and Ponzi units, leading to what Minsky called a financially fragile economy. As the boom went bust, some firms didn’t meet their profit expectations, and bankruptcy ensued. Bankruptcies set off a chain of events, as some firms couldn’t pay suppliers or their lenders. This chain reaction was typically manifested in a financial crisis or collapse of a large financial institution—the Minsky Moment. But because the financial crisis spilled over into the overall business sector, the Minsky Moment signaled the start of the general, all-encompassing economic downturn that affected all businesses and consumers, and not just the financial world.

Minsky had many other great insights into the workings of the capitalist system when it becomes dominated by finance, and many Wall Street practitioners were influenced by his writings. So why was he (and the other schools) neglected and marginalized by mainstream academia? Two reasons: First, as Krugman stated, there is a fetish to describe economic concepts with rigorous mathematical models which only specialists can readily understand. But second, in a world of publish or perish, the top academic journals are controlled by those who adhere to the dominant model, so you won’t get published in those journals if you reject or criticize the model.

Not only won’t you get published if you attack the orthodoxy—you certainly won’t join the academic gravy train maintained by the Federal Reserve Bank, in which professors get invited to consult and to take short-term appointments. The result is an insular discipline that promotes the status quo and requires a significant level of mathematical skill to join its club. It’s a monopoly, and like most monopolies, it tends to lead to a lack of innovation even while it marginalizes competition.

But because of the crisis, other ways of thinking now have a window of opportunity to make their case. On October 9 and 10, Buffalo State College hosts 50 Post-Keynesian scholars from around the world who will attend and present their research—in English, not just in mathematical formulae. A keynote panel is scheduled which includes professors Bob Pollin, whose work was heavily influence by Minsky and Marx; Jan Kregel, who studied at Cambridge with those who first refined Keynes’s own thinking; and Randy Wray, who was Minsky’s student at Washington University in St. Louis. The conference program can be found at www.buffalostate.edu/economics. Registration is required, but some events are free and open to the public.

Bruce Fisher is visiting professor of economics and finance at Buffalo State College, where he directs the Center for Economic and Policy Studies.

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