I know something of economic theory and the jargon used, so following some of this was not too much of a challenge, but the use of acronyms really does detract from otherwise compelling argument. The unemployment meme has been challenged at some length recently as has market efficiency so those arguments are familiar and need no additional back ground. This would win lots of arguments with typical republicans who spout talking points but have no sound basis for their assertions, it may not win with those who have looked at the topic in depth, an example can be found in the final section “share holders do not chose managers”, true to some extent, but they do chose which shares to buy and are less likely to buy from badly managed companies….. The piece would benefit from a little more explanation and defining the acronyms before first use.

Productivity.

For years we’ve heard the glories of productivity. It’s wonderful, we’re producing more widgets with less human input. But comrades, we can do even better!! For the glory of the economy do your best!

It’s easy to increase productivity in a labor market where workers are fearful of losing their jobs (think heath insurance). Let’s say we have 100 people producing 1,000 widgets per week. Simply fire 10 of them and imply (or threaten) you’re ready to fire more. But of course the goal, 1,000 widgets per week, remains the same for the 90 remaining comrades. Wow, you’ve suddenly increased productivity by 11.1%, it’s magic!

In strictly monetary terms, dollars out for dollars in, you can accomplish exactly the same thing by cutting wages. Keep on employing the full 100 people but cut their wages. The more you cut wages while demanding the workers meet the original production goal the higher the productivity climbs.

So when you hear the “good news” about rising productivity think twice about what this really means.

I remember first reading Galbraith's The New Industrial State, in particular his discussion of Wisconsin dairy farmers as examples of firms more typical of those in more traditional, unplanned markets, and wondering if Galbraith would have chosen a different example if he'd ever seen his television ask him, "Got Milk?" (One thesis in The New Industrial State is that advertising implies demand management, which, in turn, implies a market dominated by "planning.")

Perhaps a better way to sum up all of these points is that orthodox Economics is all about solving a fundamental problem that no longer exists: finding an allocation of resources that maximizes the amount of met needs in society. In Adam Smit's day, society lacked the capacity to produce enough to meet everyone's basic needs. The problem, then, was how best to allocate inputs.

Today, the fundamental Economic problem is different. Poverty exists despite the fact that we have the capacity to produce enough to meet the basic needs of the entire planet. Today, the fundamental Economic problem resolves around distributing outputs instead of allocating inputs.

We graft new assumptions and methods onto an old model that focuses on allocating inputes in the hopes that it will lead to a satisfactory distribution of output, but there really is no connection between what the orthodox model seeks to describe and the basic problems we need to solve in society today.

This is why, for example, orthodox models have difficulty with employment issues. Employment is both an issue of allocating labor as a resource and an issue of distributing income to workers, and why traditional supply and demand models don't explain things like the effects of a minimum wage. We can see the effect of a minimum wage on allocating labor to firms, but we can't see the effect of a minimum wage on the distribution of income accross the labor force.

Great post. Here's my problem with economics: it puts itself forth as some sort of predictive science with laws that policy makers have to follow. But, the only reason it has any predictive power at all is that we've set up our economy according to economic laws.

The laws of physics describe reality. We didn't create reality, we were born into it. So, we have to obey the laws of physics.

But we create economies. Economists tells us we have to obey economic laws. But, we don't. We can alter the fundamental scheme that those laws describe.

thosethingswesay.blogspot.com

11. Transitivity of preferences. Or rather, not-transitivity of preferences. In arithmetic if a > b and b > c then a > c. And it is an assumption of classical microeconomics that people behave this way too: if you choose chocolate over vanilla and vanilla over strawberry then you will of course choose chocolate over strawberry. But for me personally I will choose chocolate over vanilla and vanilla over strawberry, but offered chocolate and strawberrry I will chose strawberry 2/3 of the time. In my observation this is true of many areas of human behavior - and it damages the Micro 101 arguments pretty badly.

12. Optimizing vs. satisficing. Basic utility theory says that human beings optimize every decision they make. That is, they survey all possible alternatives and choose the one with the absolute highest payoff in every case. However, most humans have neither the time nor the inclination to optimize even a fraction of their decisions and satisfice instead: they look at a few alternatives and pick the best of that much smaller group. Sort of like climbing to the top of the tallest hill within a half-hour drive rather than the finding and climbing the tallest hill in your state. Much more sophisticated micro models have been constructed that take this into account, but these are taught at the graduate level and are absolutely not the simplistic models that are used as policy guides on the Sunday talk shows - or the floor of the Senate.

sPh

Collective goods:

Privacy is just another word for property, both the demand and, hence, supply of privacy -- including police services -- following the distribution of property. This is probably non-linear meaning that those with more and more property may well have less and less privacy unless they command greater and greater police and guard forces.

Note that the US now has the military and police institutions of the British empire and devotes something on the order of 26% of its workforce to "guarding things" -- without having much in the way of economic, personal, or physical security save at "undisclosed locations" where its political economic nomenklature hide out, avoiding political accountability and market discipline alike.

Security, as in "to secure the blessings of liberty for ourselves and our posterity", is a collective good, based on communitarian sources of happiness, including sacrificial and altruistic motives, social cohesion, fraternity, equality, and other traditional qualities of adult life that are elaborately disparaged by deranged, juvenile, racist, or senile libertarians.

(The few economists with a modicum of actual military, political, or civic experience beyond patronage of very wealthy individuals or powerful father-figures tend to be rather heterodox.)

Concievably this collectively consumed good -- security could be privately produced by mercenaries funded by efficient and fair taxation. But, since the Treaty of Westphalia, the traditional way of providing for it in a republic is a "well regulated militia" -- that is to say a universal military obligation coterminous with a universal franchise.

Curiously, the US Constitution is clear and constructive on these points but largely ignored by anglophile legal theorists -- masquerading as economists -- who never went along with substitution of the phrase "pursuit of happiness" for "property".

::JRBehrman

The unstated goal of economics is not to better understand the world, but find the way to "optimize" trade. This is like the difference between biomedical research and clinical medical practice. One discipline examine the how and the other just uses whatever tools are available to fight disease.

Economics spends too much time in the clinical phase and not enough in the research phase (in spite of the fancy formulas that academic economists turn out). Models are not data, they are hypothesis. They don't explain anything they just quantify it.

Since the goal of economics is to "optimize" the functioning of the market there is little consideration given to other possible viewpoints. In general "optimizing" means enhancing growth. This can be through improvements in efficiency or productivity, technological change or even controlling markets via monopolies or oligopolies.

The group of ecological economists have spent the last 40 years questioning this assumption. They make the obvious point that growth can't continue in a finite world. Only recently has anyone even started to listen to them, inspired by the looming prospect of peak oil.

If we are to replace growth as a goal with a steady-state society than we can no longer have a capitalist economic system. This change would render useless most of the popular economic work of the 20th Century. It is time for some group of fresh thinkers to start pondering this question. What will a post-capitalist society look like and how can be transition to it with the minimum of dislocation?

--- Policies not Politics
Daily Landscape

I especially appreciate #8. I'm always puzzled by liberals who are unalloyed free traders. If you tell them that environmental regulations, worker safety laws, or corporate taxes are distortions of the market which inhibit economic activity and destroy jobs, they will rightly scoff. But if you say the exact same things about tariffs or trade laws, they'll nod their heads approvingly.

So much for Marx.

The entire traditional macro apparatus fails to allow for the interventions of large foreign lenders who aren't dumb enough to believe what the textbooks say.

Actually, they are dumb if they don't invest in the Euro, which isn't in disgraceful decline and therefore diminishing in yield due to deficits.

Well, except for China, who's getting its lent money back via the trade deficit. With budgetary deficits, the US becomes China's sharecropper.

Here's my # 11:

11) Natural resources are cheap and endlessly abundant. Labor is scarce and expensive. Thus, the trade off of more resource inputs (fuel, plastic, grain, or whatever) in order to reduce labor costs is always a good thing. The costs to employment and the environment are externalized and so have no impact on profit. And the fact that natural resource extraction is heavily subsidized is not even considered.

Also, I've said this before and I'll say it again. Economics is not a science. The "science" it comes closest to is Asimov's psychohistory.

Psychohistory, although conveniently fictional, at least had predictive power.

That was great, Max.  I think one could almost go on indefinitely with what the assumptions overlook. Even setting aside social goods, inequalities, externalities, etc., etc., there's so much. 

It leaves out the role of government and society in creating markets and competitors. The fiction of a corporation as a person covers this up, as if they were natural. It leaves out the role of governments in creating entire economies, as in the historic role of first canals and then railroads in American industrialization, or highways in later enabling both trucking and a new shape for American living. 

It leaves out how much of government that market fans want to privatize exist owing to a market failure, such as public schools because schools no longer were available to all or the NYC subways, which became a single public entity because no one wanted them. Now market fans in constrast blame passenger railroads if they're unprofitable and try to pretend that the changes in airport regulation and air traffic control since Reagan didn't create a problem.

It leaves out the creation of labor markets and the need for them. Without the post-WWII explicit and implicit in tax structure home subsidies, rent regulation in return for tax cuts to developers, college grants, and so on, there wouldn't have been the "ideal" family of before the culture wars as fodder for flourishing central financial districts. And so on. Sometimes, too, the free-market objection takes on selective blinders. Say, more suport exists for a mortgage deduction, as an incentive, than for rent regulation, which disturbs the market, but both were part of the same history. 

It of course leaves out the classic criticism from Marx to Krugman that maybe the market really does favor consolidation and not more players.  

And I've ranted before about the confusion of ends (more efficient markets) with means (business efforts, when efficiency may result instead from failures and new market entries). I'm not an economist obviously, but why is this all so hard for economists to model?  

John 

http://www.haberarts.com/

But if you study the economics of firms, even under orthodox auspices, you find out they don't maximize profits.

Right. They maximize the promotion and self-preservation of powerful individuals, to the expense of everyone else.

For example, say you have a VP who is heading toward retirement. His pension is based on his earnings during his last five years of employment. His earnings include bonuses for increases in productivity and cost management. Therefore, to maximize his bonuses and thus the final value of his pension, he cuts the pensions of all his exployees and lays off a tenth of the work force to increase productivity.

No actual profit is made for the company or the shareholders. All the benefit goes to the individual, and the next VP who comes along will be forced to do essentially the same thing, only worse, because she is expected to exceed the performance of her predecessor. Meanwhile, morale plummets, employee turnover skyrockets, the company has to spend ever more on recruiting, retaining, and training new employees - meanwhile the product suffers and sales drop.

Free market capitalism assumes the economy is the ecosystem in which the organisms of society must fight to survive, but society in competition is tantamount to war. The economy is the internal, digestive ecosystem of the society. A proof of this is that public debt is an essential percentage of private sector investment. Recycling surplus wealth back through the public sector is necessary to maintain the value of the currency. As with Social Security, there just isn't enough capacity in the private markets to hold that amount of investment, so the government recycles it and provides a promise of return. The question is whether there will eventually be a debt writeoff, or will all government assets be eventually privatized. The highways all become toll roads, private security companies buying warships, selling off parkland, etc.
The problem with running the economy like a game of Monopoly is that when one person controls everything, the game is over and you start again. In real life, this stage is called revolution.

Go read the writings of Oliver E. Williamson as he uses transactional cost analysis to explain why organizations are necessary to internalize and reduce those aspects of uncertainty and opportunism present in the market.

He explains why sometimes markets are too expensive (because of the information acquisition costs required), so they are replaced by the hierarchical allocation functions of organizations. This explains why some functions are performed by markets of relative degrees of freedom, while some functions are marketed by large hierarchical organizations that control an entire supply chain. If you want innovation, you want a market filled with small firms that compete with each other, but it is expensive in terms of unit cost.

If you want low unit cost and high efficiency, then you want a big business, often in an oligopoly or even monopoly market. But the innovation is largely lost, to be replaced by centrally controlled allocation of resources. Such a business model will routinely take monopoly profits, so that the lower costs of production are often not available to the end consumers.

Some of his arguments can also be extrapolated over to the distinction between functions best performed by business and those best performed by government. I haven't seen the argument in Williamson, but government frequently provides essential functions which are quite standardized (how much innovation is possible in the way a toll road or even a public road is run? We are talking about engineering which has developed since the Romans. Government also does the best job of providing services for which the costs cannot be allocated directly to the end users, such as police, fire suppression, justice and defense. The free-rider effects in these areas are tremendous.

As for Marx - discussing Marx is sooo 19th century. For Economics you really want to look at Keynes and post-Keynsian developments. Particularly look at the causes of the Great Depression and the (still imperfect) solutions.

You may note that I am not totally anti-Economist. It's just that in political policies, the original discipline of Political Economics died sometime after the Depression. It can't be found in the Universities or in the halls of Congress - and God Forbid that any living news person or pundit attempts to explain economic theory and apply it to political policy! For every time someone demands an economic solution to a social problem, turn around and ask who gains power from that solution and why they want it installed. The power analysis will be a lot more useful than the economic analysis unless you are looking at central banking and the Federal Reserve. And even then, power is the more important issue.

In grad school we occasionally discussed the lack of reliability of Economic predictions in comparison with the predictions by physicists. Our conclusion is that physicists are lucky that the subjects of their calculations do not have minds and goals of their own, and do not read the physics journals to try to learn the latest ways to game the advances in physics.

Economics may have inherent laws, but since the subjects-of-study DO read the journals and game the results, the feedback effects of every reliable discovery of economics cause almost immediate arbitrage effects. The system being studied immediately incorporates the discovery and all we see are the left-over random effects that the theory cannot explain.

But this does not prove that economic theory sucks. Economic theory includes New Keynesian economics, accoring to which sticky prices and wages can cause markets to fail to clear during recessions. Rather than condemming all economic theory across the board, Sawicky should recognize that there are important disagreements amoung mainstreeam economic theorists.