Janet Yellen. The mainstream: meeting the historic challenges?

The "People's" Economist? Yellen raked in $7 million in 2 years from Wall Street Firms

by Michael Roberts

Recently, newly confirmed US Treasury secretary and former Fed chief, Janet Yellen, spelt out the challenges facing US capitalism in a letter to her new staff.  She said: “the current crisis is very different from 2008. But the scale is as big, if not bigger. The pandemic has wrought wholesale devastation on the economy. Entire industries have paused their work. Sixteen million Americans are still relying on unemployment insurance. Food bank shelves are going empty.”  That’s now; but ahead, Yellen says that there were “four historic crises: COVID-19 is one. But in addition to the pandemic, the country is also facing a climate crisis, a crisis of systemic racism, and an economic crisis that has been building for fifty years. “

She did not spell out what this 50-year crisis was. But she was confident that mainstream economics can find the solutions to these crises. “Economics isn’t just something you find in textbook. Nor is it simply a collection of theories. Indeed, the reason I went from academia to government is because I believe economic policy can be a potent tool to improve society. We can – and should – use it to address inequality, racism, and climate change.  I still try to see my science – the science of economics – the way my father saw his: as a means to help people.”

These are fine words. But is mainstream economics really designed to ‘help people’ improve their lives and livelihoods?  Indeed, is mainstream economics really offering a scientific analysis of modern economies that can lead to policies that can solve the ‘four historic challenges’ that Yellen outlines?

The failure of mainstream economics to forecast, explain or deal with the global financial crash and the ensuing Great Recession of 2008-9 is well documented – indeed see my paper here.  That hardly backs up Yellen’s claims.

Mainstream economics cannot deliver even on its own terms because it makes two basic assumptions that are not based on reality; one in so-called ‘microeconomics’ and one in so-called ‘macroeconomics’. As a result, mainstream falls down as a scientific analysis of modern (capitalist) economies.

First, there is utility theory and marginalism – and the resultant adoption of general equilibrium theory.  Where does ‘wealth’ come from in society and how do we measure it?  The classical economists, Adam Smith, David Ricardo etc recognised that there was only one reliable and universal measure of value: the amount of labour (hours) that is expended to produce goods and services. But this labour theory of value was replaced in the mid-19^th century by utility theory, or more precisely, marginal utility theory.

This became the dominant explanation for value.  As Engels remarked: “The fashionable theory just now here is that of Stanley Jevons, according to which value is determined by utility and on the other hand by the limit of supply (i.e. the cost of production), which is merely a confused and circuitous way of saying that value is determined by supply and demand. Vulgar Economy everywhere”.  But marginal utility theory quickly became untenable even in mainstream circles because subjective value (ie every individual values something differently according to their inclination or circumstance) cannot be measured and aggregated, so the psychological foundation of marginal utility was soon given up.  For more on the fallacious assumptions of mainstream value theory, see Steve Keen’s excellent book, Debunking economics, or more recently, Ben Fine’s critique of both micro and macroeconomics.

Engels called mainstream economics ‘vulgar’ because it was no longer an objective scientific analysis of economies but had become an ideological justification for capitalism.  As Fred Moseley has explained, “marginal productivity theory provides crucial ideological support for capitalism, in that it justifies the profit of capitalists, by arguing that profit is produced by the capital goods owned by capitalists. All is fair in capitalism. There is no exploitation of workers. In general, everyone receives an income that is equal to their contribution to production.” In contrast, “The main alternative theory of profit is Marx’s theory and the conclusions of Marx’s theory (exploitation of workers, fundamental conflicts between workers and capitalists, recurring depressions, etc.) are too subversive to be acceptable by the mainstream. But these are ideological reasons, not scientific reasons. If the choice between Marx’s theory and marginal productivity theory were made strictly on the basis of the standard scientific criteria of logical consistency and empirical explanatory power, Marx’s theory would win hands down.”

The ultimate logical result of this vulgar economics is general equilibrium theory, where it is argued that modern economies tend towards equilibrium and harmony. The founder of general equilibrium theory, Leon Walras, characterised a market economy as like a giant pool of water. Sometimes a rock would be thrown into the pool, causing ripples across it.  But eventually, the ripples would die out and the pool would be tranquil again.  Supply might exceed demand in a market through some shock, but eventually the market would adjust to bring supply and demand into equilibrium.

Walras was well aware that his theory was an ideological defence of capitalism.  As his father wrote to him in 1859, when Marx was preparing Capital, “I totally approve of your plan of work to stay within the least offensive limits as regard property owners. It is necessary to do political economy as one would do acoustics or mechanics.”  More recently, Nobel prize winner Esther Duflo gave a speech in 2017 to the American Economics Association in which she reckoned economists should give up on the big ideas and instead just solve problems like plumbers “lay the pipes and fix the leaks”. 

But do economies and markets really tend to equilibrium, if occasionally disrupted by ‘shocks’?  We only have to look at the gyrations in the stock markets of the world this week to doubt that.  Actually, modern economies are more like oceans with rolling waves (booms and slumps), with tides pulled by the gravity (profit) of the moon and storms (crashes) from the forces of the weather. There is no tranquility or equilibrium but continual, turbulent movement.  Marxist economics aims to examine the dynamic ‘laws of motion’ over time in modern capitalism; in contrast to mainstream economics where time stands still and any ‘disturbances’ are caused by ‘shocks’ external to ‘free’ markets.

Of course, some mainstream economists admit that marginal utility and general equilibrium theory is nonsense.  And occasionally some physicists of the ‘natural sciences’ attack the assumptions of mainstream economics. The latest critic is a British physicist Ole Peters who claims the Everything We’ve Learned About Modern Economic Theory Is Wrong.  What’s wrong is that mainstream economic models assume something called “ergodicity.” That is the average of all possible outcomes of a given situation informs how any one person might experience it.

Peters takes aim at mainstream utility theory, which argues that when we make decisions, we conduct a cost-benefit analysis and try to choose the option that maximizes our wealth. The problem, Peters says, is this fails to predict how humans actually behave because the math is flawed. Expected utility is calculated as an average of all possible outcomes for a given event. What this misses is how a single outlier can, in effect, skew perceptions. Or put another way, what you might expect on average has little resemblance to what most people experience. His solution is to borrow math commonly used in thermodynamics to model outcomes using the ‘correct average’.

Peters is saying that reality operates more often like ‘power laws’, where far from markets, wealth, employment etc tending towards the average, or towards the equilibrium, Walras-style; instead, inequality can increase to extremes, unemployment can rise not fall etc.  Outliers in the statistics can become decisive in their impact.

But it does not take us very far just to recognise uncertainty and chance and feed that into some mathematical model.  We need to base economic ‘models’ on the reality of capitalist production, namely the exploitation of labour for profit and the resultant regular and recurring crises in production and investment ie the laws of motion of capitalism. Marxist economist of the early 20^th century, Henryk Grossman perceptively exposed the failure of mainstream theories which are based on static analysis.  Capitalism is not gradually moving on (with occasional shocks) in a generally harmonious way towards superabundance and a leisure society where toil ceases – on the contrary it is increasingly driven by crises, inequality and destruction of the planet.

Instead, mainstream economics just invents possible exogenous causes or ‘shocks’ to explain crises because it does not want to admit that crises could be endogenous.  The Great Recession of 2008-9 was ‘a chance in a million’or an ‘unexpected shock’, or a ‘black swan, the unknown unknown, that perhaps requires a new mathematical model to account for these shocks.  Similarly, the COVID-19 pandemic is apparently an unforeseen exogenous ‘shock’, not a well forecast consequence of capitalism’s drive for profits from expansion into remote areas of the world where these dangerous pathogens reside.  But the mainstream does not require or want a theory of endogenous causes of crises.

At the level of macroeconomics, modern Keynesian theory has also been found wanting.  Modern Keynesianism (or ‘bastard Keynesianism’ as Joan Robinson called it) bases its analysis of crises in capitalism on ‘shocks’ to the equilibrium and uses Dynamic Stochastic General Equilibrium (DGSE) models to analyse the impact of these ‘shocks’.

Among others, Keynesian economic journalist Martin Sandbu has been running a little campaign against the DSGE approach. There is “little doubt that mainstream macroeconomics is in deep need of reform.” He says: “the question is how, and whether the standard approach, DSGE modelling, can be sufficiently improved or should be jettisoned altogether.” As Sandbu says, “DSGE macroeconomics does not really allow for the large-scale financial panic we saw in 2008, nor for some of the main contending explanations for the slow recovery and a level of economic activity that remains far below the pre-crisis trend.” Sandbu wants to plough on with “a more expansive and liberal form of DSGE”.

Recently he has praised the idea of so-called multiple equilibria as a standard feature of their core mainstream macro model ie “allowing that there are several different self-reinforcing states the economy can fall into, not just a single equilibrium around which it fluctuates. But with multiple equilibria, there is no single central tendency. If anything, there are several, and while one can give probability distributions around the precise outcome in each equilibrium, predicting in which equilibrium the economy will find itself is a different beast altogether.” Sanbu puts up this multiple equilibria approach as a method of getting better results from economics: “it becomes clear that by far the most important policy question is equilibrium selection: how to get the economy out of a self-reinforcing bad state, or prevent disruptions that tip it out of a good state.” But that sounds little different from general equilibrium models. And even worse, if there really are ‘multiple equilibria’ in modern economies then, says Sandbu, it “is something economists are not well-equipped to advise on.”

If that is so, then we cannot expect mainstream economics to meet the four historic challenges that Janet Yellen reckons capitalism faces.  What were they again?  Dealing with future pandemics; solving the climate crisis; ending inequality and racism; and the undefined 50-year crisis of capitalism (which is presumably the regular and recurring turbulence in capitalist production for profit).

We can only hope that Janet Yellen’s speeches to financial institutions in Wall Street, which has earned her over $7m in the last few years, provided these bastions of capital the solutions to those historic challenges.  But don’t hold your breath.