Five reasons why the Keynesians lost the battle

1 Oct

From Mark Blyth:

The first reason is time. Simply put, by the time this article is published it will be a mere four years on from the crisis of 2008 (at the time of writing) and it’s far from clear that we will be out of the economic woods by 2012. There may be a quick recovery that rehabilitates the orthodox theory, as practitioners of austerity politics such as the European Central Bank (ECB) and the German government seems to hope. There may be a slow and sluggish recovery, which those in favor of sustained stimulus argue. Or there may be a secondary collapse and further banking crises stemming from the flawed policy responses of the first crisis and/or the death of the underlying model of finance driven capital (Haldane 2010). The point is however, if it’s too early to tell, then it’s too early to expect the accumulated wisdom of an entire generation to be trashed and replaced. Time is the friend of paradigm maintenance irrespective of evidence. Humans get ‘stuck in the idea,’ as they say in finance, since path dependence is fundamentally a cognitive phenomenon (Blyth 2001).

A second concern is the expectation that paradigm shifts are ‘all or nothing’ affairs; that one fails and another enters after waiting in the wings. However, it’s entirely possible that the dominant paradigm is seen to fail and that nothing in particular comes along to replace it, so complete was its initial victory. Take the so-called ‘Washington Consensus’ on development and growth from the mid 1990s (Babb 2010) for example. Arguably, the rise of the BRIC nations plus the global financial crisis put paid to that model. Yet it is not as if the ‘Beijing Consensus’ has popped up to replace it (Ferchen 2010). The same thing is just as likely here.

The third reason is possibly the most important, and yet perhaps the most the most mundane. The essence of the problem is well captured by John Cassidy at the end of his book How Markets Fail (2009: 346). He notes how even after the crisis Greg Mankiw, author of a best selling economics textbook, argued in a New York Times column that, “despite the enormity of events, the principles of economics are largely unchanged. Students still need to learn about the gains from trade, supply and demand, the efficiency properties of market outcomes and so on.” Cassidy notes wryly “note the phrase ‘the efficiency properties of markets.’ What do you suppose that refers to?” Cassidy points to the meltdown of the markets. But I suggest it points to something else: disciplinary incentives.

Economics is today one of the most popular and fastest growing majors on US college campuses. Students see that incomes in the financial sector dwarf those in other fields, and if an economics degree is seen as a ticket to the ball, then there will be real demand for courses: irrespective of their content. Inside the academy, the costs of being wrong, in terms of external validity in the world, are negligible. Tenure is tenure and error is error; let’s not confuse the two. Hedge funds run by economists blow up: tenured economists who run hedge funds do not. Promotion depends upon tenure and that depends upon acceptance of the reigning paradigm that all the people reading your tenure file created. As such, adding incrementally to the existing corpus of knowledge rather than nailing contrarian theses to the disciplinary door is the way to succeed. Despite the crisis, the economics of the world and the economics of the classroom can be kept as separate bodies of knowledge, and rather than this undermining a paradigm, such incommensuration within a field of knowledge can serve to reinforce it. If the crisis of 2008 did indeed constitute an ‘experiment’ on these ideas, then the classroom version of events remains curiously unaffected.

A fourth reason builds upon these prior observations by linking Hall’s concepts of the locus of authority in paradigmatic struggles to questions of empirical evidence. There is plenty of evidence that stimulus packages worked and the bigger the package the better the outcome. After thirty years of dominance by a paradigm that denies the possibility of this being true, while it was fine to throw some money at a problem when it threatened the global payments system and the solvency of major core banks, the response soon came back from the global centers of economic authority, ‘let’s not chuck the neoclassical baby out with the EMH bathwater. Too many careers and institutions are at stake!’

Consider the inflation-phobic European Central Bank’s sclerotic response to the crisis, fretting over ‘inflation risks’ in the middle of a deflation, and its continuing determination not to create a Eurobond despite the fact that not doing so could well lead to the collapse of the Euro. The ECB’s behavior is a singular testimony to the power of ideas determining outcomes. Recall the ‘new’ International Monetary Fund (IMF), who had for so long championed belt tightening for developing states in moments of crisis, and yet who turned on the money pumps for the developed world at the first hint of trouble, reverted to type and called for ‘sensible fiscal consolidation’ after a mere year of compensation. Remember how the British Conservative party, who sat at the time of their election on a public debt ratio close to the Maastricht criteria, used the crisis of the financial sector to de-facto privatize British universities and make exceptional cuts in the welfare state and public employment. Yet what is driving the UK’s bond yield is its ability to print its way out of trouble in extremis, not its fiscal probity. Again, it’s the perception of the facts that matters. In each of these instances a crisis of finance was deftly constructed as a crisis of the profligate state despite the inequity of the put (who pays) and the inanity of the analysis (who is to blame).

A fifth and final reason links back to our prior discussion of processes of change being more sociological than scientific, thus determining of who gets to speak authoritatively. In Hall’s case of the UK in the 1970s, the locus of authority, who gets to speak concerning how the world works, were the Treasury and the Cambridge Keynesians. Surrounding them, shooting arrows of dissent like so many Hollywood Indians in a Western movie, were a panoply of organizations; British and American think-tanks, the British Conservative party, the financial press, the City of London, all pushing against the dominant paradigm. One locus of authority, many challengers, each ‘failure’ amplified and distributed, discrediting the source, leaving the old guard outgunned and outflanked.

Now compare this to the politics of the 2008 crisis. Saving the global payments system from itself was self-interestedly essential, and so the unreconstructed brute Keynesianism of output gaps and stimulus became wedded to an enormous redistribution of wealth from taxpayers to rentiers as financial bailouts became the order of the day. But once the system was stabilized, this time around the Indians were few and the Cowboys were many and distributed. Thirty years of spectacular returns and pseudo-stability (Taleb and Blyth 2011) had convinced every recognized authority, from the Organization of Economic Cooperation and Development (OECD) to the ECB, from the Bank of International Settlements (BIS) to the IMF, from the Swedish Riksbank to the US Federal Reserve, that markets were rational, prices were right, and their policies were optimal. Given this, those invested in selling ‘the Great Moderation,’ those whose identities were bound up with these ideas and their instantiation, could hardly be expected to turn around and tear it all down so easily, no matter the weight of the evidence. This time around, with so many distributed yet mutually supportive authorities invested in ‘paradigm maintenance’ (Wade 1997), the forces for paradigm change had to spread their fire over such a wide area that their effect was dissipated. This time around, and with apologies to Milton, there was no paradigm lost.

Forthcoming in Governance

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