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The Evolving State of Economics and Steve Keen's Debunking Economics

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Gary Karz, CFA Follow GKarz on Twitter
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     In the wake of the Global Financial Crisis (GFC), economists worldwide have been reassessing their opinions and theories about how the economy works, what caused the crisis, and how to fix it. In fact, many have blamed the profession of economics (and specific economists) for contributing to the crisis.

     A chief critic of mainstream economics that has been drawing increasing attention in recent years is Australian Professor Steve Keen. While there are (I believe) more than 50 prominent individuals that warned in advance of the crisis, thousands of economists at Real-World Economics Review overwhelmingly voted Keen the winner of the Revere Award (the criteria being those that "first and most clearly anticipated and gave public warning of the Global Financial Collapse and whose work is most likely to prevent another GFC in the future"). The result is particularly impressive given that Keen outpolled the other prominent nominees including Nouriel Roubini (who placed second and is widely acknowledged by the press for predicting the crisis), Robert Shiller, George Soros, as well as Nobel laureates Joseph Stiglitz and Paul Krugman.

     Keen originally published the first edition of his book Debunking Economics in 2001 and he expanded and updated the 2nd Edition, which was released near the end of 2011. Keen argues that virtually every aspect of conventional neo-classical economics' thinking is intellectually unsound and that "neoclassical economics is not bad because it is mathematical per se, but because it is bad mathematics." Keen discusses many of the modern world's most well-known economists and economic theories and critiques the principle concepts, theories, and methodologies of economics in the book. He is particularly critical of many of the commonly used economics textbooks and Keen states "the critiques in this book are not based on politics, but on logic. No political position - left, right or middle - should be based on foundations which can easily be shown to be illogical. Yet much of economic theory is illogical."

     As the GFC evolved there were many that gravitated toward the work of the late economist Hyman Minsky. Keen's PhD thesis was on modeling Minsky's financial instability hypothesis and Keen argues that some of those that have jumped on the Minsky bandwagon misinterpret or display ignorance of Minsky's work. For instance, Keen writes that some prominent economists seem "incapable of conceiving that aggregate debt can have a macroeconomic impact . . . While Krugman reached some policy conclusions with which I concur - such as arguing against government austerity programs during a debt-deflation crisis - his analysis is proof for the prosecution that even cutting edge' neoclassical economics, by continuing to ignore the role of aggregate debt in macroeconomic dynamics, is part of the problem of the Great Recession, not part of the solution." I'm sure there is more to the story, but I did see this Krugman blog post (11/29/2011) "looking at the long-term debt history of the United States" showing nonfinancial private-sector debt as percentage of GDP. He concluded "for now, I think the data are really interesting."

     One interesting detail Keen notes in the book is that Minsky himself identified 1966 as the time at which America made the transition from a productive to a Ponzi economy. I always try to look at (and link to) the various sides of an argument/theory and there are others that have not joined the Minsky bandwagon, one prominent one being Richard Roll. See the The Possible Misdiagnosis of a Crisis (March/April 2011) and his response to a comment referencing Minsky in the May/June 2011 issue of the Financial Analysts Journal.

     While the news regularly cites unemployment numbers (the definition of which was changed in 1994), Keen argues the correct comparison to the Great Depression is an "alternative measure for the US measure that includes long-term discouraged workers." (See Shadowstats). Keen points out that "one in six Americans are out of work today, versus a peak rate of one in four during the Great Depression. The current crisis, though it is called the Great Recession, is therefore really a depression too." A sample chapter that Keen has made available is Misunderstanding the Great Depression and the Great Recession. In the book, Keen makes "the empirical case that a collapse in debt-financed demand was the cause of both the Great Depression and the Great Recession. Bernanke's neoclassical goggles rendered him incapable of comprehending the best explanations of the Great Depression and let him to ignore the one data set that overwhelmingly explained the fall in aggregate demand and the collapse in employment." See also Down and Out: Measuring Long-Term Hardship in the Labor Market (January 2012) and Unemployment Is Down Because People Have Given Up Looking for Work (24 January 2012) from The Center for Economic and Policy Research.

     Keen writes further that "The Great Depression remains the greatest economic crisis that capitalism has ever experienced, but on every debt metric, the forces that caused the Great Recession are bigger. Private debt rose 50% of the 1920s, from $106 Billion (yes, billion) in 1920 to $161 billion by 1930; it rose from $17 trillion between 1999 and 2009 - a 140 percent increase. The debt-to-GDP ratio was 175 percent when the Great Depression began; it is over 100 percent higher today and hit 298 percent before it began to reverse in 2009." Diagrams supporting the book are also available from his web site here (46 pages), with graphic 96 accompanying the preceding text. The book is over 429 pages without the diagrams. Incidentally, Krugman has also said we are in a depression (and still believes that to this day).

     Keen's prescription for fixing our debt problems has been finding more support recently. "There is a simple, but confrontational, way to stop this process: a unilateral write-off of debt." See also Keen's response to my GFC Survey. While it would be fascinating to see Keen debate some of the prominent economists he comments on, he doesn't expect many would change their minds, because "there is no point trying to debate fundamental beliefs with a zealot."

     My first exposure to Keen's writing was when I found his FCIC Report critique Sound and fury, signifying nothing in which he commented that he "wasted a perfectly good day reading the report." While it's generally difficult to make economics books interesting, I find Keen to be consistently interesting and quotable. For instance, Keen summarized that "Economics is not the emperor of the social sciences, but the Humpty Dumpty." Frank Fabozzi and Sergio Focardi comment in What Can We Really Know about Economics? where they summarize "The science of economics is in an uncomfortable position, somewhere between the physical sciences and the human sciences . . . One can say: In physics, we have lots of information corrupted by a little noise; in economics, we have lots of noise corrupted by a little information."

     In economics and investing, noise is a major issue, causing misdiagnosis, too much trading, and way too much overconfidence on the part of both economists and investors. After reading Debunking Economics, one thing I can say is I'm sure glad that I didn't major in economics.

     Despite it's issues, economics clearly plays a role in the investment business, which is one of the reasons I link to many prominent economists' web sites and blogs. As I noted above, I like to hear both sides of an argument, so it's somewhat intentional that I link to the blogs of Paul Krugman and Greg Mankiw next to each other on the InvestorHome home page, as well as to Robert Reich alongside Karl Rove (alphabetically organized). I've added Steve Keen's blog to those links, and I think he has earned the right to be heard on major economic issues. As the debates about how to improve the world's economy continue, I think many will be well served to consult the advice of Keen and others, rather than solely relying on those with similar opinions to their own and/or only those in traditional positions of influence. Keen is seeking sponsors for his continued efforts to develop "a realistic theory of economics, and public knowledge of both the flaws in neoclassical analysis and the existence of alternatives."

     Debunking Economics also has interesting discussions on many other topics including monopolies and unions, as well as the efficient market hypothesis. The final chapter is one of the most interesting and in it Keen discusses alternative economic approaches and their strengths, weaknesses, and track records. My collection of other interesting quotes from Debunking Economics include the following (it was difficult to cull the list down to these).

     For an entertaining diversion while debating economics, invest a few minutes to watch 10 Principles of Economics by Stand-Up Economist Yoram Bauman. Additional examples of changing perceptions of economics (called the dismal science by some) in the wake of the GFC include the following.

     Some other recent books discussing the state of economics.

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