Customer Reviews

Debunking Economics: The Naked Emperor of the Social Sciences

5 star:		(15)
4 star:		(2)
3 star:		(4)
2 star:		(1)
1 star:		(3)

 

 

For people, like me, who had almost given up entirely on the academic field of Economics because of ridiculous theories and poor teaching, there is fortunately still Steve Keen. In this book, the Australian Keen shows the errors of the standard views of neoclassical (orthodox) economics.

Not just some side aspects of the theory, but the actual core views of economics as it is taught in universities everywhere unravels before your eyes. Keen masterfully applies both economic models and historical analysis to show that orthodox economists not only do not know what theories exist in their own field, but they also have no inkling of the history of economics and what this means for their approach. This, combined with a possibly even poorer understanding of the philosophy of science (Keen uses Milton Friedman as the main example, but more could have been named), leads to a series of ridiculous assumptions and even more ridiculous results. That the economists consistently ignore the way industrial managers and market analysts etc. do NOT apply their pet theories is just the icing on the cake.

The book is heavy reading for those with no knowledge of economics or maths, but certainly not impossible. A basic understanding of economics and mathematics as taught at high school level (at least in The Netherlands) goes a long way, and Keen fortunately writes well and attempts to avoid long mathematical proofs as much as possible.

The only downside to the book is that his treatment of alternative theories, especially the quite closely linked Austrian school of economics, is very short and vague. This leads to the impression that Keen knows what's wrong with neoclassics, but not what is to be done instead. Therefore, start by reading this book, but don't end there.

This book provides a far more clear explanation of the ideas of standard economic theory (neo-classical economics) than do the standard texts (compare with Samuelson, Mankiw, or Barro, e.g.). The book explains utility maximization, indifference curves, and the assumptions underlying the standard economic model that is used by the IMF, the World Bank and all major western governments. Keen uses simple language that even the lay person can follow. The text should be standard reading for every student of elementary economics, but even an experienced economist like Alan Greenspan might benefit from the clarity of thought displayed therein.

Macroeconomic theory is covered from the right perspective, from the result of Sonnenshein et all which shows the basis in microeconomic theory for the standard macroeconomic model. Kirman is mentioned but his seminal connection of liquidity demand with uncertainty is not discussed. The work of Radner should have been included, but then Samuelson and Varian do not discuss Radner's contribution either.Chapter 7 presents the correct perspective on general equilibrium theory, with good advice for students of econ 101.Chapter 8 on Keynes is outstanding, presenting the clearest (and even correct!) textbook discussion of Keynes that I am aware of. Marx's contribution to the basis of capitalism, the recognition of the central role played by the profit motive, is also made apparent in the Keynsian context. The profit motive is ignored completely in Samuelson and the other standard texts, which discuss merely pure barter economies and leave out financial markets altogether. Hicks' interpretation of Keynes' ideas is also correctly presented. All in all, students of economics would be well advised to make Keen's book their main econ text.

"Debunking Economics" is a critique of neoclassical economics by a Post Keynesian who likes Sraffa, math and dynamics as much as he dislikes neoclassical economics, equilibrium and statics.

The book has three main parts: Foundations, Complexities, and Alternatives. Foundations includes discussions of neoclassical supply, demand, perfect competition and monopoly, as well as the labour market. Complexities covers capital, assumptions, time, macroeconomics and financial markets. Finally, Alternatives part presents alternative financial theories and heterodox schools of economics, argues against Marxian economics and discusses the use and abuse of mathematics.

The idea behind the book is great. The execution itself, unfortunately, is a mixed bag. I found two chapters - Chapter 6 on capital and Chapter 13 on Marxian economics - to be almost unbearable. All the other chapters are more accessible and have promising arguments, albeit delivered in a mostly tedious manner. In this regard, Chapter 2 is quite representative of the whole book. It points out that in order to derive a smooth downward sloping market demand curve, economists assume homogeneous preferences, which amounts to having only one consumer in the market. Heterogeneous preferences would yield an unpredictable, messy curve with possibly more than one equilibrium. This interesting point is arrived at through a series of boring utility hills and indifference curves. Likewise, Chapter 8 presents a nice discussion of Walras and general equilibrium, but ends with a confused exposition of what temporal analysis in economics should be. Above all, in certain cases when the lay reader (who is supposedly the author's primary audience) might need some easing in (e.g. when Hicks and IS-LM are being discussed), Keen does that very little if at all. Without doubt, the delivery of the arguments could have been much better - much more focused, more accessible. Furthermore, some interesting points are left to be developed on the author's website. Why not use increasing returns to scale (which are otherwise taken so seriously by Keen) possible in this book and develop those issues here as well? I would argue that because of this lacking delivery, many otherwise solid arguments and points will be forgotten soon after being read by the lay reader.

Long story short: this book is a good idea executed in a sloppy manner.

Keen has accomplished from the inside what many critics have attempted, and that is to decisively reveal the fatal flaws of neoclassical economics. Yes, it's a paper tiger, a giant with feet of clay, a Potempkin Village, or my favorite metaphor -- the thundering Wizard of Oz, which is really a little man behind a curtain. With Keen's book in hand, any professor ought to be able to effectively challenge the ruling TINA orthodoxy that "there is no alternative" to The Market. The supposedly iron laws of supply and demand are not iron after all, there is no One Perfect Equilibrium, so it's back to the political economy that prevailed prior to the "marginal revolution" -- politics matters, institutions matter, and the Masters of the World are nothing but Naked Emperors. Keen offers a section on alternatives, and he favors post-keynesian theory, but is fair to other approaches.

As Keen warns, this is not easy reading, and I can't imagine assigning it to undergraduates. Hopefully some economics professors will (I'm a sociologist). But it should be required reading for every professor and graduate student in the social sciences.

I am an economist. I am painfully aware of the shortcomings of my field. I am aware also of several important purely scientific developments that are likely to dramatically improve the explanatory power of economic theory, yet are slow on the uptake, and hence are not well reflected in the journals or textbooks in the field. I am often impatient with the slow-moving pace of the process of bringing the discipline up to date. Nothing of this sort would be tolerated in the natural sciences. Nevertheless, I find Steve Keen's broadside attack on economics unhelpful. In particular, his suggestion that neoclassical theory be jettisoned in favor of some mix of `heterodox' alternatives is unwarranted. Some non-mainstream theories have insights to offer us, but they must be integrated into the body of economic theory, rather than being wholesale replacements for current theory. Some impatient innovators believe that this cannot happen because the reigning orthodoxy in economics is impervious to change, but I think the experience of the past few decades suggests that this is simply not the case.

Keen is a serious critic, in the sense that his major arguments are with the analytical apparatus of economic theory; he does not disparage analytical approaches to economic theory per se (like the usual anti-economics moan and groaners) and indeed accuses economics of being backward and out of touch with modern mathematics. The casual reader will be rebuffed by many of the most pointed accusations, because they require a considerable understanding of economic theory to appreciate. Keen tries to supply this understanding by presenting much of the content of undergrad Intermediate Micro in a few figure-laden chapters. I admire Keen for trying this, but it is bound to be a failure. You can't teach a casual reader a body of theory that requires a lot of study time, homework problems, and multiple applications.

First Problem: Keen presents a laundry list of "heterodox" alternatives to traditional economics, including Austrian, Post-Keynesian, and Sraffian economics (he excludes Marxism, which he disparages almost as thoroughly as neoclassical economics). But he does not say how the traditional weaknesses are addressed and corrected in these alternative approaches. The only exception to this pattern of critique-without-better-alternative is his relatively careful treatment of heterodox financial theories (fractal/chaos theory of stock prices, chronic over-reacting to new information theories, and Post-Keynesian financial fragility theories), which indeed supply cogent insights not found in the traditional Efficient Markets Hypothesis. Even in this case, however, the problems with the neoclassical treatment of financial markets have nothing to do with Keen's critique of microeconomic theory.

By the way, people often ask me if I believe the Efficient Markets Hypothesis in financial economics, which says that stock prices incorporate all common knowledge concerning the expected future performance of stocks. My answer is that the central implication of this, the assertion that there is no "magic formula" for beating the stock market, and hence it is fruitless and even wasteful to try to "pick winners," is absolutely correct. The stock market is a great investment opportunity for the long term, but the best policy is to put your money into low-overhead mutual funds (very, very, low overhead---look at the prospectus, and try for yearly service charges less that 0.1%) and just leave them there. As you move toward retirement, move money out of stocks and into bonds such that you are never required to change your standard of living when the bottom falls out of the market, as it appears to do with some regularity. A corollary of this advice is: don't spend a lot of money on fancy financial advisors. Do so every ten years or so to make sure you're not overlooking something important, and make sure you advisor doesn't sell you any financial securities, but just gives you portfolio strategy advice.

However, another implication of the Efficient Market Hypothesis is that there is a strong tendency towards financial markets to return quickly from any shock to an equilibrium state. I don't think this is the case, and I think the reason is that the basic learning process for investors in financial markets is imitation, and imitation dynamics allow for bandwagon effects that lead to the sort of stock market bubbles we see periodically. One might think that this refutes the previous paragraph, because if the market is out of kilter for discernable periods of time, we should be able to gain by forecasting the return to equilibrium and buying and selling securities accordingly. The problem is, as John Maynard Keynes purportedly said, "The markets can stay irrational longer than you can stay solvent." On the other hand, I have personally done pretty well over the years by buying when most investors appear to be overly fearful and/or liquidity constrained, and selling when the market seems overheated. The important point is that such actions cannot be justified (if at all) more than once in a long while.

Second Problem: Keen seriously undervalues the practical contribution of traditional economics to economic policy and social planning, and hence to helping countries adopt efficient and growth-oriented economic systems. My ideal in practical economic theory is what is dealt out weekly in The Economist, and I recommend the magazine highly for both individuals and professionals. Keen stresses that neoclassical economics cannot "predict the future," and concludes that the theory is worthless. I believe economics could do a better job of predicting if it employed large-scale agent-based modeling techniques, and I am dismayed that a larger number of financial economists did not predict the current financial crisis (some did, and The Economist nagged about the housing bubble for years before it burst--I sold two houses for family members about at the top of the market on the basis of this advice), but the fact is that "heterodox" financial theories always predict crisis, so they're right once in a while. That does not make them superior theories.

Simply stated, explanation rather than prediction is often the mark of a good theory. If you understand navigation, when the wind shifts you will be able to adjust your sails accordingly; you don't have to be able to predict when the wind will shift or by how much. My auto mechanic and my plumber do not often predict when my car will break down or when a pipe will leak in my house, yet they are capable of diagnosing and fixing problems when they arise.

Traditional economic theory has much to contribute in many areas of economic policy, despite Keen's categorical denial of this fact. Keen depicts all economists as market-fundamentalist who believe the market system is perfect and intervention will always make things worse off. This is not true of most economists (indeed, the free market fundamentalists rarely have any economic training at all, and base their beliefs on quasi-religious faith), and those economists for whom the epithet is apt are certainly not drawing on economic theory for support. Traditional economic theory has stressed since the 1950's the ubiquity of market failures and the fruitful role of state intervention in correcting such failures (provided there are not "state failures" that lead to worse outcomes from inept regulation than the original problems the regulation was meant to solve).

The policies of the IMF, for instance, are not dictated by economic theory, and highly prominent economists (including Nobel Prize winner Joseph Stiglitz) have been vitriolic in criticizing the IMF's policies on the basis of sound economic theory. Similarly, Alan Greenspan might have falsely believed that financial markets are self-correcting, but he did not get this idea from neoclassical economic theory, which has no dynamical theory of price movements in at all in multi-market systems (the reader might suggest that the Efficient Markets Hypothesis in financial economics is such a theory, but in fact, this hypothesis is based empirical observations and is not derived from microeconomic theory based on a general model of market interaction).

Third Problem: Keen presents as neoclassical orthodoxy a version of Marshallian economic theory that the graduate schools in the United States and Europe have not been teaching for forty years or so. The great economist Alfred Marshall's approach in the late nineteenth century was to study individual markets in detail based on the interaction of supply and demand schedules and an intricate model of firm production in which optimal firm size is a function of market price. I was trained in economics at Harvard in the mid-1960s, where the name of Marshall was revered but whose theories were simply not taught. After I completed my Ph.D., I did learn the Marshallian system by reading Marc Blaug's excellent exposition in his book Economic Theory in Retrospect. Also, I recall that Bishop taught micro at MIT for many years during my graduate years at Harvard, subjecting generations of hapless grad students to seemingly endless diagrams of Marshallian LRACs and MRACs, worthy of Keen's diagrammatic treatment in this book.

In place of Marshall, we learned the general equilibrium model of the Swiss economist Leon Walras, perfected after WWII by Kenneth Arrow, Gerard Debreu, Frank Hahn, Lionel McKenzie, and others. In Marshall's time, there was a virtual war of ideas between Marshall's supporters (mostly in Britain) and those of the Walras (represented in England by the formidable but relatively isolated Francis Ysidro Edgeworth). The Walrasian orthodoxy has been the mainstay of graduate education in economics now for a half century. This model, however, is not even discussed in Keen's book. Nor does the Walrasian model suffer from the many problems identified by Keen (although it has problems of its own, as discussed below). Keen is simply debunking a long, long-dead economics.

The Walrasian model is itself seriously faulty, not so much because it says things that are wrong, but because it says very little. It does say enough for us to understand the nature of market externalities and missing markets, ideas central to the theory of market regulation. But it makes the mistake of depicting all markets as complete, third-party (judicially) enforceable, which means it doesn't properly model labor markets (you can't sell a particular quantity and quality of `labor'), capital markets (you can't enforce a promise to repay a loan if the borrower is broke), and even consumer goods markets (it isn't worth it to take Perdue Chicken to court if a chicken isn't up to snuff). For this reason, the Walrasian model treats equilibrium as market clearing, whereas in markets without third party enforcement (Samuel Bowles and I call them `contested exchange' markets---see our article on the topic, Samuel Bowles and Herbert Gintis, "The Revenge of Homo economicus: Contested Exchange and the Revival of Political Economy", Journal of Economic Perspectives 7,1 (1993):83-102, and/or Samuel Bowles and Herbert Gintis, "Walrasian Economics in Retrospect", Quarterly Journal of Economics 115,4 (2000):1411-1439), there is usually unemployment in equilibrium (for instance, an excess supply of labor, more people desiring loans at the going interest rate that lenders are supplying, and firms that sell quality goods maintain price way above marginal cost, so they always desire to sell more stuff at the going price). We call this `short-side power.'

Much more embarrassing about the Walrasian model, however, is it has absolutely no known dynamical properties. Every attempt to turn the theory into a model of how prices change over time has been an abject failure, as long as both production and consumption are included in the model, and there are more than three or four industries. The fact is that economist really know nothing about economic dynamics, although most pretend that the problem does not exist, and "one of these days," someone will come up with the proper dynamical extension of the general equilibrium model. Problem: they've been saying this for sixty years! My own position is that a general equilibrium system is a complex dynamical nonlinear system, and it cannot be modeled using the usual tools of smooth manifold theory and differential equations. My own attempt to model the general equilibrium economy using agent-based techniques is, I believe, extremely successful, and points to future advances in this direction (see Herbert Gintis, "The Dynamics of General Equilibrium", The Economic Journal 117 (2007):1289-1309. This model also shows why financial markets can be extremely volatile even when there are no aggregate shocks to the economy.

How do we explain Steve Keen's intemperate treatment of standard economics? I think the answer lies in the nature of the undergraduate curriculum, which in my experience is still stuck in nineteenth century Marshallian economics. I taught Intermediate Microeconomics for several years in the mid-eighties, and I can attest to how absolutely obsolete was the treatment of production I was obliged to teach. Moreover, all the textbooks were the same! I finally gave up and refused to teach the stuff. Most important about the Marshallian model (not mentioned by Keen, surprisingly) is that it is not a theory of the firm, but rather a theory of the "plant," whereas a firm can consist of many "plants" (think of a soft-drink firm, an auto maker, a beer firm, a fast food franchise, a multi-branch bank). Who cares about the theory of "optimal plant size," except in very advanced and specialized courses on Industrial Organization? Except for very small firms, we might as well treat firms has having a horizongal supply curve, because a change in demand simply leads to a change in the number of plants, not the optimal size of a plant.

Of course, the textbooks all had an obligatory chapter on the "Edgeworth Box Diagram," and hand-waved about "convergence to general equilibrium" as the number of sides of the box becomes large. But, all of this is light-years beyond the poor undergrad, who must sweat out LRACs, MRACs, Product Expansion Paths, Envelope Theorems, and the like. I am sure that if I had ever had a course in economics as an undergrad, I would never have become an economist.

I honestly do not know why the treatment of core economic theory in the undergraduate curriculum is so abjectly brainless, and I cannot imagine why economics professors teach stuff every day that that know is at best irrelevant, and often just plain wrong. It's like teaching about the four humors in anatomy class, or phlogiston and ether in physics class. There is plenty of interesting and veridical stuff to teach that still puts the student through his or her analytical paces. One of my joys in life is that I no longer have to teach this junk.

This is an excellent critique of neo-classical economics. The author identifies himself as a "post-Keynesian." However, he has strong sympathies with the Complexity Theory and Evolutionary Economics schools of thought. If I read him correctly, he believes that ideas from these various alternative economic schools of thought will eventually be blended into a triumphant 21rst century truly "scientific" predominant school of thought. Or so he and I hope.... Maggie Thatcher's declaration that, "There is NO ALTERNATIVE!!!", to neo-classical monetarism is decidedly contradicted by the author.

His evaluation of neo-classical economics and its devotees is substantially unsympathetic. He believes that much of what passes for "modern" neo-classical economic thought is mired in outdated 19th century thought. The underlying neo-classical foundations of Bentham's hedonistic calculus, static market equilibrium points, Say's Law, increasing marginal costs of production, etc. are all examined critically. In my view, he does a very thorough autopsy of the ideological corpse.

He also covers Marx and modern Marxism in one of the chapters in the book. He effectively debunks Marx's theory of labor surplus value, falling profits for capitalists, increasing misery of the workers, and the "inevitability" of scientific socialism. However, he also credits Marx with coming up with some of the most insightful critiques of capitalism.

This is a very good book--in my opinion. It is a very hard read for the uninitiated. However, if you've taken some traditional economics courses and have a bit of facility with math, I think you will find the case he makes interesting. I found it very compelling. I'd recommend that you buy the book (or check it out from the library) and see which of the pro and con book critics are correct.

As I sit here at my PC on Sept. 28, 2008 with Congress debating the "bailout" of Wall Street, some of Keen's ominous predictions that he made back in 2001 when he wrote the book about large scale market failures appear to be coming to fruition. He really understood the danger of market excesses and warned against the dismantlement of government's protective market regulations. Unlike the neoclasical "Mr. Market" adherents who were cheering the Titantic on its full speed ahead course....

His view of inevitable economic disaster given the late 20th and early 21rst western market excesses appears to be prophetic at this time.

This is a tremendous book which is written in such a way to be of use to both the novice and the 'expert' in any field/sub-specialism of economics. Most undergrad economics training is still steeped in the neoclassical tradition. This book presents the neoclassical paradigm in a most lucid fashion (moreso than many conventional and popular texts) and simultaneously refutes even the most basic tenets on which the paradigm is built. Prof Keen also tackles some rival theories. Progressing through this book I kept feeling drawn to some of the structuralist models, but alas, these are not specifically covered to any significant degree. This book is already on my 10 favourite of all time (see my list). My recommendation for the person to whom neoclassical economics and/or challenges to it are new is to start with this great work and then go on to some of the structuralist and IP literature (suggest: Prebisch; Lewis; Beckford; Lall to start). Specifically for the "non-economist" in the developing world - this helps explain why people have had to pay such a high price as a result of neo-liberal policy imposed on LDC's. It will also help resolve the issue of how within the profession we can brutally criticise our models yet at the same time reject the commonly heard lay-person's judgement of economics as a 'failure'. Reading this we should remember that it is no more a failure than engineering or medicine: these sciences are also supported by evolving masses of paradgims,theories, observations etc.

I must confess I am mystified by JRZ's critique of Keen's book. I was under the impression that the Central Limit Theorem stated that, as the sample size increases, EVERY random distribution converges to a normal distribution. In other words, if it is truly just random factors that affect stock price movements, we should expect them to be normally distributed, whatever the underlying distribution. The fact that they are not strongly implies (if not out-and-out proves) that the movements are not, in fact, completly random.

This makes intuitive sense: a coin, or a die, has no memory - the result of the last flip does not affect any future flips. But people do have memories - people buy and sell financial instruments because of their own judgements about what ithers are doing, and based on such emotions as hope and fear. This can set up the feedback loops that are the essense of nonlinear dynamical systems - the "chaos theory" that most economist's don;t understand and thus dismiss as irrelevant.

Read the book. If there was any justice, Keen would have a regular column in the New York Times instead of that fool Krugman...

A must read. Professor Keen unveils with mathematical elegance and plain English the inconsistencies of classical and neo classical economics. Economists of all strands should at least be familiar with the arguments and controversies presented in this thought-provoking book. Mr Keen opens his book quoting from Keynes (from the preface of the General Theory):
"The ideas which are here expressed so labouriously are extremely simple and should be obvious. The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds."
The same aplies to Keen's book itself.

I was hesitant to purchase this book largely because of the title (which I know is just as irrational as judging a book by its cover, something I have been taught not to do). But the title made me think this was going to be just another superficial critique of economics from a non-economist. It is easy to criticize a number of the assumptions that crop up in standard economic theory and that seem especially unrealistic to the layperson like me (the notion that humans are nothing but rational utility maximizers for example) or to find empirical evidence which seems to contradict the predictions of economic theory in various respects. You do not have to be an economist or delve very deeply into economic theory to make such criticisms. But it turns out I was very wrong about this book. [There is an updated version of this book available which apparently includes sections about the current financial crisis: Debunking Economics - Revised and Expanded Edition: The Naked Emperor Dethroned?

Steve Keen actually explains neoclassical economic theory, and the foundations of neoclassical economic theory, in more depth in this book than most of the textbooks I have read which makes it an excellent book for anyone who is struggling to understand neoclassical theory. The textbooks often simply present the standard tools of economic theory, such as supply and demand curves, without explaining how they are derived. Steve Keen explains precisely how they are derived and in doing so Steve Keen also offers some truly devastating criticisms of neoclassical theory which cut right to the heart of the theories. The criticisms are especially devastating because they reveal logical inconsistencies within the theories themselves. They are not merely external criticisms based on unrealistic assumptions or contrary empirical evidence. To give just one example, in the second chapter Steve Keen shows that the standard downward sloping aggregate demand curve in price theory is actually inconsistent with the assumption that prices determine distribution. Since Engels curves are going to be different shapes for different income brackets, and since every change in price will shift the distribution of income, we do not wind up with a single downward sloping demand curve but rather with a new demand curve for every single price when we attempt to aggregate individual demand curves. Neoclassical theory is simply inconsistent with itself on this point. We do not in general tolerate logical inconsistency in our theories and Steve Keen does not think we should tolerate it in economics either. Steve Keen applies the same treatment to nearly every aspect of neoclassical theory. Anyone who has struggled through the intermediate micro- and macroeconomic textbooks needs to read this as a necessary corrective. It will not only deepen your understanding of neoclassical economic theory itself but it will reveal a number of serious problems with the theories that the textbooks understandably pass over.

Steve Keen also offers a fairly interesting analysis of Marx. Steve Keen believes that the labor theory of value is simply incorrect (he agrees with standard neoclassical economic theory on this point). What is interesting is that Keen seems to believe that Marx began to question the standard labor theory of value in his late writings as well. Basically the labor theory of value, according to Keen, is based on a dualism between exchange value and use value. This is how Marx was able to solve the problem of surplus value under conditions of equilibrium. Exchange value is determined by the socially necessary labor time needed to reproduce a given commodity (including labor power) which has nothing to do with use-value. Wages, therefore, are determined by the amount of labor necessary to physically reproduce the human being. The human being sells their labor power which has the particular use-value of being able to create value. According to the standard labor theory of value only labor has this property and so all surplus-value is based on unpaid labor (exploitation). Steve Keen argues that the dualism between use-value and exchange value applies equally to capital and that Marx seemed to be moving in this direction himself. This would mean that both labor and capital would be capable of producing surplus-value. Whether you agree or disagree with Keen's analysis (and most Marxists I think will disagree) this is certainly an interesting interpretation of Marx and one worth considering.

In short, this book is highly, highly recommended. For anyone seriously interested in economics this book needs to move to the top of your "to read" list.

-Brian