Five heterodox groups of economists who should be brought out from under the shadow of the orthodox economists who have no answers for financial crises

If you are as interested as I am in the fact that the most prestigious groups of economists were totally surprised by the recent financial meltdown, have no models or theory to explain it after the fact, and are continuing their virtual reality games as though nothing happened, you'll want to read this paper by Jamie Galbraith in the NEA Higher Education Journal. My summary:

While the two mainstream schools, Chicago (or freshwater or neoclassicists) vs. MIT (or saltwater or new Keynesians), have contended vigorously with each other over details, they remain united in a commitment to an all-encompassing theory expressed in mathematics.  They are in the same "gentlemen's club" in which nobody loses face for predicting things that don't happen, failing to predict things that do happen, or maintaining positions that outsiders can clearly see are goofy. Galbraith describes five heterodox groups that did predict the recent crisis and similar crises in the past and says we would be better off if they had more resources and influence.

The hoariest are the "American Marxists" who believe the economic system is fundamentally flawed by conflicting power relationships and that its eventual collapse will be triggered by one of several events (they don't all agree on the specific type) like a collapse in the dollar, accumulating current account deficits, overextension of debt in the financial system, etc. Since these economists are "habitual Cassandras" and are uninterested in policy adjustments for what they think is a unsalvageable system, it's hard to see how they are helpful, but they did predict the financial crisis.

Dean Baker and others have predicted asset bubbles by observing large deviations from their means of relationships such as P/E ratios, home ownership prices to rents, etc. Critics complain that it relies on the assumption that the chosen relationship will revert to a mean not because there is a theoretical reason why it should but only because it always did in the past. The lack of theory is troubling to other economists, but these folks were right about the financial crisis and have a methodology that predicts reasonably well the sizes of adjustments.

Another group in Cambridge (UK) and the Levy Economics Institute studies relationships in the National Income and Product Accounts (which generate GDP) and argue, with some theoretical underpinnings, that large increases or decreases in Consumption, Private Investment, Government Spending, or Net Exports must induce opposite changes in certain other accounts and that at some point these shifts are unsustainable and must reverse. They too were right about the financial crisis.

Hyman Minsky and his followers like Barkley Rosser and Ping Chen developed a theory that stability in markets breeds instability and that self-generated boom-bust cycles are inevitable unless government intervenes to prevent hedging, which normally morphs into speculation (the obvious need to refinance in the future), from passing into the Ponzi phase (where ever-increasing amounts will have to be refinanced). This group warned against the policies of Alan Greenspan and Larry Summers that not only facilitated but actively encouraged what was obvious Ponzi financing, and they predicted the financial crisis.

The economics of John Kenneth Galbraith in The New Industrial State (1967) sought to focus less on markets and more on institutions (big corporations, labor unions, governments, etc.) and how those institutions function internally and in relation to each other. The mainstream economists hated and marginalized it. Jamie Galbraith followed this tradition in The Predator State (2008), arguing that after about 1970 there was a withering of internal controls in corporations, less governmental oversight, and other pressures that led to managements running amok, often blindly. As several financial crises (S&L, Dot.com, Enron/Worldcom, Sub-prime) were autopsied, a lack of control and irresponsible behavior is at the center of all. Other economists studying these institutional dynamics have pointed out recurrent patterns not only of irresponsibility and chaos but of fraud and looting and warned of recurrences if the institutions were not reformed. This group also predicted the financial crisis.

Finally, Galbraith argues that the "gentlemen's club" must be circumvented by university administrators, foundations, students, and others outside the mainstream economics departments to create academic space and public visibility for these versions of economics.

Comments

[Tom Hickey]

"Another group in Cambridge (UK) and the Levy Economics Institute studies relationships in the National Income and Product Accounts (which generate GDP) and argue, with some theoretical underpinnings, that large increases or decreases in Consumption, Private Investment, Government Spending, or Net Exports must induce opposite changes in certain other accounts and that at some point these shifts are unsustainable and must reverse."

This group is sometimes called Neo-Chartalism and Modern Monetary Theory (MMT), although it should be emphasized that this is a loose group that does not subscribe to a common moniker. However, what underlies their position is not theory based on assumptions but rather a description of the operation of a modern monetary system based on national accounting identities and stock-flow consistency.

A key work addressed to professionals is Wynne Godley and Marc Lavoie's Monetary economics: an integrated approach to credit, money, income. L Randall Wray "s Understanding Modern Money: The Key to Full Employment and Price Stability is accessible to non-economists. Blog posts (generally accessible) by Wray, Bill Mitchell, Warren Mosler, Scott Fulwiler, and Marshall Auerback are based on MMT.