As yet another school year begins, we once again find ourselves returning to an atmosphere of economic uncertainty, sluggish growth, and heated debate over how to return the economies of the United States and Europe back onto a growth trajectory. In the last couple of weeks alone the US government has barely avoided a default on its national debt, ratings agencies have downgraded US government bonds, global stock markets have tumbled, confidence in the Eurozone has been pummeled over fears of larger than expected deficits in Italy and Greece, and the US dollar has reached historic lows against currencies such as the Swiss Franc and the Japanese Yen.

What are we to make of all this turmoil? I will not pretend I can offer a clear explanation to all this chaos, but I can offer here a little summary of the big debate over one of the issues above: the debate over the US national debt and what the US should be doing right now to assure future economic and financial stability.

There are basically two sides to this debate, one we will refer to as the “demand-side” and one we will call the “supply-side”. On the demand-side you have economists like Paul Krugman, and in Washington the left wing of the Democratic party, who believe that America’s biggest problem is a lack of aggregate demand.

Supply-siders, on the other hand, are worried more about the US national debt, which currently stands around 98% of US GDP, and the budget deficit, which this year is around $1.5 trillion, or 10% of GDP. Every dollar spent by the US government beyond what it collects in taxes, argue the supply-siders, must be borrowed, and the cost of borrowing is the interest the government (i.e. taxpayers) have to pay to those buying government bonds. The larger the deficit, the larger the debt burden and the more that must be paid in interest on this debt. Furthermore, increased debt leads to greater uncertainty about the future and the expectation that taxes will have to be raised sometime down the road, thus creating an environment in which firms and households will postpone spending, prolonging the period of economic slump.

The demand-siders, however, believe that debt is only a problem if it grows more rapidly than national income, and in the US right now income growth is almost zero, meaning that the growing debt will pose a greater threat over time due to the slow growth in income. Think of it this way, if I owe you $98 and I only earn $100, then that $98 is a BIG DEAL. But if my income increases to $110 and my debt grows to $100, that is not as big a deal. Yes, I owe you more money, but I am also earning more money, so the debt burden has actually decreased.

In order to get US income to grow, say the demand-siders, continued fiscal and monetary stimulus are needed. With the debt deal struck two weeks ago, however, the US government has vowed to slash future spending by $2.4 trillion, effectively doing the opposite of what the demand-siders would like to see happen, pursuing fiscal contraction rather than expansion. As government spending grows less in the future than it otherwise would have, employment will fall and incomes will grow more slowly, or worse, the US will enter a second recession, meaning even lower incomes in the future, causing a the debt burden to grow.

Now let’s consider the supply-side argument. The supply-siders argue that America’s biggest problem is not the lack of demand, rather it is the debt itself. Every borrowed dollar spent by the goverment, say the supply-siders, is a dollar taken out of the private sector’s pocket. As government spending continues to grow faster than tax receipts, the government must borrow more and more from the private sector, and in order to attract lenders, interest on government bonds must be raised. Higher interest paid on government debt leads to a flow of funds into the public sector and away from the private sector, causing borrowing costs to rise for everyone else. In IB and AP Economics, this phenomenon is known as  the crowding-out effect: Public sector borrowing crowds out private sector investment, slowing growth and leading to less overall demand in the economy.

Additionally, argue the supply-siders, the increase in debt required for further stimulus will only lead to the expectation among households and firms of future increases in tax rates, which will be necessary to pay down the higher level of debt sometime in the future. The expectation of future tax hikes will be enough to discourage current consumption and investment, so despite the increase in government spending now, the fall in private sector confidence will mean less investment and consumption, so aggregate demand may not even grow if we do borrow and spend today!

This debate is not a new one. The demand-side / supply-side battle has raged for nearly a century, going back to the Great Depression when the prevailing economic view was that the cause of the global economic crisis was unbalanced budgets and too much foreign competition. In the early 30′s governments around the world cut spending, raised taxes and erected new barriers to trade in order to try and fix their economic woes. The result was a deepening of the depression and a lost decade of economic activity, culminating in a World War that led to a massive increase in demand and a return to full employment. Let’s hope that this time around the same won’t be necessary to end our global economic woes.

Recently, CNN’s Fareed Zakaria had two of the leading voices in this economic debate on his show to share their views on what is needed to bring the US and the world out of its economic slump. Princeton’s Paul Krugman, a proud Keynesian, spoke for the demand-side, while Harvard’s Kenneth Rogoff represented the supply-side. Watch the interview below (up to 24:40), read my notes summarizing the two side’s arguments, and answer the questions that follow.

Summary of Krugman’s argument:

• Despite the downgrade by Standard & Poor’s (a ratings agency) there appears to be strong demand for US government bonds right now, meaning really low borrowing costs (interest rates) for the US government.
• This means investors are not afraid of what S&P is telling them to be afraid of, and are more than happy to lend money to the US government at low interest rates.
• Investors are fleeing from equities (stocks in companies), and buying US bonds because US debt is the safest asset out there. The market is saying that the downgrade may lead to more contractionary policies, hurting the real economy. Investors are afraid of contractionary fiscal policy, so are sending a message to Washington that it should spend more now.
• The really scary thing is the prospect of another Great Depression.
• Can fiscal stimulus succeed in an environment of large amounts of debt held by the private sector? YES, says Krugman, the government can sustain spending to maintain employment and output, which leads to income growth and makes it easier for the private sector to pay down their debt.
• With 9% unemployment and historically high levels of long-term unemployment, we should be addressing the employment problem first. We should throw everything we can at increasing employment and incomes.
• Is there some upper limit to the national debt? Krugman says the deficit and debt are high, but we must consider costs versus benefits: The US can borrow money and repay in constant dollars (inflation adjusted) less than it borrowed. There must be projects the federal government could undertake with at least a constant rate of return that could get workers employed. If the world wants to buy US bonds, let’s borrow now and invest for the future!
• If we discovered that space aliens were about to attack and we needed a massive military buildup to protect ourselves from invasion, inflation and budget deficits would be a secondary concern to that and the recession would be over in 18 months.
• We have so many hypothetical risks (inflation, bond market panic, crowding out, etc…) that we are afraid to tackle the actual challenge that is happening (unemployment, deflation, etc..) and we are destroying a lot of lives to protect ourselves from these “phantom threats”.
• The thing that’s holding us back right now in the US is private sector debt. Yes we won’t have a self-sustaining recovery until private sector debt comes down, at least relative to incomes. Therefore we need policies that make income grow, which will reduce the burden of private debt.
• The idea that we cannot do anything to grow until private debt comes down on its own is flawed… increase income, decrease debt burden!
• Things that we have no evidence for that are supposed to be dangerous are not a good reason not to pursue income growth policies.
• When it comes down to it, there just isn’t enough spending in the economy!

Summary of Rogoff’s argument:

• The downgrade was well justified, and the reason for the demand for treasuries is that they look good compared to the other options right now.
• There is a panic going on as investors adjust to lower growth expectations, due to lack of leadership in the US and Europe.
• This is not a classical recession, rather a “Great Contraction”: Recessions are periodic, but a financial crisis like this is unusual, this is the 2nd Great Contraction since the Depresssion. It’s not output and employment, but credit and housing which are contracting, due to the “debt overhang”.
• If you look at a contraction, it can take up to 4 or 5 years just to get back where you started.
• This is not a double dip recession, because we never left the first one.
• Rogoff thinks continued fiscal stimulus would worsen the debt overhang because it leads to the expectation of future tax increases, thus causing firms and households increased uncertainty and reduces future growth.
• If we used our credit to help facilitate a plan to bring down the mortgage debt (debt held by the private sector), Rogoff would consider that a better option than spending on employment and output. Fix the debt problem, and spending will resume.
• Rogoff thinks we should not assume that interest rates of US debt will last indefinitely. Infrastructure spending, if well spent, is great, but he is suspicious whether the government is able to target its spending so efficiently to make borrowing the money worthwhile.
• Rogoff thinks if government invests in productive projects, stimulus is a good idea, but “digging ditches” will not fix the economy.
• Until we get the debt levels down, we cannot get back to robust growth.
• It’s because of the government’s debt that the private sector is worried about where the country’s going. If we increase the debt to finance more stimulus, there will be more uncertainty, higher interest rates, possibly inflation, and prolonged stagnation in output and incomes.
• When it comes down to it, there is just too much debt in the economy!

Discussion Question:

1. What is the fundamental difference between the two arguments being debated above? Both agree that the national debt is a problem, but where do the two economists differ on how to deal with the debt?
2. The issues of “digging ditches and filling them in” comes up in the discussion. What is the context of this metaphor? What are the two economists views on the effectiveness of such projects?
3. Following the debate, Fareed Zakaria talks about the reaction in China to S&P’s downgrade of US debt. What does he think about the popular demands in China for the government to pull out of the market for US government bonds?
4. Explain what Zakaria means when he describes the relationship between the US and China as “Mutually Assured Destruction (MAD)”.
5. Should the US government pursue a second stimulus and directly try to stimulate employment and income? Or should it continue down the path to austerity, cutting government programs to try and balance its budget?

Homo Economicus, the “Economic Man” is the concept underlying most economic theories. It holds that all humans are purely self-interested, rational actors who have the ability to make judgments that fulfill their subjectively defined ends. In modern economic theory, the end man seeks is generally accepted to be increasing monetary well-being and material wealth.

Philosophical foundations of “homo economicus“:

Aristotle (350 BC):

Again, how immeasurably greater is the pleasure, when a man feels a thing to be his own; for surely the love of self is a feeling implanted by nature and not given in vain, although selfishness is rightly censured; this, however, is not the mere love of self, but the love of self in excess, like the miser’s love of money; for all, or almost all, men love money and other such objects in a measure. And further, there is the greatest pleasure in doing a kindness or service to friends or guests or companions, which can only be rendered when a man has private property. These advantages are lost by excessive unification of the state.

• What does Aristotle think about the interference of government in the private property rights of man?
  

Adam Smith (1776):

In almost every other race of animals, each individual, when it is grown up to maturity, is entirely independent, and in its natural state has occasion for the assistance of no other living creature. But man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer: and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher the brewer or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity, but to their self-love, and never talk to them of our own necessities, but of their advantages.

• How does Smith believe the pursuit of individual self-interest can lead to benefits for society as a whole?

John Stuart Mill (1836)

What is now commonly understood by the term “economics” is not the science of speculative politics, but a branch of that science. It does not treat of the whole of man’s nature as modified by the social state, nor of the whole conduct of man in society. It is concerned with him solely as a being who desires to possess wealth, and who is capable of judging of the comparative efficacy of means for obtaining that end. It predicts only such of the phenomena of the social state as take place in consequence of the pursuit of wealth. It makes entire abstraction of every other human passion or motive; except those which may be regarded as perpetually antagonizing principles to the desire of wealth, namely, aversion to labor, and desire of the present enjoyment of costly indulgences. These it takes, to a certain extent, into its calculations, because these do not merely, like our other desires, occasionally conflict with the pursuit of wealth, but accompany it always as a drag, or impediment, and are therefore inseparably mixed up in the consideration of it.

• According to Mill, labor is not something humans value for its own sake, but only because it allows us to do what?

Fredrick von Hayek (1930s):

We will benefit our fellow man most if we are guided solely by the striving for gain. For this purpose we have to return to an automatic system which brings this about, a self-directing automatic system which alone can restore liberty and prosperity.

• How would Hayek respond to those who argue that the government’s role in society and the economy is to promote fairness and equality?

Are you a “homo economicus“? - The Golden Balls Game

The prize: $1 million

How to play:

• Find an opponent from among your classmates.
• You and your opponent have never met before today, never spoken to one another, and will never see nor speak to one another again after the game ends.
• Since you do not know or care about your opponent, you must play this game with your own self-interest in mind, and assume that your opponent will play it with his or her self-interest in mind.
• You have in front of you two folded pieces of paper. One says “SPLIT” and one says “STEAL”
• You must decide which piece of paper to select, based on the following possible outcomes

The payoffs:

• If both players decide to “split”, each player will take home $500,000.
• If one player chooses to “split” and the other chooses to “steal” then the one who chooses to steel will take home $1 million, and the one who chose to split will get nothing
• If both players choose to “steel”, both players go home empty handed.

Let’s play!

• You only have one chance to play this game. Remember, you care only about yourself and should do what is best for you.
  
• On the teacher’s command, reveal your decision to your opponent.
  
• Take note of your payoff and report it to the teacher
  

Discussion:

• What was the outcome of your game?
  
• Was the outcome rational? Was it predictable?
  
• Did the outcome reflect the concept of “homo economicus“? Were you and your opponents’ decisions purely self-interested and coldly rational, intended to maximize your OWN payoff?
  
• Are you a homo economicus? What would homo economicus have done? Why?
  

Videos:

Golden Balls – the real gameshow: http://www.youtube.com/watch?v=p3Uos2fzIJ0&feature=player_embedded

• Which player was more like homo economicus? Sarah or Steve?
• Which player acts rationally? What makes it rational?
• Which player acts irrationally? What makes it irrational?

“The Trap”: Intro to game theory and rational self-interest in politics and economics: http://www.youtube.com/watch?v=qzNcY-gZdiA&feature=related

• John Nash’s Game Theory proved that “a system driven by selfishness did not have to lead to chaos”, that “there could always be a point of equilibrium in which everyone’s self-interest is perfectly balanced against each other”? How does such a theory support the concept of homo economicus?
• What is the Prisoner’s Dilemma? “The rational choice is always to betray the other person.” What does this say about humans in society? Is government regulation needed to prevent constant betrayal by greedy, self-interested individuals? Or are constant betrayal and self-interest themselves capable of achieving a socially optimal outcome?

Noam Chomsky on the inefficiency of markets and the threat posed by de-regulation: http://www.youtube.com/watch?v=QPl27BO7fHE&feature=related

• What is the “externality” of financial market failure that Chomsky identifies?
• Why is the failure of a financial market more worrisome than the failure of a market like that for used automobiles?
• How does Chomsky feel about the de-regulation of financial markets? Does he think markets are always rational and efficient?

Modern applications of the concept of Homo Economicus:

• Rational Expectations Theory (RET): This economic theory assumes that humans acting generally in their own self-interest will make rational decision based on the best available information. Therefore, it assumes that people (and therefore, markets, which are made up of rational people) do not make systematic errors when predicting the future.
• Efficient Markets Hypothesis (EMH): Rooted in Rational Expectations Theory, which itself is rooted in the concept of homo economicus, EMH says that prices in markets, particularly financial markets (whose collapse has caused the today’s global economic crisis) represent the best possible estimates of the risks attached to the ownership of various financial assets (stocks, shares, bonds, etc…) Asset bubbles are therefore impossible, since “bubble” implies an irrational and unsustainable increase in the value of an asset which will ultimately “burst”. Markets are “self-correcting”, and the most effective tool for assuring economic stability is free markets, rather than government regulation or oversight.
  

Connecting the dots – from Homo Economicus to today’s Economic downturn:

The general acceptance of theories rooted in the concept of homo economicus led to the de-regulation of financial markets, which allowed money and resources to go whichever way the “market” (rational or not) determined.

• During the last decade, the market decided that more and more money and resources should go towards particular assets, specifically the United States mortgage market (the market for new homes in the US).
• As money flooded the US home mortgage market, it became cheaper and easier for Americans to get loans to build a home. GREAT, RIGHT?! Well, only until it came time to pay back those loans.
• Trillions of dollars worldwide became tangled up in the US mortgage market, representing households’ savings from around the globe.
• When Americans suddenly found their loans coming due, they found it hard to repay them due to adjustable interest rates and falling home price (supply had grown more rapidly than demand).
• American and many Europeans began defaulting on their mortgages, meaning all that money that had been lent to home buyers literally disappeared.
• Banks and financial markets faced a “liquidity crisis”, meaning they had no money.
• Lending stopped to households, firms, and other banks , meaning spending on goods and services decreased, meaning jobs were lost and economies entered recession.
• How could any of this have happened if the concept homo economicus and the economic theories based on the concept are correct? Are humans always rational, calculating, perfectly informed, self-interested beings acting purely in their own self-interest?

Conclusion: The concept of homo economicus has formed the basis for economic theories for centuries and for major macroeconomic policies over the last 30 years. Policies of “market liberalization” (freeing the market from the guiding, regulatory hands of government) have led to great prosperity, but even greater risk and volatility as irrational exuberance over asset prices has led to inefficient market outcomes, bubbles, and financial shocks plunging the “real” economies of the world into recession.

Perhaps a more complete understanding of humans is needed as the human science of economics enters a new era. The human as a cold, rational, calculating creature interested in only his own gain is an over-simplification, and forming theories and policies on such an assumption is dangerous. The future of economics must incorporate a more complete and complex understanding of human behavior if the economic crises of the last two years are to be avoided down the road.

Milton Friedman: “there is no alternative way so far discovered of improving the lot of ordinary people that can hold a candle to the productive activities that are unleashed by the free enterprise system”

With all the talk of government spending, fiscal stimulus, nationalization of the financial industry, the “new new deal”, infrastructure, education, health, “job creation”, and on and on… I thought it wise to share this bit of wisdom from the greatest advocate of free markets of the last 100 years, Milton Friedman.

AP Economics teacher Michelle Hastings sent the link to this video to the AP Econ email list. Thanks, Michelle.

Discussion Questions:

1. What is Friedman’s view of command economies?
2. Does Friedman imply that “greed is good”? To what extent is greed an important component of free markets?
3. Do you think Milton Friedman would support the current $800 billion fiscal stimulus package being debated in Washington right now? Why or why not?

Thanks to my friend Jerry from Shanghai for posting this cartoon to his Facebook profile!

How timely, just as my year 2 IB Economics class is studying the pitfalls of expansionary fiscal policy in times of economic slowdowns. Now, many critics would say that Clinton was the luckiest president of recent decades as he happened to ride a wave of technological innovation fueled by the internet that led to unprecedented grown in income and tax revenue during the 1990s. Sustained 5% growth combined with a period of relative peace on the foreign fronts in between the two Gulf Wars allowed Clinton to balance the budget and begin putting a dent in the country’s $3 trillion deficit during his final years in office.

Along come the “fiscally conservative” Republicans and their faithful leader GWB, just in time to evaporate our budget surplus and add $6 trillion to our national debt over the next eight years. Today, after a long period of “fiscal conservatism” the debt stands at $9.3 trillion, and last year’s budget deficit of $400+ billion broke a record for the largest gap between tax revenue and government spending in US history.

Yeah, you can blame it one the times: a War on Terror costing the US roughly a billion bucks a day, a slowdown in new technology creation, diminishing returns on internet investments, out-sourcing of American industry and jobs, yada yada… but the cartoon does hold some truth. The Democratic Party, long labeled as the “tax and spend liberals”, managed to do what few other administrations have done since the ’60s in balancing the budget, proving that the old stereotype is simply wrong.

Some now consider the Democrats the fiscally conservative party, based only on the simple observation that they tend to spend closer to what they collect in taxes. The Republicans, on the other hand, have had no qualms about spending what they DON’T collect in taxes, in other words, running up huge budget deficits through borrowing from the public and abroad. Are the Republicans the an even worse incarnation of the “tax and spend liberals”? Are they the “DON’T tax and STILL spend Conservatives”?

Discussion questions:

1. How did the Bush administration’s $160 billion “fiscal stimulus package” that sent $600 checks to every American worker demonstrate the Republican party’s willingness to deficit spend.
2. What effect will deficit spending by the government have on interest rates and private investment in the economy? What is this effect known as?
3. In times of weak aggregate demand, as in the US earlier this year, what sort of approach would a “supply-sider” recommend as an alternative to Bush’s deficit-financed expansionary fiscal policy?

While students and teachers across America settle into their summer routine and look forward to three more weeks of summer vacation, the first week of August marks an unseen exodus of thousands of international students and teachers in countries on every continent. For some reason, international schools all seem to start about two weeks earlier than the post-Labor day start date enjoyed by most public school in the US. Here at Shanghai American school, teachers arrive in droves around the 7th and 8th of August, just in time for our first work day on the 9th.

My wife and I returned to 95 degree heat from the pleasant 70′s of Seattle last night to begin preparing for our second year at Shanghai American School. In a week SAS will welcome around 2900 students, making it one of the largest international schools in the world. As part of our orientation this morning, our director, Dr. Dennis Larkin, shared a bit of SAS’s 95 year history with the faculty, enlightening many of us to the school’s storied past stretching back to the concession era of Shanghai’s “golden age” when thousands of Westerners made their settlements in the city’s center. 100 years ago Shanghai underwent a renaissance unseen in China’s thousands of years of history. European influence brought the city into the 20th century architecturally, culturally, economically, and perhaps more notoriously in the realm of criminal activity as gangsters took over the city through much of the 20′s and 30′s.

With the large Western presence came a demand for Western schools, thus in 1912 Shanghai American School welcomed its first class of 12 students. By the 20′s enrollment rose to 600, and by the 30′s it approached 1,000. In 1937 China was invaded by Japan, and foreign firms and embassies began nervously moving their people out of Shanghai. By 1939 Shanghai had fallen to the Japanese and the school grounds were occupied by Japanese troops. But with the surrender of the Japanese in 1945, the school was back in operation, albeit for only a short time as a civil war between the Chinese Communist Party and the US backed Nationalists brought violence to the streets of Shanghai once more. By 1950 Beijing had fallen to Mao and the Communists, and SAS was shut down “for good”. Its doors would remained closed for 30 years until 1980, when Mao had died and Deng Xiaoping had ushered in the era of “Reform and Opening”, a euphemism for westernization. Once again SAS opened for business.

In the 27 years since the school’s rebirth, the student body has grown from the seven children of American diplomats to 2,900 students from over 50 countries. In the last five years alone the student body has nearly doubled in size, as the school has added a second campus and countless new buildings to serve the growing population of foreigners in Shanghai. Over the same 27 years, around ten other international schools have opened in Shanghai, some with two or three campuses spread across the vast city, several serving over 1000 students also from scores of foreign countries. What impact has the opening and expansion of SAS and other international schools had on tuition paid by foreign students in Shanghai? You may think that with so many schools competing to attract students, each school would have to lower its fees in order to attract students away from its competitors. Well, you’d be wrong. SAS increased its tuition fees by 10% this year, bringing a year’s tuition to around $22,000. Its competitors charge something in the same ballpark, meaning a year of schooling at any of Shanghai’s international schools will cost a family more than a year’s tuition at most state universities in the US.

Discussion Questions:

So, what does all this history and data have to do with economics? Here’s a simple supply and demand question for you. In 1980, international schools in Shanghai had room for, let’s say 20 students total. I am not sure, but I’d guess tuition in 1980 probably ran around $2,000. Today, there are somewhere around 10 international schools with room for probably around 10,000 students, and the average tuition is somewhere in the realm of $20,000.

1. How would an economist explain the 1,000% increase in tuition over the last 27 years, given the fact that today international schools in Shanghai have the capacity to serve 500 times as many students as they could in 1980?
2. Could you draw a supply and demand diagram illustrating the changes that have occurred since 1980 in the market for international education in Shanghai?
3. Let’s be honest, $22,000 is a lot of money for a year of school. What would have to happen in the market for international education in Shanghai for the tuition fees to go down? Identify two scenarios that would result in a tuition decrease. Illustrate these scenarios on your diagram.

Powered by ScribeFire.

Two heterodox economists respond to an article I blogged about last week, Hip Heterodoxy, published in the Nation, written by Chris Hayes.

Challenging Orthodox Economics – Part I | TPMCafe by Thomas Palley

Economics Outside the Mainstream | TPMCafe by David Ruccio

As our year winds down and we begin getting our materials and lessons in order for our next batch of AP Econ students, it’s unlikely we’ll pause to ask a rather important question: “Is the economics I’m teaching my students the correct and immutable truth?”

After all, isn’t economics still a young science? It’s only been a few generations since Smith, Riccardo and Locke laid the groundwork for what has become the mainstream, neo-classical/neo-Keynesian theory that makes up every major economics text and principles course out there. Who’s to say that in another one hundred years these views, products of the late 20th century themselves, will still be considered the correct solutions for dealing with the economic problem?

As mentioned in a previous post “Keynesian vs. Neo-classical Economics – and what is Heterodox Economics?”, the field loosely described as “heterodox economics” raises difficult questions of human behavior and thinking that challenges the neo-classical view of perfectly rational actors and the efficiency and perfectibility of free markets (the view that we teach in AP Economics). David Ruccio, econ professor at Notre Dame, laments on mainstream economists:

All reasonable arguments are accepted in the marketplace of ideas. Except they (mainstream economists) never read any heterodox economics, and have no idea how the hegemony of their favorite theory shuts out all other ideas…That’s the situation that heterodox economists are trying to change. By using economic theories other than those of the mainstream… By forming journals and associations apart from those of the mainstream (in which their ideas never get aired). And by challenging the mainstream conception of the discipline itself
(including its notions of what science is, and what it means to “think like an economist”).

We do heterodox economics, or what some refer to as political economy—as against economics (which, as Chris correctly argues, has become identified with a tiny number of theoretical approaches). We write about rates of exploitation and the role of power in increasing inequality and the existence of patriarchy and structural racism. Not only do we want to argue that economic actors are sometimes irrational or guided by norms and values; some of us also want to analyze economic institutions and events without even starting from individual actors. Or efficiency. Or constrained optimization.

So, do you feel guilty yet about teaching only the mainstream view in your course? Don’t fret, even Professor Ruccio has to teach his students the neo-classical approach; here’s how he deals with the status quo in his courses:

In all honesty, I mostly prefer not to read maintream economics these days. Either it says nothing of interest, or it gets me very angry. But I teach it, and I teach it in a way that is more rigorous than my mainstream colleagues. Because I teach its basic assumptions (and not as a kind of common sense) and because I present alternative views, heterodox economics. And then I read and do heterodox economics, independently of the mainstream. Because if we spend all our time worrying about mainstream economics, attempting to do mainstream economics (with a tweak here and a changed assumption there), we’ll never get around to developing alternatives.

Professor Ruccio makes an important point here. Before students can become agents of positive change, aware and capable of making the world a better place (and the field of economics a better science) they must first know what needs fixing. I know as much as any AP Econ teacher how rushed this course is, how little time is really left for discussions beyond the basic principles in the syllabus; but in the future, I think I’ll challenge myself and my students to take a little time and find out what alternative approaches to the economic problem are being researched, published, and put into action out there. Technology, the web, blogs: these are the tools that will enable us to easily connect our students to alternative, heterodox economics despite the hectic pace of our AP course. And if your school has access to online journal databases, here’s a few suggestions for economics publications that give a voice to heterodox economists like Professor Ruccio:

The Review of Income and Wealth, the Cambridge Journal of Economics, the European Journal of Comparative Economics, Research in Economic History, Industrial and Corporate Change, CES Ifo Economic Studies, the Eastern Economic Journal, the BNL Quarterly Review and The Economist’s Voice.

Powered by ScribeFire.

NCEE | EconomicsAmerica® | National Standards

A CRITIQUE OF “STANDARDS OF ECONOMICS” from the URPE

What is Heterodox Economics? Perhaps it’s easier to start by saying what it is NOT. Heterodox Economics is NOT what we teach in Advanced Placement Economics. It is not what most major universities and colleges teach in their undergraduate and graduate economics courses. It is not widely accepted as a mainstream view in the field of professional economics. Its economists are not widely published in the top five economic journals. It is not neo-classical in its views that “humans are rational, utility-maximizing agents with fixed preferences, that they make decisions “at the margins” and that the mechanisms of supply and demand (operating free of government interference) will lead to a general equilibrium whereby resources are allocated efficiently.” In other words, heterodox economics challenges the widely accepted view that free markets and free individuals acting in their own self interest will perfectly allocate resources and achieve a general equilibrium where resources are put to their most efficient uses and goods and services are distributed efficiently among individuals in society. Markets are imperfect, and human institutions should offer Adam Smith’s “invisible hand” a helping hand when it comes to allocation of resources and output.

The National Council for Economics Education (NCEE, which publishes the widely used workbook “Advanced Placement Economics”) released in 2000 its National Standards on Economic Education, based on the “essential principles of economics”. High school economics courses, including AP, are rooted in these standards, which themselves are rooted in neo-classical theory originating with Adam Smith and carrying on to Milton Friedman and today’s mainstream economists whose work receives the most acclaim in top economic journals.

On the other end of the spectrum from the NCEE is the Union for Radical Political Economics (URPE), originally founded in the 1960′s by heterodox economics with the following goals:

First, to promote a new interdisciplinary approach to political economy which
includes also relevant themes from political science, sociology and social psychology.
Secondly, to develop new courses and research areas which reflect the urgencies of the day
and a new value premise. Such areas include the economics of the ghetto, poverty,
imperialism, interest groups, and the military-industry complex. And thirdly, political
economics should be sensitive to the needs of the social movements of our day, and have
more group research, with an approach that links all issues to a broad framework of
analysis.

To better understand the differences between heterodox economics and mainstream, neo-classical economics, it may help to examine the heterodox critique of the NCEE’s 20 Standards on Economic Education. The links above will take you to the full critique, but here’s a short excerpt that I think illustrates rather clearly the differing philosophies of these two modern schools of economic thought. The NCEE standards are in bold, the URPE’s critique is italicized:

1 and 2. Resources are limited so people cannot have all they want.
This is the traditional “starting point” of neo-classical economics which focuses our attention on how to allocate scare resources. The focus is on efficiency, which is understood to mean maximizing total production. Thus the central question is how to CHOOSE – how to trade-off one thing for another. Classical economists, such as Adam Smith, looked not only at total production but at how it was distributed between classes (landlords, capitalists and workers), and Marx viewed the appropriation of surplus production (over and above what was necessary for working people) as “theft” by the ruling classes. A total “disinterest” in distribution is one of the defining characteristics of neoclassical economics. An alternative focus for economics would be how to insure a decent standard of living for the people of the world..

3. People choose different methods of allocation of goods and services.
Note throughout the use of terms such as “people” and “individuals” with no distinction between capitalists and workers. Thus “people” choose their economic systems. The assumption here is that the “choice” is merely a matter of the level at which government decisions are made rather than any disagreement about a system which relies on profit-making as the motive force behind the private provision of goods and services, Thus the “command economy” (which is implicitly identified with communism) is presented as one in which the market plays no role, and there is absolutely no mention of the communists’ abolition of the capitalism class, and subsequent end to distribution on the basis of ownership of property.

4 and 5. People respond to incentives and voluntary exchange is beneficial.
There is not reference here to the starting point of this “voluntary exchange. The poverty-stricken will take starvation wages and even sell themselves or their children into slavery – this is, of course, “voluntary” in one sense but a more comprehensive approach recognizes that “they have no choice.”

The list goes on. It’s very interesting to compare the reasonable critique offered by heterodox economists to the “truths” of economics that we teach in our principles courses. It also frustrates me that in our limited time in the AP course we are unable to further explore these alternative, yet very valid and important approaches to understanding economic behavior and policy. I will encourage my students to seek courses in university that challenge the neo-classical view taught in AP Economics. The field of heterodox economic, while it has not yet achieved mainstream status, surely will play a crucial role in the evolution of this science in the decades to come, as social unrest, political turmoil, conflict, scarcity, environmental and social ills continue to plague our ever-changing world.

While adherents of heterodoxy may not yet be widely accepted in the mainstream field, their “human” approach to the “economic problem” will surely gain appeal as growth continues to broaden the divide between rich and poor, haves and have nots, urban and rural. Bright young students who have been exposed first hand to the challenges and downsides of economic growth (such as those faced by the millions o poor migrant workers here in Shanghai) are just the kind of students who can go on to make valuable contributions to heterodox economics.

Powered by ScribeFire.

Hip Heterodoxy

I just found a link to this long and interesting article about a fledgling field called “heterodox” economics. Heterodox is defined as “not in accordance with established or accepted doctrines or opinions, esp. in theology; unorthodox.”

In the case of heterodox economists, what they don’t believe is the
neoclassical model that anchors the economics profession. Classical
economics refers to the theories laid out by Adam Smith and David
Ricardo in the eighteenth and nineteenth centuries, which emphasized
the power of the “invisible hand” of the market to promote the division
of labor and economic growth. Smith famously summed up the recipe for
prosperity as “peace, easy taxes, and a tolerable administration of
justice,” with “all the rest being brought about by the natural course
of things.”

There’s a lot to digest in this five page article from the Nation. I think I’ll have to blog it in a few separate posts. This will also be a great article for use in my AP Econ course when we compare the neo-classical version of the vertical Aggregate Supply to the Keynesian horizontal AS curve, and the implications therein regarding use of monetary and fiscal policies to achieve macroeconomic stability.

One line that jumps out at me right now is:

Indeed, the cradle for much of our policy discussions can be found in
the first chapter of just about any introductory economics textbook,
where the basic precepts of the neoclassical framework are described
under the rubric of “thinking like an economist.”

Again, I continue to come across evidence that an education in Economics is absolutely crucial to understanding important issues in all realms of society today. As I continue digesting this important analysis and history of competing economic ideologies, I will continue to think about how to use this in my class next fall, and blog any ideas that come to mind. If you have the time and interest, give this article a read and post your comments here!

Powered by ScribeFire.

Bloomberg.com: Calendar, Abacus Help Determine Size of Chinese Rate Increases

Here’s an interesting piece about Monetary Policy in China.

“The People’s Bank of China today raised its one-year benchmark lending rate by 0.18 percentage point and its one-year deposit rate by 0.27 percentage point. Why 18 or 27 basis points instead of the increments of 25 used by most other central banks?

The answer has to do with the Chinese calendar and superstition, as well as the ancient Asian counting device, the abacus.”

While “traditional” Chinese culture may seem to disappear with globalization, the superstitions of old are alive and well in the financial community:

“`Rates divisible by nine avoid rounding of interest and allow easier calculation by abacus,” said Wang Qing, chief China economist at Morgan Stanley in Hong Kong.

In addition, the number nine in Chinese shares a pronunciation with the word “longevity” and has long been considered a lucky number. Chinese wedding feasts have nine dishes; Beijing’s Forbidden City has 9,999 rooms.

`The number nine is very important in the Chinese society and business world,’ said Chan Mansing, associate professor at the School of Chinese at the University of Hong Kong. `Nine stands for longevity, abundance and masculinity. It also represents the highest attainable level in all human endeavors in the Book of Change, a Chinese philosophy book that has been read for thousands of years.’ “

Hey, who knew?!

Powered by ScribeFire.