Capitalist Crisis book by Mick Brooks

The failure of orthodox economics
Mick Brooks Interviewed on his book Capitalist Crisis Theory and Practice

The economics establishment was completely caught on the hop by the Great Recession. When Queen Elizabeth II visited the London School of Economics in November 2008, she asked the assembled academics, “How come nobody could foresee it?” Eventually she received a letter in reply from Tim Besley and Peter Hennessy. It spoke of a “psychology of denial” and concluded that “it is difficult to recall a greater example of wishful thinking combined with hubris”.

Not only did the vast majority of the official economists fail to foresee the approaching catastrophe. For many such a prospect was completely impossible according to the basic principles of orthodox theory that they taught and believed in.

Ben Bernanke, current Chair of the Federal Reserve (the US central bank) talked of the Great Moderation in recent decades. He meant that, though there have still been economic fluctuations, they no longer threatened the capitalist system like the convulsions in the 1970s and early 1980s. The right wing economist Robert Lucas went further. He averred in his 2003 Presidential Address to the American Economic Association that, “Macroeconomics…has succeeded. Its central problem of depression-prevention has been solved for all practical purposes, and has in fact been solved for many decades.” Economic orthodoxy was that the Great Recession just couldn’t happen.

How do the neoclassical economists differ from the moral philosopher Dr. Pangloss in Voltaire’sCandide? He argued, “Observe that noses were made to use spectacles; and so we have spectacles.” Pangloss, like the neoclassical economists, concluded that all was for the best in the best of all possible worlds. The only difference is that Voltaire intended Pangloss to be a figure of fun. Most economists deal in apologetics, not explanation. Naturally there are dissenters from the economic orthodoxy. We shall come across some in the course of this book.

An example of the dogma that buttressed this misplaced optimism is the efficient markets hypothesis, developed by economist Eugene Fama at the University of Chicago. Put simply, the efficient markets hypothesis (EMH) argues that markets fully reflect all available information. This suggests that markets ‘get it right’.

Now, as we show in Part 1, the Great Recession was preceded by a house price bubble. The bursting of this bubble was the proximate cause of the credit crunch, the opening phase of the Great Recession. A bubble is a situation where prices go up because people are buying, and people are buying more and more because prices are going up. In other words it is an instance of markets getting it wrong on the grand scale. It is now widely agreed that there was indeed a house price bubble in Britain, the USA, Spain and other countries in the years before the credit crunch. It has to be said that this was very much a minority view at the time the bubble was actually being inflated. Then the economists and commentators rushed to reassure us that all was well.

Here is Eugene Fama being interviewed by journalist and author John Cassidy in 2010, after the onset of crisis. He is asked several times about the existence of a bubble which, of course, contradicts the foundations of his EMH theory. He wriggles and twists:

“Cassidy: Many people would argue that, in this case, the inefficiency was primarily in the credit markets, not the stock market—that there was a credit bubble that inflated and ultimately burst.

“I guess most people would define a bubble as an extended period during which asset prices depart quite significantly from economic fundamentals…

“Fama:…I don’t know what a credit bubble means. I don’t even know what a bubble means. These words have become popular. I don’t think they have any meaning.”

He is then asked to suggest an alternative explanation for the collapse:

“Cassidy: So what caused the recession if it wasn’t the financial crisis?

“Fama: (Laughs) That’s where economics has always broken down. We don’t know what causes recessions. Now, I’m not a macroeconomist so I don’t feel bad about that. (Laughs again.) We’ve never known. Debates go on to this day about what caused the Great Depression. Economics is not very good at explaining swings in economic activity…”

To further examine the limitations of orthodox economic theory, and the EMH in particular, we turn to Justin Fox’s accessible and entertaining review (Is the market rational? Fortune 09.12.02). He begins:

“’In an efficient market,’ wrote Chicago professor Eugene Fama in a landmark paper he delivered at the 1969 annual meeting of the American Finance Association, ‘prices fully reflect available information.’”

It follows that any future movement will be a ‘random walk’, depending on new information emerging. This theory did not pass the test of real world events. Fox goes on:

“That real-world phenomenon was the stock market bubble of the late 1990s. According to strict efficient-markets thinking, there must be a rational explanation for what happened. Fama describes those sky-high Internet stock valuations as a risky but not crazy bet that one or two of those money-losing Net companies would end up as big as Microsoft. But he’s almost all alone on this one. ‘We have just lived through the biggest bubble of all time,’ says Malkiel, who now calls himself a ‘random walker with a crutch.’ Fama’s favorite collaborator, Dartmouth’s French, is on the verge of using the b-word as well when he stops himself. ‘I work very closely with Gene,’ he says. ‘He would be very upset if I used that word in print.’

“Yale economist Robert Shiller has no such compunctions about ticking off Gene Fama. In 1984 he declared that the logical leap from observing that stock price movements were unpredictable to concluding that the prices are in fact right ‘represents one of the most remarkable errors in the history of economic thought’.”

As we shall see in Part 7: Economic Perspectives Shiller, in challenging the orthodoxy, was also able to explain the Internet share bust of 2000 as the inevitable outcome of a bubble in his book Irrational Exuberance. Fox continues his account, showing the complete inability of mainstream economists such as William Sharpe to explain what was going on in the economy:

“That was Shiller’s first brush with fame.” (In 1984) “He got more popular attention after the 1987 stock market crash, which the efficient-markets professors had trouble explaining. (‘It’s weird,’ Sharpe told a reporter at the time. Later his mother called to berate him: ‘Fifteen years of education, three advanced degrees, and all you can say is, ‘It’s weird?’)”

Perelman, in The invisible handcuffs of capitalism, gives a fascinating insight into how academic debate and dissent is handled within the economics establishment. Perelman makes a general critique of the method of neoclassical economics. The account below is drawn from his book. We deal with the discussion on the minimum wage as an example.

David Card and Alan B. Krueger investigated the effects of different minimum wage levels on employment. (In the USA the minimum wage is set at a state-wide level.) Their findings suggested that raising the minimum wage did not increase unemployment. This tended to disprove a central dogma of neoclassical economics. They suffered a hail of bullying and intimidation as a result. Card found that his academic career suffered:

“I’ve subsequently stayed away from the minimum wage literature for a number of reasons. First, it cost me a lot of friends. People that I had known for many years, for instance, some of the ones I met at my first job at the University of Chicago, became very angry or disappointed. They thought that in publishing our work we were being traitors to the cause of economics as a whole.” (Interview with David Card, The Region, December 2006)

James Buchanan retorted to the duo, “Fortunately, only a handful of economists are willing to throw over the teaching of two centuries; we have not yet become a bevy of camp-following whores.” (Wall Street Journal 25.04.96)

This abuse is extraordinary. Card and Krueger had provided evidence indicating that “the teaching of two centuries” was false. Buchanan did not argue against this evidence. He simply dismissed it. Surely those who argue against a minimum wage as a basic defence for the poorest workers in the face of the evidence (in the process defending the interests of the rich and big business) should more accurately be described as “camp-following whores?”

Given this ‘herd reaction’ from the economics profession it would be unrealistic to expect any answers from them as to the causes of the Great Recession, let alone an effective programme to get us out of this mess. Denial seems to be their default reactions to events that are not in their books. Nobody can make a stronger case for a Marxist analysis than the official economists, through their abject failure to face up to facts and their outright dishonesty in defending vested interests.

Contrast the wilful ignorance of the official economists with the wisdom and foresight of Marx. These words were published in 1848 and are as true today as they were then:

“For many a decade past the history of industry and commerce is but the history of the revolt of modern productive forces against modern conditions of production, against the property relations that are the conditions for the existence of the bourgeoisie and of its rule. It is enough to mention the commercial crises that by their periodical return put the existence of the entire bourgeois society on its trial, each time more threateningly…In these crises there breaks out an epidemic that, in all earlier epochs, would have seemed an absurdity – the epidemic of overproduction. Society suddenly finds itself put back into a state of momentary barbarism; it appears as if a famine, a universal war of devastation had cut off the supply of every means of subsistence; industry and commerce seem to be destroyed; why? Because there is too much civilisation, too much means of subsistence, too much industry, too much commerce” (Communist Manifesto, pp.7-8)

We offer a Marxist explanation of the Great Recession. We believe it provides a powerful account of recent events. Of course there are debates within Marxism and contending explanations of capitalist crisis, which we explore. A Marxist analysis also provides an understanding of the tasks ahead in fighting the cuts and clues for a way out of a future that we fear could be an age of austerity.