Wednesday, 27 April 2016

Pluralism since the ‘1992 Plea’ in the AER

First published on the Rethinking Economics Blog, March 12th 2014

In May 1992, a ‘Plea for a Pluralistic and Rigorous Economics’ was published in the American Economic Review (Vol 82 No. 2). It was signed by Harcourt, Galbraith, Goodwin, Kindelberger, Minsky, Pasinetti and other eminent economists. The Plea was funded by FEED who launched a second ‘Plea’ in 2009 and support the 2012 ‘Manifesto for Economic Sense’.  Geoffrey Hodgson, Research Professor in Business Studies at the University of Hertfordshire and one of the co-organisers of the ‘1992 Plea’, is interviewed here about the history of economic pluralism, and the challenges facing economics today.

NL: Twenty two years after the ‘1992 Plea’, do you think the mainstream has changed?
GH: I think things have changed in economics, to some degree. It’s not entirely positive, but in some senses economics is more diverse now that it was twenty two years ago… for example, new areas like experimental economics and behavioural economics have gained respectability. The main problem now with economics is not so much its diversity, or its insufficient internal pluralism, but the way that technique dominates and gets in the way of substance. Economists are engaged with mathematical puzzle solving rather than real-world problems…
NL: By that you mean things like regression analysis and theoretical model building?
GH: Theoretical model building and econometrics … that is all that now seems to matter in terms of publication in top journals or academic promotion. The whole discipline has become dominated by people who are very clever in technique but innocent of many important aspects of the real world and the history of their own discipline.
NL: In that 1992 Edition of the AER there were some pluralist surveys of economists, do you think the AER would publish that kind of qualitative research today?
GH: Generally it is very difficult to publish anything like that, and not just in the AER. I include other leading journals, like the Quarterly Journal of Economics or the Economic Journal in the UK… although occasionally they publish qualitative pieces, to spice up interest in their journal.
NL: What successes have you seen in the campaign for pluralism?
GH: The ‘1992 Plea’ was an early ringing of alarm bells about the nature of the discipline and the way it had been developing. It may have stimulated further similar complaints, such as from the French student movement… and dispersed attempts in Cambridge and also in the US… but the real change came with the 2008 crash. This provoked a much larger tide of complaint among students and others about the alleged inadequacies of mainstream economics.
NL: Was there a pluralist movement prior to the ‘1992 Plea’?
GH: Several prominent economists had made complaints. The petition was preceded by an important 1988 report by a commission of the American Economics Association, called ‘Report by the Commission on Graduate Education’ (Krueger et al, 1991), which complained about the dominance of technique in the discipline. A number of leading individuals, including Milton Friedman, also complained about the subject turning into advanced mathematics.  The most important event was the 1988 commission and its critical and scathing report.
NL: Did it have any success at the time?
GH: No.
NL: So why do you think the profession keeps coming back to these very inward-looking methods?
GH: The economics profession has an internal reward system that gets reinforced and replicated. Someone once compared it to the peacock’s tail. Once this positive feedback loop gets established, then people look for the glorious tail feathers despite their questionable usefulness. Fancy mathematics gets economists published and gets them promoted. As those people rise in the profession they will recruit people who perform similarly and the same kind of behaviour gets replicated. Other people, who think more widely or philosophically, or are more interested in the history of the subject or how it has changed, or who look more deeply at the conceptual assumptions, don’t get considered for influential positions in the discipline.
NL: What advice would you give Rethinking Economics?
GH: I hate to be pessimistic, because I don’t want to dampen the enthusiasm of those people committed to this, but unless you get some of the top universities appointing professors who are more broad-minded, who are not dominated by technique, who have influence, and some of the top journals consider more conceptual, historical material rather than simply technique-driven material,  then it will fail. Mark Blaug, who was a friend of mine who died a couple of years ago, got very pessimistic about this, and so did Ronald Coase who died last year. Another problem is that American economics is now overwhelmingly dominant. I often ask people… can you name a living British economist…  and they really have difficulty thinking of anybody. When mainstream economists took over the Cambridge department in the 1980s, after the era of Robinson and Kaldor, their explicit aim was to make Cambridge a rival to the top American Universities In other words, they aimed not to develop Cambridge’s own niche, but simply to follow what America was doing. You are inevitably 5 years behind if you are lucky, and that US emulation has led to the near-destruction of British economics… with this subservient mentality it is very difficult to change things in the UK.
NL: Can we talk about your hope for the future?
You may have heard of a new association called WINIR: the World Interdisciplinary Network for Institutional Research. What we are trying to do is create a new field for study. It’s not just about economics, but institutional economics is a part. I think that this is a more productive strategy than trying to change economics…  but the problem with WINIR is it doesn’t cover everything. At the moment, it omits crucial areas like finance… we can’t do everything. We are hoping to find new ways of promoting realist approaches and developing new ideas
NL: When you look at Blanchard’s work at the IMF…  is there at least a sense that more reflective research is coming out, even on the finance side?
GH: That’s right, and there are other good examples, like Thomas Piketty’s work on capital and inequality…. but these are the exceptions. All the incentives, all the ways that you get promoted in the system are not by thinking outside of the box. When I gave a talk to the Post-Crash group in Manchester, I said you have to take the institutions of science seriously. One of the problems with heterodox criticism is that it’s a fragmented growth of people who can’t agree amongst themselves on much, except that they are opposed to the mainstream: that will never generate cumulative knowledge. We actually need an alternative centre of orthodoxy. Science cannot progress by questioning everything, all the time….  some assumptions or knowledge has to be taken for granted. These assumptions may need to be changed later, but we need consensus as much as pluralism. Hence I’m against organising opposition to mainstream economics on the basis of a ‘heterodox’ label…  in fact there are many good and interesting things going on in the mainstream.  Heterodox organisations and leading figures who work under that label often overlook potential allies in the mainstream…
NL: One of the things we are struggling with in the UK curriculum review is the word ‘CORE’… this Popperian idea of a heuristic around which everything else revolves…  is the idea of a ‘CORE’ something the profession can escape?
GH: I think the CORE idea is important: the problem with things at the moment is that the core is defined in terms of technical skills. An undergraduate doing an economics degree has to understand key aspects of game theory, to understand key certain econometric techniques, and these take up the time of teaching and testing for the student… and as the bar is always being lifted… because the complexities of game theory and econometrics are always increasing…  so it’s not so much changing the subject matter of the core, it’s changing the preoccupation of the core. We need to establish that the first and foremost job of an economist is to understand the economy…  all other things are subservient to that.
Many heterodox economists blame Marshall, among others, for what went wrong. He was part of the neoclassical revolution of the 1870s and 1880s. But if you actually look at how Marshall wrote and how he behaved he was extremely tolerant and open minded…  he wrote in his Principles and also in his letters that economic theory is not a mathematical toy. He argued that we have to understand the real world. For him, mathematics was a tool, but not the main part of the subject…
NL: Several of the petitions for pluralism talk about solving climate change, global warming, inequality, wealth accumulation, capital flight, all of these issues. Do you agree that economics is that broad? Can economics solve all of these problems or is that too grand a claim?
GH: Marshall’s definition of economics was the study mankind in the ordinary business of life: by that he meant processes concerning the generation of wealth and its distribution, which include problems like the impact of climate change…  we need to develop economic policies to deal with climate change in some way.
NL: Which includes solving these issues…
GH:  Yes.
NL: Could you recommend three pieces of your work to a student interested in pluralism?
GH:  My 2004 book on institutional economics; my 2013 book on evolutionary economics; and my book on capitalism that is coming out this year. Each book addresses the issue of pluralism and challenges mainstream assumptions.
NL: Thank you very much.

Hodgson, Geoffrey M. (2004) The Evolution of Institutional Economics: Agency, Structure and Darwinism in American Institutionalism (London and New York: Routledge).
Hodgson, Geoffrey M. (2013) From Pleasure Machines to Moral Communities: An Evolutionary Economics without Homo Economicus (Chicago: University of Chicago Press).
Hodgson, Geoffrey M. (forthcoming) Conceptualizing Capitalism: Institutions, Evolution, Future (Chicago: University of Chicago Press).
Krueger, A.O. Arrow, K.J. et al (1991). Report of the commission on graduate education in economics.  Journal of Economic Literature. 29(3):1035-1053
Various (1992). A Plea for a Pluralistic and Rigorous Economics”, American Economic Review, 82(2):25

Friday, 8 April 2016

Black holes and free lunches

This is a response to a blog post and Twitter chat about the persistence of UK and US current accounts deficits. It's a hot topic: see Frances Coppola. The worst case scenario is generally assumed to be capital flight and devaluation: a return to the summer of 1976 when Callaghan went to the IMF for a loan. This post is an attempt to dig a little deeper, and address the politics and ethics: whose free lunch is it anyway?

The biggest problem for any researcher is the poor quality of the balance sheet data. In theory, if you knew the gross position on the financial and capital account, you could run various stress tests on sustainability: currency and asset price shocks; illiquidity; loan defaults; and so on. I can imagine there are wannabe financial stability super-regulators salivating at the thought of this kind of real-time, country-level portfolio analytics. However, the data are poor and the time series are incomplete.

I know of two major efforts to improve the balance sheet data: the External Wealth of Nations dataset from Lane and Milesi-Ferretti, and the Hidden Wealth of Nations dataset by Gabriel Zucman. Having tried, and failed, to work with the underlying datasets, I consider both these efforts akin to the story of David vs Goliath: heroically correcting the data errors that accumulated in international financial statistics under the laisser-faire stewardship of the IMF and UN.

I'm not very familiar with Zucman but, from what I can see (Table T1) he agrees with Lane and Milesi-Ferretti that the official US external position is, effectively, bankruptcy: assets-liabilities net at around -35% of GDP in 2012. However, both Zucman and Lane/Milesi-Ferrretti argue that this is due to the under-reporting of foreign assets. The most plausible explanations for this are tax avoidance (the purchase of domestic assets by non-residents, who are nonetheless UK residents but moving domestic assets offshore) and capital gains on foreign assets (favourable yields, foreign exchange gains and asset price rises). This somewhat out-of-date graph from Lane and  Milesi-Ferretti (2007, p.232, below) shows the world's aggregate current account deficit disappearing into an offshore 'black hole':

At a first order approximation, Lane and Milesi-Ferretti agree with Zucman's estimate that ~8% of World GDP (or $7.6 trillion) that is being held offshore in tax havens: a 'black hole'.

So far, so good. However, the problem with other parts of the 'dark matter' theory is that it has a poor track record for prediction. Consider Hausmann and Sturzenegger (2006) who, just before the GFC, cast 'doubts on the need for a major adjustment of the dollar or a large rebalancing of the global economy'. I suspect that this poor prediction is partly due to methodology: Hausmann and Sturzenegger inferred the size of the 'assets from their returns... (which) is just like valuing a company by calculating its earnings and multiplying by some price-earnings ratio, or valuing a property based on its rental value ' (p.5-6): akin to driving by only using the rear view mirror.

However, Hausmann and Sturzenegger are also naive in their theoretical framework. They think about 'dark matter' not as the offshore spoils of tax avoidance, but as embedded financial services that the US and UK provide to the rest of the world: 'surprises, risk premia and embedded services [insurance and liquidity]' (page 6). Longeran says something similar in his blog: 'the US has an edge in trading assets and making superior foreign direct assets and selling financial “insurance” is a core US competitive advantage'.

There are well-rehearsed heterodox theories that explain an edge in financial trading, where developed countries exploit their information advantages. If financial markets are rigged ('markets for lemons') then the rest of the world will demand reform: Bretton Woods II might be vetoed by the UK and US, but other players can demand centralised clearing, alternative forms of collateral, breaking up trading cartels; and so on.

What about other embedded services: insurance and liquidity? Does the rest of the world pay a fair price for these? According to Godley and Lavoie (2007), provided UK and US trading partners accept IOUs, they can always issue new IOUs in return for goods and services. There is no need for a Walrasian auctioneer, or equilibrium. If the UK or US issue securities at a higher yield, such as an expensive nuclear power stations or high yield sub-prime/PFI debt, then they only hasten their demise. There is some evidence, at least for the UK, that an obsession with issuing higher yield private debt is doing exactly that, with direct investment income accounting 'for more than 80% of the increase in the (UK current account) deficit since 2011' (Hamroush et al, 2016).

We can also use exchange rate movements to estimate, in part, the historical insurance premium payable on 'safe haven' assets. The following graph takes the known reserves of major exporters (China, Germany and Japan) and estimates foreign exchange losses (the currency composition of reserves is taken from COFER). For China, these unrealised exchange losses approached $1 trillion during the period of USD and GBP weakness after the GFC:

A similar exercise, using Japan's trade surplus as a proxy for Japanese private holdings of US T Bills (not shown) suggests that private Japanese citizens paid out a similar insurance premium. From 1975 to 2013, the YENUSD exchange rate fell from around 300 to around 90. In simple terms, imagine a Japanese exporter in 1979 who had accepted USD in exchange for a Sony Walkman. After 30 years of low returns, they finally decide to convert back to YEN and spend it: their YEN buying power has fallen by about two-thirds.

The foreign exchange losses are consistent with superior trading by the UK and US, but we come full circle: the Walrasian auctioneer is sluggish, unpredictable, greedy and avoiding tax. The insurance premia for safe havens are expensive, and the auctioneer is constantly demanding privatisations to satiate foreign demand and to feed the 'black hole'. The sustainability question is reduced to something simpler: are the insurance premiums too high, and are offshore 'black holes' desirable or sustainable?


Godley, W. and Lavoie, M. (2007). Monetary Economics: an integrated approach to credit, money, income, production and wealth. Palgrave MacMillan. Basingstoke, Hampshire, UK.

Hamroush, S., Luff, M., Banks, A. and Hardie, M. (2016). An analysis of the drivers behind the fall in direct investment earnings and their impact on the UK's current account deficit. Office for National Statistics. Available from: 

Hausmann, R. and Sturzenegger, F. (2006). Global imbalances or bad accounting? The missing dark matter in the wealth of nations ( No. 124). Centre for International Development at Harvard University, Centre for International Development. Cambridge, Mass. Available from:

Lane, P. and Milesi-Ferretti, G. (2007). The external wealth of nations mark II: revised and extended estimates of foreign assets and liabilities, 1970-2004. Journal of International Economics. 73(2007): pp223-250.