It has taken me a long time to finish Steve Keen’s Debunking Economics: The Naked Emperor Dethroned. Its author has enjoyed great celebrity, at least for an economist. For example, he featured in a recent BBC Radio 4 Analysis programme, and has battled Paul Krugman in the blogosphere. This might be a touch cynical of me, but I’m pretty sure his popular acclaim is due to the appeal of his conclusions rather than a detailed appraisal of the nearly 500 pages he takes to reach them. For this is a dense and rather academic book, although Professor Keen presents it as an explanation for non-experts – he explicitly says it is written for non-economists, but that does not make it an easy read.
The first two parts present a detailed critique of the basics of economic theory, all of it from the basics of consumer choice and theory of the firm through general equilibrium theory to conventional macroeconomics. Keen describes the flaws of conventional theoretical economics on its own terms, with detailed reference to original papers, and I think he does a reasonably convincing job.
Does that make me want to throw away everything I know about economics? Well, no. For example, the book spends pages analysing the internal contradictions of the standard derivation of a downward sloping demand curve: “Market demand curves should have any shape except the one that is drawn in the textbooks.” He draws a ‘true’ market demand curve as a wiggly snake. However, when I contemplate my eight years of market analysis on the Competition Commission, and more than a decade of consultancy, I conclude that, you know what, demand tends to go up when prices go down. Similarly, Keen concludes that output and prices will be identical in competitive and monopolistic markets. That could only be true by chance as firms with and without monopoly power set prices in completely different ways: competitive firms know what their costs are and charge a cost-plus price; firms with market power charge ‘what the market will bear’ and find it difficult to identify and allocate their costs.
After chapters of logical analysis, I realised that Professor Keen’s theorising is as abstract as the theories he criticises. I have no trouble agreeing with him about the practical unreality of the basics of economic theory, but I don’t think it’s the knock-out blow he considers it to be. The reason is related to a classification of types of assumptions he sets out on pp161-163 of the book. I for one regard most of the assumptions made in the theory as ‘heuristic’ assumptions, known to be false but useful as a device for thinking about a problem. It wouldn’t trouble me at all to ditch the formalities of Arrow-Debreu general equilibrium theory, as long as we keep the deeper reality that the economy is a connected system. My guess is that many applied economists are in my camp. Maybe, though, many academic economists would be as scandalised by Professor Keen’s debunking as he thinks. I certainly agree with his plea from the heart for wholesale reform of the way economics is taught. (See the forthcoming What’s The Use of Economics – watch this space.)
The book hits its stride in the sections on macroeconomics, in the third part, in which Keen sets out his own theory, a Marx-Minsky-Keynes (M-M-K) approach that meant he was able to issue public warnings of the impending crisis ahead of 2008. The key difference between his model and more mainstream ones is the inclusion of a financial sector and financial cycles with asset bubbles. All credit to Professor Keen for talking about a debt problem when most macroeconomists hadn’t even noticed the astonishing aggregate build-up of leverage in the global economy.
This section is easier going than the earlier parts of the book. Although Debunking Economics cites non-mainstream approaches such as Alan Kirman’s network and complexity theories (in Complex Economics) earlier in the book, it does not include them in this section as an alternative way of thinking about the aggregate economy, which seems a bit of an omission. The trouble with Keen’s M-M-K synthesis, using aggregate variables in different relationships than in the conventional model, is that it might lack generality. This worry is what originally drove the project of finding micro-foundations for macro-models, even though it took us in the end into the madness of Dynamic Stochastic General Equilbrium modelling of representative agents. Perhaps a lack of generality is ok. I’ve always been a fan of Malinvaud’s distinction (in Theory of Unemployment Reconsidered) between different states of the macroeconomy, requiring entirely different policy regimes. However, I do think we ought to be open as well to a completely new modeling strategy.
So, without in any way wanting to defend the mainstream theories at all costs, I don’t think Debunking Economics is the last word on either what’s wrong with the subject or how to fix it. I have a lot of sympathy with the details of Professor Keen’s project, but not its ultimate ambition. For in the end I think the Naked Emperor needs to be reclothed rather than dethroned.
First pubished on The Enlightened Economist