Fundamental Choice

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Core neoclassical principles that govern macro modeling are optimization, general equilibrium, and market centricity. The GEM Project argues that the third tenet, the restriction of rational exchange to the marketplace, long ago outlived its usefulness. The emergent ubiquity of complex, bureaucratic corporations fundamentally altered the nature of rational price-mediated exchange, badly damaging the capacity of textbook market-centric macroeconomics to explain critical evidence. The Project demonstrates that, in order to be stabilization-relevant, consensus macro thinking must accept the generalization of optimizing exchange from the marketplace to information-challenged workplaces.

Market exchange versus production. Joan Robinson (1977, p.1321), perhaps even more than her Cambridge colleague John Maynard Keynes, anticipated the GEM Project: “There are various brands of micro theory; …but all share the characteristic of stressing exchange and neglecting production.” She cites Nikolay Bukharin as an economist who got it right. In 1919, he lamented that “there is almost no [mainstream] discussion of how scarce means are organized to yield outputs; the whole emphasis is on exchanges of ready-made goods.”

She then cites the estimable Robert Clower as an example of getting it wrong. From Clower: “An ongoing exchange economy with specialist traders is a production economy since there is no bar to any merchant capitalist acquiring labor services and transforming them (repackaging, processing into new forms, etc.) into outputs that are unlike the original inputs and are ‘sold’ accordingly as are commodities that undergo no such transformation. In short, a production unit is a particular type of middleman or trading specialist.”

Robinson’s step-back perspective on the fundamental macro debate is insightful: “We cannot help trying to understand the world we are living in, and we need to construct some kind of picture of an economy from which  to draw hypotheses about its mode of operation. We cannot hope to get neat and precise answers to the questions that hypotheses raise, but we can discriminate among the pictures of reality that are offered and choose the least implausible ones to elaborate and to confront whatever evidence we can find… Hypotheses are invented and die every day. The criteria by which some are chosen to survive and enter into the corpus of economic teaching are of two kinds. One is that a hypothesis seems life-like and offers some explanation that appears sufficiently promising to be worth exploring, and the other is that it fits into and supports received doctrine.”

Call it the fundamental choice. On Robinson’s first path, theorists’ primary goal is to explain important evidence; they seek to build models that are relevant to actual problems. On the second, research is Ptolemaic in nature with primacy assigned to maintenance of mainstream theorists’ comfort and reputations.

GEM Project. The generalized-exchange theory opens up the analysis of production in the promising circumstances of workplaces subject to costly, asymmetric employer-employee information. It generates coherent hypotheses on wage determination, the role of nominal demand in macro instability, and the incidence and consequence of labor rent. It successfully explains a great deal of previously inexplicable evidence.

It demonstrates that Clower did indeed get it wrong with respect to highly specialized production. Nonmarket methods of pricing and using labor services are necessary when modeling modern highly specialized economies. The website’s eBook chapter 2 beautifully illustrates how that nonmarket optimization differs from received market-centric doctrine. Generalized exchange replaces the cartoonish mainstream worker preference to shirk with the evidence-consistent desire for equitable treatment, helping to explain the huge investment in human-resource management and the quasi-judicial work rules that constrain arbitrary managerial authority. The profit-seeking payment of labor-market opportunity costs is replaced by the profit-seeking payment of wages that embody downward rigidity (over the stationary business cycle) and chronic time-varying above-rents. The outlines of how to resolve longstanding problems of market-centricity in modern highly-specialized economies become more clear.

It is up to the macro academy to closely examine Robinson’s two functions of economic models and decide with which they want to align. Macroeconomists, especially the applied business branch working for leaders (in government and private business) who care deeply about understanding real-world, are suffering under the mainstream regime that marginalizes effective demand, ignores involuntary job loss, and explains the large variation in unemployment with appeals to variations in the efficiency of job search. That complaint captures the extraordinary irresponsibility of our most respected macro theorists. The foolishness that gets them published, promoted, and awarded would get their applied brethren fired. The Ptolemaic mainstream research agenda of the macro academy must be repudiated before all of the client goodwill produced by the Early Keynesians is exhausted. I always thought that the big-reputation macro theorists are (generally speaking) smart people. Can’t a few of them recognize that there will be awards aplenty for the mainstream macro theorists who are in the first wave to break out of the badly outdated market-centric box, vigorously rejecting the claim that market-centric, dynamic stochastic general-equilibrium macroeconomics is settled theory. The GEM Project would give them a leg up on what to do next.

Blog Type: New Keynesians Chicago, Illinois

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