“[T]he characteristics of great theoretical achievements are clear foundations, consistency with many observed facts, unification of theories which previously appeared as fundamentally distinct.” That high bar was set Edmond Malinvaud (1977), the late, greatly admired French macro theorist. Mainstream New Keynesian (NK) modeling – what they very much want every macroeconomist to use – falls woefully short of Malinvaud’s aspirations. The friction-augmented general market equilibrium theory does have clear foundations, but they are at the cost of inadequate consistency with observed facts. FGME analysis is also better at excluding, not unifying, other theories.
The ignored evidence is sufficiently critical to render the NK model toxic to any serious effort, most notably by stabilization policymakers, to make sense of macro behavior. Moreover, deliberately pushed-aside evidence is startingly widespread. The interrelated suppressed facts include involuntary job loss that occur in the millions in every recession, that the labor-market is in chronic disequilibrium, that forced layoffs occur almost exclusively in firms restricted by information-challenged workplaces (denoted by LEV in the GEM Project), that LEV labor pricing is always performed by large human-resource departments, that LEV periodic wage adjustments for inflation always uses catch-up to past product-price change instead of rational expectations of future inflation, that the 1930s depression and its massive job downsizing actually occurred and must be understood, that the devastating 1980s LEV job downsizing actually occurred in the “rust belt” of iconic industries and must be understood, that the Thatcher revolution actually occurred and must be understood, that the next jobs of downsized workers pay substantially less than the one they lost.
Take a breath and then continue. Suppressed evidence further includes that that chronic sizable wage rents are paid by LEV firms, that LEV jobs and hours on those jobs are chronically rationed, that the optimizing neoclassical trade-off between work and leisure is rationally suppressed in highly specialized economies, that the consequential importance of worker seniority in personnel decisions of LEV firms is rationally suppressed, that Keynes’s second classical postulate must indeed be scrapped, that the interindustry wage structure became much more dispersed during the stagflation decade, and much more. Stepping back, a crucial general question is how NK theorists get away with ignoring what even casual observers of modern economies know: that labor pricing and use is hugely different in firms that have effective OJB supervision versus those restricted by badly compromised worker oversight.
The remarkable power of the GEM two-venue reworking of market-centric analysis may be most striking in Malinvaud’s third characteristic. Its capacity to unify and revive insightful theories is unmatched. As a result of their poor fit in the mainstream market-centric framework, many useful macro models are today largely ignored, Sir Arthur Lewis’s two-venue growth theory that assigns a central role to labor flows between low- and high-productivity sectors is one of the most obvious examples. The fixed-wage general-equilibrium microfounding of Keynesian consumption, elegantly modeled by Robert Barro and Hershel Grossman, is another critical revival. Generalized-exchange modeling makes the primacy of income, and the associated diminution of interest rates, in consumption spending consistent with continuous general decision-rule equilibrium, correcting a longstanding misalignment of mainstream theory with well-known facts.
David Ricardo’s residual-surplus approach to factor-income distribution, reinterpreted for highly specialized economies by Michael Jensen (2000), is also restored to modern modeling, further helping to recalibrate the outsized consensus role of interest rates. Replacement of the textbook market-centric analysis of Wicksteed and Wicksell allows pure profit to assume primacy in investment decisions after its long, embarrassing banishment from macro thinking. Finally, in this incomplete introductory list, is the revival of the large-firm workplace modeling by the original Internal-Labor-Market (ILM) theorists who dominated American labor economics in the middle 20th-century. The work of Clark Kerr, John Dunlop, and their colleagues, ignored in modern macroeconomics, provides a powerful roadmap for the intuitive generalization of rational exchange from the marketplace to the highly specialized workplace. Using their neoclassical training, they pioneered the economic analysis of rational workplace behavior in the circumstances of costly, asymmetric information.
There is no theory in the macro literature that better satisfies Malinvaud’s high model-building standards than the workplace-marketplace synthesis. None comes close. The two-venue model class uniquely microfounds downward wage rigidity (DWR), pure wage rent (PWR), and a powerful channel through which nominal demand disturbances induce same-direction, proportional movement in employment, production, profit, and investment. The GEM model class, rooted in optimization and equilibrium, uniquely accommodates involuntary job loss, both stationary cyclical layoffs and trend permanent downsizing The consistency of the two-venue analysis with both the broad range of stabilization-relevant evidence and the revival of a remarkable range of suppressed, albeit critical, macro models is beyond the reach of any coherent market-centric theory. Inclusion of GEM research in mainstream debate and dissemination provides consensus thinking a path to stabilization-policy relevance as well as an enriched understanding of economic growth. It is a big deal.
Blog Type: New Keynesians Saint Joseph, Michigan