Recalling Arthur Okun

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Arthur Okun’s name came up. It happened in a conversation with a friend from the high-wire policymaking days at the Fed when stagflation – simultaneously high unemployment and high  inflation – was generating an instability crisis second only to the 1930s Great Depression. Okun, then at the Brookings Institution, was at the forefront of the Washington macro theorists seriously working on that mass market breakdown. We all thought he would be the one to rigorously explain what was happening. That assumption died with his fatal 1980 heart attack at 51 years old.

My friend and I both believe that had Okun lived the development of macro theory would have been substantially different. More specifically, the costly failures of mainstream modeling that today continue to badly compromise the profession’s policy relevancy could have been avoided. Rigorous textbook macroeconomics would not ignore the involuntary job loss produced by adverse aggregate demand disturbances. Such disturbances would have maintained their centerpiece role in cyclical analysis; the foolish, deeply damaging diversion into making technological regress and other real (not-nominal) shocks the main drivers of business cycles would have been avoided. It is mortifying that modern macro theorists still unapologetically teach that mistaken stuff.

How would Okun have saved the day? For readers of this Blog, the answer is familiar. Using his unfinished research as a guide, he would likely have brought his high standing in the macro academy along with the power of the Brookings Institution to the task of gaining acceptance for the necessity (in order for macro theory to be both stabilization-relevant and rooted in rational behavior) of generalizing rational exchange from the marketplace to information-challenged workplaces. Much later, the GEM Project has made clear that such generalization is a needed for stabilization-relevant macroeconomics. But, and here’s the rub, the Project also makes clear the addition of that second venue of rational exchange requires a great deal of work. At a minimum, macroeconomists would have to learn what actually goes on in workplaces restricted by asymmetric employer-employee information. Intra-firm constraints, mechanisms of exchange, motivations, and outcomes differ greatly from characteristic market activity. Perhaps unsurprisingly, mainstream theorists today have made their strong preference to avoid such an undertaking clear. While accepting that there is no error in modern workplace modeling, they continue to suppress the generalization of exchange by asserting that it is not needed. There is an unhappy consensus that market-centric analysis is sufficient to make sense out of highly specialized economies.

Back in Okun’s heyday, the commitment to market centricity was not so dogmatic. It had not yet become an article of faith rather than analysis and evidence. It is a good bet that, if his workplace analysis had (as he intended) microfounded wage rigidities, Okun’s reputation plus the power of the Brookings Institution would have forced recognition of his intrafirm modeling by mainstream scholars. It is also a good bet that his model would have looked very much like GEM theory today.

I believe that, but for the fateful heart attack, an Okun-constructed workplace-marketplace synthesis would have averted the costly diversions associated with the growing aggressiveness of market-centric analysts in the following half-century. The transition from market-centric analysis to the market-workplace synthesis would not have been much more possible.

In closing this somewhat meandering essay, indulge another perspective on the transition from market centricity to a workplace-marketplace synthesis. Start with the origins of market exchange. In his masterwork, Adam Smith (1776) provides two particularly deep insights about economic activity: the spontaneous organization of self-interested market exchange (the “invisible hand”) and the nature and implications of production specialization (the “pin factory”). John Stuart Mill notably generalized Adam Smith’s division of labor to the “more fundamental” principle of worker cooperation.

Smith’ “invisible hand” sought to explain decentralized market cooperation by large numbers of persons who efficiently price and distribute specialized output. Much later, Okun (1981) fundamentally enriched Smith with the “invisible handshake”. Okun’s handshake helped introduce economists to fair treatment as a critical determinant of employer-employee relations. Adam Smith anticipated that contribution. In The Theory of Moral Sentiments, Smith identifies critical motivators of behavior to be the interrelated factors of status, respect, and justice, with the latter generally equivalent to equitable treatment: “… we find ourselves to be under a stricter obligation to act according to justice than agreeably to friendship, charity or generosity; that the practice of these last-mentioned virtues seems to be left to some measure to our own choice, but that, somehow or other, we feel ourselves to be in a peculiar manner tied, bound, and obliged to the observation of justice.” The handshake became the organizing metaphor for Okun’s (incomplete) analysis of optimizing exchange inside large, specialized establishments, featuring wage rigidity through which nominal-demand disturbances induce same-direction movement in production, employment, income, and profits.

Okun, like Smith, was onto something really important. Nonmarket rational price-mediated exchange is necessary if formal economic theory is to accommodate the mutation of pin factories into the large, specialized corporations ubiquitously organized in the aftermath of the Second Industrial Revolution. Bureaucratic workplaces, producing goods or services, are needed to motivate employee cooperation in circumstances of costly, asymmetric intra-firm information and routinized jobs. It is not surprising that Alfred Chandler’s “new corporate forms”, distilling over time best-practices management of workplace behavior, became globally widespread.

It is surprising, and increasingly problematic, that macro theorists did not adapt. Deep thinking about integrating production and price-mediated exchange in the tradition of Smith, Chandler, and Okun is little rewarded in modern macroeconomics. Mainstream theorists are expected to think incrementally, pushing aside the massively altered production landscape that transformed workplace exchange into a critical economic activity. Coherent macro thinking has, for many generations, remained fixed in the profession’s comfort zone of market transactions. Meanwhile, the intra-firm class of optimizing decision rules, constraints, and exchange mechanisms has been studied elsewhere, finding homes in business schools and the burgeoning best-practices management literature. The cavalier dismissal of workplace modeling as unnecessary is an exercise in hubris that has greatly damaged the stabilization-relevance of consensus macro theory.

The crowding out of the powerful implications of specialized production was inspired by Walras, Jevons, Menger, and other authors of the marginalist revolution, who conceptualized economies as market systems in search of general equilibrium. It is interesting that Continental-tradition economists worked during, but were able to contain their interest in, the onset of the global transformation to large-scale, specialized production. Today, rigorous analysis that occupies the profession’s mainstream remains proudly coterminous with the study of market exchange, as illustrated by the otherwise admirable micro textbook by Mas-Colell, Whinston, and Green (1995, p.127): “Many aspects enter a full description of a firm: Who owns it? Who manages it? How is it managed? How is it organized? What can it do? Of all these questions, we concentrate on the last one. Our justification is not that the other questions are not interesting (indeed, they are), but that we want to arrive as quickly as possible at a minimal conceptual apparatus that allows us to analyze market behavior. Thus, our model of production possibilities is going to be very parsimonious: The firm is viewed merely as a ‘black box’, able to transform inputs into outputs.”

The GEM theory has demonstrated that, in clearly defined circumstances, optimizing employees and employers generate meaningful wage rigidity that especially informs the aggregation and analysis of supply in axiomatic modeling. Most fundamentally, the exhaustion of mutually beneficial trades is now understood to be sufficient to produce full employment only if exchange is arbitrarily restricted to the marketplace. Recognizing the readily apparent workplace venue enriches dynamic general decision-rule equilibrium, making it consistent with broad continuous-equilibrium market failure that microfounds activist management of nominal demand.

Blog Type: Wonkish San Miguel de Allende, Mexico

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