Essentials of Heterodox
and Post-Keynesian
Economics
Marc Lavoie
University of Ottawa
The global financial crisis has had an
impact on…
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Students of economics
Some reporters
Trade unions
Central bankers
The IMF
But little impact on …
• The European Commission
• Most academic economists and their
economics departments
Where has economics been going?
• “Indeed, the typical graduate
macroeconomics and monetary economics
training received at Anglo-American
universities during the past 30 years or so,
may have set back by decades serious
investigations of aggregate economic
behaviour and economic policy-relevant
understanding.”
– Willem Buiter, 2009 (former member of the
Monetary Policy Committee of the Bank of
England)
Where could it go?
• Stop the growing hegemony of neoclassical
economics in economics departments.
• Stop repressing dissent.
• Change the curriculum.
• Less emphasis on techniques, more emphasis on
history and institutions
• Introduce more competition in the field of economic
ideas: bring in heterodox schools of thought
Outline
• 1. Heterodox economics versus
orthodox economics
• 2. Post-Keynesian economics
• 3. Who’s afraid of neoclassical
economics?
PART I
Heterodox economics versus
orthodox economics
Heterodox vs Orthodox economics
• HETERODOX ECONOMICS
• ORTHODOX ECONOMICS
• NON-ORTHODOX ECONOMICS
• DOMINANT PARADIGM
• POST-CLASSICAL ECONOMICS
• NEOCLASSICAL
ECONOMICS
• RADICAL POLITICAL
ECONOMY
• THE MAINSTREAM
• REAL-WORLD ECONOMICS
• MARGINALISM
• NEW PARADIGM
ECONOMICS
• OLD PARADIGM
ECONOMICS
Heterodox schools in economics
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Post-Keynesians
Sraffians (Neo-Ricardians)
Old Institutionalists
Marxists, Radicals
Development Structuralists (Latin-American school, Furtado,
Prebisch)
French Regulation School, Social Structure of Accumulation (SSA)
Neo-Schumpeterians
Circuitists
Social economics and Humanistic economics
Anti-Utilitarism (MAUSS)
Economists of « conventions »
Feminist economics
Green economics (Ecological Economics)
Old behavioural economics
And no doubt many others (Ghandi economics, Henry George,
Gesell, Polanyi, system dynamics, agent-based, Neo-Austrians(?)...
Macroeconomics
Heterodox
authors
KEYNES
Marxists
Cambridge
Keynesians
Radicals
French
Regulation
School
PostKeynesians
Neoclassical
school
Old
Keynesians
Monetarists
New
Keynesians
New
Classicals
Dissenters in economics
Heterodoxy
Dissenters
Orthodoxy
Mainstream
Examples of orthodox dissenters
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Milton Friedman
Amartya Sen
George Akerlof
Paul Krugman
Joseph Stiglitz
Oliver Williamson
Ronald Coase
William Vickrey ?
Herbert Simon ?
Keynes ?
What do all these heterodox
schools have in common?
• Differences between schools of thought and their
relative ranking have a lot to do with the sociology of
the profession.
• Some of the discrepancies are due to specialization
in certain fields (cf. T. Lawson).
• Still, in my opinion there are broad features that
characterize heterodox and orthodox schools.
• These are called the presuppositions of research
programmes by philosophers of science: they are
things that cannot be questioned
Presuppositions of the heterodox
programme vs those of the mainstream
Paradigm
Presupposition
Heterodox schools
Orthodox schools
Epistemology/Ontology
Realism
Instrumentalism
Method
Holism, organicism
Individualism, atomicism
Rationality
Reasonable rationality
Hyper rationality
Optimizing agent
Economic core
Production, growth,
income effects
Exchange, scarcity,
substitution effect
Political core
Regulated, tamed,
markets
Unfettered market
optimism
Instrumentalism vs realism
• Friedman’s as if doctrine
• « Good models have to necessarily be artificial, abstract,
patently unreal » (Lucas, 1981)
• « Of course, that model does not not represent reality and that is
not its purpose » (Bliss, 1975)
• « It is better to be precisely wrong rather than roughly right »
• Ex.: The use of the Gaussian copula function to price CDO
(collaterized debt obligations) was based on an index of CDS
(credit default swaps) market prices instead of looking at true
default rates.
Rationality
• “ Orthodox macroeconomists came to conflate being
rational with thinking like an orthodox economist.
What this implied was that agents knew the one and
only true model of the economy (which conveniently
was stipulated as identical with neoclassical
microeconomics)”. (Philip Mirowski, 2011)
• ‘A systematic deviation from an “insane” standard
should not automatically be called a judgmental error’
(Gerd Gigerenzer, 2008)
Scarcity versus production
• Economics is the study of scarcity (Robbins, 1932)
• « Neoclassical economics is the study of an upwardsloping supply curve with a downward-sloping
demand curve »
• Vs
• « Economics is the study of the process by which
society brings its available resources into production,
and the distribution of that production among its
members. » (John Weeks, 2012)
Distrust in unfettered markets
• « On the one side are those who believe that
the existing economic system is, in the long
run, a self-adjusting system, though with
creaks and groans and jerks and interrupted
by time lags, outside interference and
mistakes … . On the other side of the gulf are
those that reject the idea that the existing
economic system is, in any significant sense,
self-adjusting »
– Keynes, CW, xiii, p. 487 (1934)
Holism: Some crisis-related macro paradoxes
Paradox of thrift (Keynes 1936)
Higher saving rates lead to reduced
output,
Paradox of costs (Kalecki 1969,
Rowthorn 1981)
Higher real wages lead to higher profit
rates
Paradox of public deficits (Kalecki
1971)
Government deficits raise private
profits
Paradox of tranquility (Minsky 1975)
Stability is destabilizing
Paradox of debt (I. Fisher 1933,
Steindl 1952)
Efforts to de-leverage might lead to
higher leverage ratios
Paradox of liquidity (Dow 1987,
Nesvetailova 2007)
Efforts to become more liquid
transform liquid assets into illiquid
ones
Paradox of risk (Wojnilower 1980)
The possibility of individual risk cover
leads to more risk overall
Paradox of profit-led demand (Blecker
1989)
Lower wages lead to slower growth
despite all countries being profit-led
Edward Fullbrook(2013): new paradigm
• Start from real data
not apriorism
• Real-world
rationality
• Holism
• No market clearing
• Disequilibria
• Pluralism
• Math-formalism
upside-down
• Radical uncertainty
• Economy is a
subset of biosphere
• Facts and values
are inseparable
Summing up this part….
• Heterodox economics is distinct from orthodox
economics.
• The various heterodox schools of thought have a lot
in common, especially on the methodology side.
• Different schools of thought often focus on different
fields, so that their similarities are not always
obvious.
• But just as there are battles between New Classical
and New Keynesian economics, there are
disagreements between various heterodox schools.
Part II
Post-Keynesian economics
Phases in the creation of PKE
• 1930s-1950s: The Beginnings:
– Keynes 1936 Robinson 1956
• 1960s-early 1970s: The Capital controversies, the
response to monetarism
– Sraffa, Pasinetti, Garegnani – Kaldor, Davidson
• Mid 1970s-1980s: The Romantic Age
– Kregel-Eichner, syntheses, institutionalization
• 1990s: The Age of Uncertainty
– Methodology
• 2000s: The Age of Policy
PKE adopt the five general
heterodox presuppositions
Specific post-Keynesian
presuppostions
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The relevance of the principle of effective demand
(demand-led economies)
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Both in the short and the long run
The supply adjusts to demand (inversed Say’s law), but
see Kalecki and Robinson on capacity constraints
The autonomy of investment from inter-temporal decisions
of households (investment causes saving)
The importance and irreversibility of time
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Historical time
Dynamics, the traverse
The long run is a consequence of a series of short runs,
there is no independent long run trend
Path dependence, multiple equilibria
Tracking financial stocks through time
Auxiliary post-Keynesian
features
• Fundamental or radical uncertainty
• A monetary production economy
• Alternative microeconomics (little reliance on
substitution effects)
• Diversity of methods and theories
• Institutions make a difference (Monetary and fiscal
policies do have an impact on real quantities)
The shape of cost curves
mc
TUC
AVC
AVC = DUC = mc
qfc
qth
q
The various PK strands: 5-way typology
• Fundamentalist or Financial Keynesians:
– Money, finance, liquidity preference, uncertainty, methodology
– Davidson, Minsky, Kregel, Chick, Dow, Fontana
• Kaleckians:
– Pricing, growth, cycles, employment, income distribution
– Sawyer, Bhaduri, Dutt, Blecker, Fazzari
• Sraffians:
– Relative prices, technical choice, input-output models, capital theory
– Garegnani, Kurz, Pasinetti, Steedman
• Institutionalists:
– Institutions (firms, banks), pricing, behavioural economics
– Fred Lee, Peter Earl, Galbraith 2x, MMT (Wray)
• Kaldorians:
– Growth, money, international trade, productivity growth
– Godley, Thirlwall, McCombie, Palley
– Some authors go across the strands: Arestis, Nell….
Part III
Who’s afraid of neoclassical
economics or why do neoclassical
theories always seem to be
supported by empirical evidence?
Theoretical constructs rejected by PK
economists
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NAIRU or the natural rate of unemployment
The loanable funds theory and the natural rate of interest
Crowding-out effects (except for possible psychological effects)
Say’s law
Inflation is a monetary phenomenon
Aggregate employment determined in the labour market
Higher saving leads to higher investment
The government debt constraint is similar to that of households
The efficient market hypothesis, in its various incarnations
That unemployment is only due to sticky prices
Bank reserves cause bank loans and deposits
Unit cost curves have a U-shape
Another theoretical construct rejected
by PK economists
• The well-behaved neoclassical production function
• For instance the Cobb-Douglas production function
• This was at the heart of the Cambridge capital
controversies of the 1960s and 1970s
• It was shown that standard results of neoclassical
theory obtained with such aggregate production
functions did not hold in a model with two or more
sectors (say, two sectors producing investment and
consumption goods respectively)
Cambridge UK vs Cambridge Massachusetts
w/p
LD
LS
w/p
L/K
(a)
w/p
(b)
LD
L/K
(c)
LD
L/K
The response of neoclassical economists
• « Placing reliance upon neoclassical
economic theory is a matter of faith’
(Ferguson, 1969)
• Regressions based on the Cobb-Douglas
seem to work, when properly specified. It
works, therefore it exists (Empirism)
The counter of post-Keynesians
• The coefficents of the regressions are supposed to
yield the output elasticies of labour and capital, which
depend on technology.
• In reality, because macro data must be deflated, what
is truly being computed by these regressions are the
wage and profit shares in national income.
• This has been demonstrated by John McCombie
(2001) (see the recent book of Jesus Felipe and John
McCombie (Not Even Wrong, 2013)
This puts in jeopardy all of
neoclassical economics because…
• « The neoclassical production function is the cornerstone of
neoclassical theory and is used in virtually all applied analyses »
(Prescott 1998)
• NAIRU measures, labour demand functions and wage
elasticities; investment theory; measures of multifactor
productivity or total factor productivity growth; estimates of
endogenous growth; theories of economic development;
theories of income distribution; estimates of cost functions;
measures of potential output; theories of real business cycles;
estimates of the impact of changes in the minimum wage, social
programs, or in tax rates.
Further issue: publication bias
• Data fishing, data mining, data massaging
• Now famous example: the Reinhart and Rogoff
(2010) AER study on the negative impact of public
debt ratios above 90%
• Herndon, Ash and Pollin (2014) found there were
coding mistakes, omitted entries, unconventional
weighting.
• « Reviewers and editors [of academic journals] may
be predisposed to accept papers consistent with the
conventional view » (Tom Stanley, 2005)
Meta-regression analysis: regression
on regression results
Meta-regression analysis …
• Shows that more than half of the fields of research
suffer from severe publication bias.
• Falsifies the claim that larger government deficits
lead to reduced household spending (Ricardo
equivalence theorem)
• Falsifies the claim that there exists a natural rate of
unemployment towards which the economy
converges. Also falsifies the claim that expected
inflation leads to a one-on-one increase in the rate of
inflation. Thus, the NAIRU, which is at the heart of
current monetary policy, is falsified.
The role of post-Keynesian economists
(and young economists in general)
• The crisis has clearly demonstrated, if such a
demonstration was needed, that there is something
wrong with mainstream economics (Financial Times:
“The credit crunch has destroyed faith in the free
market ideology”).
• In view of these failures, it is our social duty to keep
developing an alternative view of the economic
system.
• It is our duty to sustain and clarify the heterodox
traditions that question the efficiency of unfettered
markets.