These two standards, of realism and logical consistency of thought, are important, especially in a liberal/social democracy, where the the proper functioning of society depends on citizens actively thinking about social and economic issues and engaging in the democratic process (see Habermas' public sphere theory). If people don't learn economics and think critically about it, then there is a good chance that they will be misled by politicians and sections of the mass media that serve the interests of special interest groups. Contemporary Australia is a brilliant case in point. When our voters went to the polls in 2013, the majority identified the economy as their most pressing concern, more pressing even than climate change (which is depressing in and of itself). And yet, even with this economic focus, we ended up with an economic illiterate for a prime minister.
Let's just take a moment to recall that Abbott's only substantive economic policies in the lead-up to the election were repealing the carbon tax and the mining tax, as well as the establishment of a paid-parental leave scheme. He had basically nothing constructive to say on economic policy. His tactic was to repeat ad nauseum that Labor had left the Australian economy in a 'debt and deficit crisis'. Of course, he never substantiated this claim. Nor did the media ask the crucial question, 'Why is debt bad?' The media and the Australian public just assumed that government debt is bad, and they took Abbott for his word (even though the government debt-to-GDP ratio is less than 30%...). Researchers at the IMF have recently released a paper arguing that there is no correlation between the level of government debt and the rate of economic growth. Although there is a correlation between the rate of change of government debt and the rate of economic growth, it is generally recognised that it is the latter that causes the former. When economic growth slows, incomes fall and unemployment rises. Necessarily, income taxation will fall and transfer payments will rise, thereby automatically increasing government deficits; this is the Keynesian 'automatic stabiliser' at work. But of course, nobody asked Abbott why debt is a bad thing, and here we are today; our economically-minded voters have given Abbott carte blanche to wreck our economy. And boy is he working on that. This is the consequence of an unthinking, uncritical citizenry (as well as a host of other problems with representative democracy). And this needs to change.
However, my criticism doesn't stop with the lay person - it's far more serious than that. It's also an indictment of the mainstream economics profession, people who are exceptionally bright and creative, and capable of constructing immensely complex models of the economy. I don't question their intelligence, I question their own unthinking acceptance of economic theories that have been handed down from the 1970s, and earlier from the 1870s. Realism has never been a strong point for this economic orthodoxy. Indeed, some economists, like nobel prize winners Milton Friedman and Robert Lucas, take pride in the fact that their models do not have realistic foundations. They claim that, provided a theory can both explain and predict economic phenomena, the assumptions underpinning the theory are irrelevant. They even stress that unrealistic, strong assumptions make their theories 'empirical' and capable of being tested. One example of such an assumption is the so-called 'rational expectations hypothesis' (REH), which assumes that individuals are able to make accurate predictions of future economic outcomes, subject to random error, but fundamentally, individuals do not make systematic mistakes in their forecasts. This means that, e.g. if the central bank reduces interest rates, economic agents will automatically adjust their inflationary expectations such that they will account for any increased inflation in future economic transactions, immediately neutralising any effect of monetary policy on their economic activity. This is known as monetary super-neutrality - monetary policy has zero effect on output or employment, and only influences inflation. Of course this assumption completely disqualifies the possibility of uncertainty and of decisions made under conditions of uncertainty, which is most certainly important in the real world. These are also the same economists who predicted that quantitative easing would lead to hyperinflation in the US. Of course they didn't get that one right. And so they fail according to their own standards as well. Oh and they didn't predict that thing that happened in 2007 either... What was it again? Oh yes a global financial crisis and the deepest recession since the Great Depression. No biggie, they said, we can continue with this research paradigm and just recalibrate our models to account for that blip in our predictions. Unfortunately, I'm unconvinced.
However, something that is even more disturbing is the logical inconsistencies/errors that exist in mainstream neoclassical economic models. There are two main 'internal critiques' of neoclassical economics that point out serious logical flaws in the models . In later posts I hope to elaborate, in simple terms (something I need to work on more generally) the Cambridge Capital Controversies and the Sonnenschein-Mantel-Debreu theorem. These two findings show that there is, in general, no tendency towards a full-employment general equilibrium in markets. Put simply, the SMD theorem in particular says that, due to the fact that price changes may cause both substitution effects and income effects in consumers' consumption patterns, there is no reason to expect that a fall in the price of a commodity will lead to a rise in the quantity demanded, i.e. the law of demand does not hold. E.g. traditionally, unemployment is considered to be an oversupply of labour, something which can be resolved by reducing the price of labour, i.e. wages. If wages were to fall, the resulting lower incomes of workers could lead to lower demand for goods and services, and therefore lower derived demand for labour, thereby causing a downward spiral in both wages and employment. While these are extremely important, I don't have the time nor the sufficient understanding to elaborate on these topics, but I promise that I will get back to them in later posts. They're extremely important and have wide-ranging consequences for economic theorising. Unfortunately, they have been largely ignored as inconveniences (by those economists and economics students who know about them; very few do) and nothing has changed in the economics profession in response.
Another reason why we need to have a clear understanding of economics - and this continues from my previous post - is that it serves also as a guide to left-wing politics. To understand what exactly is wrong with capitalism, we need to have an alternative theory of capitalism that is realistic and that is also capable of explaining and predicting economic phenomena (while recognising the inherent limits to forecasting imposed by the radical uncertainty of economic life). Classical Marxism has always stressed the existence of the tendency for the rate of profit to fall, which leads inevitably to a final collapse of capitalism and a class struggle for a socialist future. I don't agree with this analysis, and this will be made clear in the next post, where I outline how the post-Keynesian and neo-Marxian (Monthly Review) schools of economics explain the dynamics of capitalist accumulation and crisis.
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