the end of business as usual

Review Essay

The End of Business as Usual

George Irvin

Thomas Palley, From Financial Crisis to Stagnation: The Destruction ofShared Prosperity and the Role of Economics. Cambridge: CambridgeUniversity Press, 2012. 236 pp. £42.00 hardback.

James K. Galbraith, Inequality and Instability: A Study of the WorldEconomy Just Before the Great Crisis. Oxford: Oxford University Press,2012. 336 pp. £19.99 hardback.

John Weeks, The Irreconcilable Inconsistencies of Neoclassical Macro-economics: A False Paradigm. London: Routledge, 2012. 304 pp. £85hardback.

In February 2013, Mayor Michael Bloomberg of New York City was in-volved in a furious row over the growth of homelessness in the city; while heclaimed that homelessness had not risen significantly, the statistics provedotherwise. And although the number of homeless people in London and Parismay be lower than in New York, the statistics also show that there are farmore down-and-outs than five years ago. What has happened to so-calledadvanced capitalist countries that they cannot provide for their citizens? Willthe rich countries regain their previous levels of prosperity and growth, andwhat, if any, are the implications for the developing world? Was the longboom of the new century ever sustainable, based as it (apparently) was onenvironmental degradation and growing social and economic inequality?As Britain’s very own Mrs Windsor famously asked in 2011, why did theeconomics profession not foresee catastrophe ahead?

It has become conventional to blame the Great Recession on excessivegreed — whether the greed of bankers whose ever-rising bonuses were fi-nanced by engaging in complex and dangerous games with the public’smoney, or the greed of growingly indebted consumers embarked on a seem-ingly endless shopping spree, or even the profligacy of governments. Thatsuch explanations of the crisis are generally unhelpful should be obvious. It

Development and Change 45(2): 376–383. DOI: 10.1111/dech.12079C© 2014 International Institute of Social Studies.Published by John Wiley & Sons Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK and350 Main St., Malden, MA 02148, USA

Review Essay: The End of Business as Usual 377

is not just that ‘excess greed’ is too simplistic; it is that placing the blamein this manner leads us to seek simplistic solutions. Hence we are told thatthe road to recovery lies mainly in better regulation of the financial sector or‘prudential governance’, or else that we must ‘tighten our belts’ and atonefor our past sins by enduring government-imposed austerity, or that we mustdo both at the same time.

The ‘regulation plus austerity’ approach has been adopted in most ofEurope — although with far more emphasis given to austerity — and thegeneral public seems to have bought it. That austerity has failed is increas-ingly obvious; six years after the crash most of the EU is still in recession,and the average level of unemployment, already bad before the recession, isat an all-time high. To find a way out, we must look for the deeper causes ofthe crash. The three books reviewed below add significantly to our abilityto do so, each in a different way; taken together, the books’ authors providea broad and penetrating examination of the genesis of the crisis. All threeview the problem from a Keynesian perspective.

Thomas Palley’s view is that the crisis is the product of a deeply flawedeconomic policy paradigm derived from a set of neoliberal economic ideas.Escaping the crisis means replacing that policy paradigm and the ideas fromwhich it derives. As Palley said in a recent interview1 about his book:

there are two alternative competing mainstream explanations of the crisis. The first is thehard-core neoliberal perspective . . . [i]n the U.S. it is identified with the Republican Partyand with the economics departments of Stanford University, the University of Chicago,and the University of Minnesota. The second is the soft-core neoliberal perspective, whichcan be labelled the ‘market failure hypothesis’. In the U.S. it is identified with the Obamaadministration and half of the Democratic Party. In Europe it is identified with the ThirdWay. Among economics departments it is identified with those such as Harvard, Yale andPrinceton.

Clearly, the author has little time for either mainstream view; he is equallydismissive of both sides of what Paul Krugman has called ‘freshwater’ and‘saltwater’ economics. Instead, Palley’s key distinction is between ‘textbookand structural Keynesianism’. ‘Textbook Keynesians’ argue that if aggre-gate demand collapses, all that is needed is for government to step in andtemporarily fill the demand gap until private sector demand revives; that is,by means of a temporary fiscal stimulus and a temporary easing of mone-tary policy. By contrast, ‘structural Keynesians’ argue that the economy’sunderlying income and demand generating process is structurally flawed —for instance, that income distribution is badly skewed creating a permanentshortfall of demand — and that private sector demand will not be revived byreflation alone. The solution is to change the economy’s income and demandgenerating process.

1. Interview with Thomas Palley conducted by Philip Pilkington and posted on Naked Capi-talism on 18 April 2012. See http://www.thomaspalley.com/?m=201204

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Here, the crucial links are, first, between demand generation, real wagesand productivity growth; and, secondly, between demand generation andforeign trade (globalization). The critical fault line in post-war growth —the uncoupling of labour productivity growth and wages — occurred in themid to late 1970s. In Palley’s view, this is the point when in the US andmuch of Europe the key demand-driver shifts to asset growth, the ideologicalreflection of which is the Reagan–Thatcher neoliberal ascendancy. Global-ization, as later exemplified by (say) NAFTA, helps complete the new modelthrough the growing outsourcing of production and the concomitant declineof the trade union movement.

The alternative model advocated by Palley is one of ‘managed globaliza-tion’; that is, of restored labour rights, strong social safety nets, coordinatedexchange rates, and managed capital flows. Finally, there is the need torecalibrate the global economy, to shift away from export-led growth strate-gies to domestic demand-led strategies — a point which will not be lost onthose concerned by the growth of right-wing German influence within theEurozone. Moreover, as Palley says of Europe:

Europe is widely viewed as the standard-bearer of social democracy and Keynesianism . . .The great irony is that social-democratic Europe has been more captured by neoliberalmacroeconomic policy than the United States. The European Central Bank (ECB) and Euro-pean finance ministries are dominated by economic policy makers trained in Chicago Schooleconomics, whereas the pragmatism of U.S. politicians has supported budget deficits andKeynesianism. (p. 160)

The Keynesian structuralist view is shared by Professor James K.Galbraith (son of the late John Kenneth Galbraith), although his Inequalityand Instability focuses more specifically on the distribution of income andearnings. His book reflects years of work in a field which, as the authorrightly remarks, was largely dormant until the 1990s; specialists will knowhis early work on the subject, for example, Created Unequal: The Crisis inAmerican Pay (1998). The latest book, it should be said, consists mainly ofclosely argued economics with at times quite daunting technical detail, butits broad argument is familiar enough.

Galbraith dismisses the conventional wisdom that inequality is the pricethat societies pay for flexible markets; he argues instead that it is the growthof the financial sector that underlies inequality and has destabilized the USand the world. In his words:

the massive rise in inequality in the global economy from 1980 . . . is a fundamental reflectionof the concentration of income and wealth among the richest of the rich, and the correspondingfinancial fragility affecting everybody else. Crises, especially debt crises, are thus not newor sudden; in global perspective we see that they have cascaded across the world for ageneration, hitting Latin America and Africa in the early 1980s, the Soviet Union and itssatellites in the late 1980s and through the 1990s, and much of Asia in the late 1990s. (p. 292)

Galbraith begins with a review of the literature and a plea for improvedmeasures of inequality, noting that data inconsistencies (such as the useof both household income and expenditure data) pose a serious problem for


international inequality comparisons, and offering us novel new measures. Ina chapter on pay inequalities and development, he resuscitates the Kuznetshypothesis, namely, that while economic ‘development’ in the sense ofindustrial growth at the expense of traditional agriculture may initially resultin growing income inequality, ultimately, as employment shifts largely fromlow productivity to a high-productivity activity, income differentials mustfall. As readers will be aware, the Kuznets hypothesis has been a subjectof much debate in the field of development economics. Galbraith’s pointis essentially about the importance of the changing sectoral composition ofGDP. The author reminds us of the crucial association between long-termdistributional changes and sectoral change.

Later in the book, Galbraith argues that the ‘skills bias’ hypothesis — theview that inequality is largely the result of a growing mismatch betweenthe high level of skills required by a technologically advanced economy andthe mediocre average attainment of the labour force — is largely an emptybox. What ‘skills bias’ totally fails to address is the rapidly growing incomegap between ordinary people and the super-rich — between the 99 per centand the 1 per cent, if you will. The skills bias argument is important becauseit has been the standard neoliberal explanation of growing income inequalitysince the late 1980s.

For Galbraith, prosperity and equality go hand in hand. In two chapterson inequality and unemployment in the European context, he challengesthe view that EU unemployment has anything to do with ‘overprotectedlabour markets’. Although taken individually EU countries are on the wholemore egalitarian than the US, when EU data are pooled, the degree of wageinequality is greater in the EU than in the US. European employment tendsto rise, not fall, with rising wages (as shown by the experience of the Nordiccountries), implying that ‘wage market flexibility’ is most certainly not theway to restore EU growth. Galbraith’s admirers will be familiar with thisargument from his earlier work, and one can only guess at why his empiricaldebunking of the wage market flexibility hypothesis has been largely ignoredby the economics community.

The final chapters deal with other countries; suffice it here to say that thechapters on inequality and instability in the erstwhile Soviet Union and inCuba are particularly interesting. Galbraith ends by arguing that the crisisof 2008 is no more than the culminating moment in the puncturing of aworldwide bubble, the largest in a series of financial crises that have visitedLatin America, Africa and Asia since 1980. For the author, there will beno happy ending, no return to ‘business as usual’. Because the asset bubblewhich sustained the richest capitalist country was encouraged to grow for somany years, its bursting has left (and will continue to leave) the US and theEU with no alternative motor of growth. Barring fundamental change, thefuture outlook is one of prolonged stagnation.

The final book reviewed here is by John Weeks. Aimed at all studentsof economics, it is a formidable logical assault on what Weeks calls the

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‘irreconcilable inconsistencies’ of the orthodox discipline as taught in (most)universities. Indeed, the author’s very first sentence pulls no punches: ‘Thisbook is intended to be a complement to a standard undergraduate textbookon undergraduate macroeconomics; to serve as an analytical antidote to theneoclassical infection’ (p. 1).

On a personal note, I first encountered a much earlier version of Week’sbook in 1989 when in Japan; I can recall being interrogated by my host, him-self an orthodox economist, about whether to publish the book in Japanese.I had just finished Weeks’s excellent critique of Walrasian general equilib-rium and replied with an enthusiastic ‘yes’. Reading his new book manyyears later, although many of the core arguments are familiar, what isstriking is just how ambitious a task the author has set himself in roughly250 pages.

One warning, though: this book is not for the faint-hearted (although abasic version, not reviewed here, has since appeared). It is written in theterse style of the professional economist and requires a somewhat more rig-orous and historical understanding of macroeconomic debate than would beavailable to the average undergraduate, or indeed, to the average young lec-turer. Even using it as a complement to a standard macroeconomics textbookwill require considerable intellectual effort and ability, particularly wherestudents are more concerned to regurgitate the conventional orthodoxies forexam purposes than to develop a deeply critical faculty. In short, the readerwill need to persevere to do justice to this book, just as the author himselfhas persevered for years in developing a solid critique of the subject. In thissame vein, the reader is urged to follow both the text and its accompanyingfootnotes.

A brief aside is necessary for those unfamiliar with Walrasian general equi-librium and its critique. The French mathematical economist Leon Walras(1834–1910) is considered, together with Stanley Jevons and Carl Menger,to be a founder of neoclassical economics, the term ‘neoclassical’ schoolderiving from its break with the eighteenth and nineteenth century classicalpolitical economy of writers such as Smith, Ricardo, Marx and Mill. In con-trast to his predecessors, Walras viewed the economy as a self-regulatingsystem in which, at the right set of prices, all markets ‘cleared’ simultane-ously — that is, supply equalled demand everywhere — enabling the marketto be represented as the ‘solution’ to a set of simultaneous equations.

This view still prevails; indeed, it remains a cornerstone of the neoclassi-cal edifice. The logic of the Walrasian story — picked apart by Weeks as byothers before him — requires the existence of a mythical ‘auctioneer’ whocalls out just the right price in each market to result in equilibrium. Any tradewhich takes place at a non-equilibrium price is called ‘false trading’ and somust be banned if the auctioneer is to do his or her job. The rub is this: onlyan auctioneer with perfect foresight could call out the right set of equilibriumprices. In consequence, the logical consistency of neoclassical economicsdepends, inter alia, on meeting this impossibly simplifying assumption.


Rather than attempting to cover the book in full, let us consider a shortsection, Chapters 5–7. These chapters cover, in turn, the ‘classical falsedichotomy model’, ‘logically consistent money neutral models’ and the‘complete model with a wealth effect’. Broadly speaking, the argument runsas follows.

The basic neoclassical closed economy model claims to reach full employ-ment automatically, but at the cost of accepting a ‘false dichotomy’ betweenthe real variables (the real wage, the employment level, etc.) and money.Such a ‘dichotomy’ exists when it is assumed that a doubling of the pricelevel would have no effect upon workers’ real wage and hence upon thefull employment level of output. To be logically consistent, ‘neutral’ moneyand the automatic attainment of full employment must be consistent. Never-theless, as Keynes saw, the fact that a full employment savings–investmentbalance might only occur at a negative interest rate — sometimes referred toas the ‘liquidity trap’ — precludes the universality of automatic adjustment.To save the logic of the model, a Pigovian ‘real balance’ effect is needed(later supplied by the Israeli economist, Don Patinkin). But Patinkin’s as-sumption raises the further problem that a ‘real balance effect’ can only existif ‘net outside wealth’ is assumed — that is, the existence of domestic assets(say bonds) not offset by liabilities. Such an assumption, although it rescuesautomatic full employment, does so at the cost of abandoning money neu-trality: QED, since money cannot be neutral, the basic neoclassical model islogically incoherent.

In subsequent chapters, Weeks logically dissects, in turn, the ration-al expectations hypothesis (REH) and the concomitant notion of a non-accelerating inflationary rate (NAIRU) or ‘natural rate’ of unemployment;orthodox ‘open economy’ analysis and the alleged superiority of flexibleexchange rates (the Mundell-Fleming model); neoclassical inflation the-ory and the tautological quantity theory of money (QTM); Friedman’s‘golden rule’ of monetary policy; and much else besides. It is a heroictask. For all that, Weeks remains a strong Keynesian, much in the ‘dis-equilibrium’ tradition of economists like Clower and Leijonhofvud whoexplicitly rejected the dominant Keynesian synthesis paradigm of the1950s–1960s.

In the 1960s it became fashionable to distinguish between ‘positive’ and‘normative’ economics, the former involving the discovery and testing ofbasic laws in the social sciences and having the same status as, say, thebuilding blocks of physics. Normative economics, by contrast, consists ofmere value judgements. Weeks strongly challenges the neoclassical claimto have produced a discipline which is quite ‘value free’. Such a claimis patently false, as any student of history and methodology in the socialsciences will attest.

Crucially, he adds: ‘recognising that neoclassical theory is heavily ladenwith ideology does not invalidate its insights, but it does require a seriousattempt to distinguish that part of the theory that is scientific and that which is

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essentially propaganda’ (p. 240). Although such a qualification does affordthe author and the reader wriggle room for cherry-picking the discipline,Weeks ends with a reminder to his readers that ‘accepting these [neoclassical]models and proceeding as if they were ideologically sound is an act ofideologically motivated faith that leads to folly’ (p. 241). No ambiguitythere!

Although much of Weeks’s core critique of neoclassical economics hasbeen made before, the arguments tend to have been made in a piece-meal manner. The key virtue of this book lies in the systematic man-ner in which it develops these arguments together to form a powerfullogical indictment of the mainstream orthodoxy. A very thorough bib-liography is included for those wishing to pursue the history of thisdiscussion.

What can be said about the lessons of the three books taken together?First, it should be obvious from reading Weeks that if the economics pro-fession failed Mrs Windsor it was because mainstream economists were sopreoccupied with the trivial pursuits of their profession that the big pic-ture was missed entirely. Even Gordon Brown, one of the high priests ofsocial-democratic orthodoxy, got it terribly wrong when he proclaimed theend of the UK business cycle to be at hand. Secondly, given the argumentsadvanced by Palley and by Galbraith, it is highly unlikely that the advancedcountries of the West will ever return to the easy growth of the world prior to2008. Not only is growth unsustainable from an ecological point of view (apoint on which to their discredit none of the authors dwells at length), but thedrivers of the recent ‘long boom’, IT in the 1990s and, most recently, risingasset prices, have largely disappeared. Finally, if the spectacular growth ofinequality is part and parcel of neoliberal financialization, it follows that anyreturn to more sustainable growth will mean reclaiming social control ofthe financial sector. But short of a massive new financial collapse followedby revolution, just how this will happen remains unclear. What is to bedone?

Perhaps the continued rapid growth of the BRIC countries will help res-cue the traditional developed countries — on this subject none of the threebooks has much to say. There is little discussion, for example, of whetherChina’s massive public investment-led growth strategy is sustainable, orwhether India’s IT boom has done much to lift ordinary rural dwellers out ofpoverty. The implicit assumption appears to be that, in the absence of radi-cal change, the neoliberal orthodoxy dominant in the ‘developed’ countrieswill ultimately drag down the ‘developing’ world through a combinationof declining trade growth, growing financial crisis and (ultimately) ecolog-ical catastrophe. Here, one enters the realm of speculation. Nevertheless,what is clear is that each of the books reviewed mounts a serious intel-lectual challenge to the conventional economic wisdom, a challenge whichsocial scientists in general and economists in particular ignore at their ownperil.


REFERENCE

Galbraith, James K. (1998) Created Unequal: The Crisis in American Pay. Chicago, IL: Univer-sity of Chicago Press.

George Irvin is Professorial Research Associate at the University of London,School of Oriental and African Studies. He works mainly on developmentand the EU economies; he lives in Brighton, Sussex, and is author of SuperRich: The Growth of Inequality in Britain and the United States (Polity,2008). He can be contacted at e-mail: [email protected]

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