Even though very few people have more than a vague idea about them, macroeconomic theories deeply affect the lives of everybody on the planet. Writings of Piketty, Stiglitz and many others, as well as personal experience of the one per cent to the 99 per cent divide, have created increasing awareness of the deep and increasing inequalities which characterise modern capitalist economies. However, the link between inequality and macroeconomic theory has not been pointed out clearly. The fact that since the 1970s top corporate salaries have increased by 1000 per cent while the average worker only earns 11 per cent more is closely linked to the revolution in economic theory that occurred over the 1970s and 1980s. We will try to sketch some parts of the complex and coordinated efforts which led to the emergence of theories which provide the invisible foundations and the enabling environment for this inequality.
The oil crisis of the early 1970s destroyed the consensus on Keynesian macroeconomics, and created the opportunities for ideologies disguised as economic theories to emerge. Chicago school economist Robert Lucas attacked the dominant Keynesian theories which argued that governments must play an important role in eliminating unemployment. Guided by free market ideology, Lucas created macroeconomic theories which suggested that government interventions are always harmful. Some elements of the Lucasian methodology provided genuinely superior alternatives to defects in existing Keynesian models. However, other elements were bizarre. Even though unemployment is a painful reality to vast numbers of people, defender-of-free-markets Lucas argued that this was a free choice. According to Lucas, the Great Depression was really the Great Vacation, where vast numbers of people suddenly decided to stop working in order to enjoy leisure. This, and many other strange assumptions of the Lucasian alternative led famous economists like Robert Solow to say that to engage in a serious discussion with the Chicago school would be analogous to discussing technicalities of the Battle of Austerlitz with a madman who claimed to be Napoleon Bonaparte. For example, Solow wrote that “Bob Lucas and Tom Sargent like nothing better than to get drawn into technical discussions, because then attention is attracted away from the basic weakness of the whole story. Since I find that fundamental framework ludicrous, I respond by treating it as ludicrous — that is, by laughing at it — so as not to fall into the trap of taking it seriously and passing on to matters of technique.”
Recent remarks of eminent economist Paul Romer, a student of Lucas, regarding the dramatic failures of contemporary macroeconomic models have generated shock waves which continue to reverberate among economists. Romer wistfully suggests that if Solow had engaged with the Chicago school, instead of subjecting them to sarcasm, contempt and ridicule, they might have been amenable to reason. Lucas, Sargent, and their followers responded to hostile attacks by closing ranks, ignoring all who disagreed with them, and giving up on basic scientific principles such as using evidence to evaluate models. Even though Romer criticises Solow for ridiculing Lucas, healso finds it difficult to take the macroeconomic theories of Lucas and Sargent seriously. Since these models remove essential real factors like money and unemployment from the picture, Romer writes that modern macroeconomic models are reduced to using mythical objects like phlogiston and gremlins to explain real world economic events. What is frightening about this is that these models, which have been blamed for their inability to see the looming global financial crisis, continue to be used by Central Banks for monetary policy decisions throughout the world.
The mystery of how ludicrous theories which invoke mythical objects and causes, came to dominate the scene is not easily resolved. One important element in the success of the Chicago School was their lack of scruples. Stigler, one of leaders of free market thought at the Chicago School, explained that “… new economic theories are introduced by the technique of the huckster” (a door-to-door peddler who sells fake items as if they were genuine). He defended this intellectual fraud on the grounds that a warrior against ignorance must subordinate the lesser truths to his quest to spread the grand truth. The grand truth, or the ideological conviction, that governments must not intervene in free markets guided the development of modern macroeconomics at the hands of Lucas, Sargent and Prescott. Ideological convictions of the Chicago School are impervious to facts — they ignore the long lines of the unemployed at the soup kitchens, and the strong empirical evidence of correlations between tight monetary policies and high unemployment.
A second crucial element was the creation of an artificial Nobel Prize in economics. Private financiers and bankers who stood to gain massively from the spread of free market theories of the Chicago School decided to purchase respectability for them. The bankers donated funds to create a prize in Economics in 1968 which was deceptively and fraudulently named after Alfred Nobel: “The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel”. The conditions and methods for granting the prize were made to resemble the genuine Nobel prizes sufficiently to deceive the masses into thinking that this was one of the genuine Nobel prizes. After creating an imitation Nobel prize, the Swedish bank proceed to award about half of all of them to Chicago School economists, giving half to assorted others to maintain a semblance of objectivity. This has resulted in a tremendous rise in the prestige of Chicago school doctrines, catapulting them from an eccentric minority to the entrenched and dominant orthodoxy in economics.
This intellectual revolution, the displacement of Keynesian economics by the Chicago School, has been used to justify economic policies to enrich the wealthy, and caused massive damage to the general public. As policies based on free market theories have been enacted globally, wealth has concentrated in the hands of the top one per cent, while the fortunes of the bottom 90 per cent have been declining. Seeing that the economic system in place has led to reduction in job opportunities and incomes, and rising costs of necessities like education and health facilities, the bottom 90 per cent have expressed their discontent and desire for radical change in the form of Brexit and Trump. However, fundamental change requires addressing the root cause of the problem, replacing defective ideology based macroeconomic theories with more empirical and evidence based theories.
Published in The Express Tribune, January 9th, 2017.