Paul Davidson savages the mainstream

Below Peter Radford's critique of economic models (the topic of yesterday's four o'clock) one finds a comment from Paul Davidson:

Keynes drew an accurate portrait of an entrepreneurial economy that uses money contracts (not real contracts) to organize all market production and exchange transactions.(Does this not sound like the world of experience?)

Unfortunately Samuelson, Hicks and others mistook Keynes’s analysis for nothing more than another neoclassical model with sticky wages and prices even though one of the chapters in Keynes’s GENERAL THEORY is entitled “Changes in Money wages”. This chapter shows that even with perfectly flexible wages, there is no automatic mechanism to restore full employment if the economy should suddenly experience a recession.

I finally convinced Sir John Hicks that his ISLM system was not Keynes — and published an article by Hicks entitled “ISLM: An Explanation” in the Journal of Post Keynesian Economics . In this article Hicks admitted that ISLM was not Keynes!! and Hicks ultimately signed on to my argument that the Keynes analysis was based on the assumption that uncertainty meant a nonergodic system.

I have written a textbook entitled POST KEYNESIAN MACROECONOMIC THEORY which places Keynes’s money contract, nonergodic portrait of the real world of experience against the mainstream fictional world of Samuelson, Friedman, Rational expectations, New Keynesianism, etc...

Echoing Radford's terminology, Davidson contrasts the portrait Keynes created to the caricatures created by others. Exactly so.

"...even with perfectly flexible wages, there is no automatic mechanism to restore full employment..."

That's the line that got me. Paul Davidson knows his Keynes.

I've heard before, of Hicks rejecting his own ISLM thing, which I understand is kind of a big deal (even though I don't understand the ISLM).

Now it turns out that Davidson convinced Hicks to reject the ISLM, and that Davidson published Hick's rejection article in his (Davidson's) magazine journal.

Wow. I never heard of Paul Davidson before, but I've heard of him now.


I got stuck on "nonergodic". Wikipedia didn't help:

In mathematics, the term ergodic is used to describe a dynamical system which, broadly speaking, has the same behavior averaged over time as averaged over the space of all the system's states (phase space).

Time and space? I Googled Paul Davidson and found an article at Naked Capitalism that was useful. Before Davidson's article is an introduction by Philip Pilkington (someone I have heard of). Pilkington writes:

In a recent interview I asked the US’s leading post-Keynesian economist and founder of the Journal of Post-Keynesian Economics, Paul Davidson to discuss what is known as the ‘ergodic axiom’ in economics. This is a particularly important axiom as it allows mainstream economists (including left-wing Keynesians like Paul Krugman and Joseph Stiglitz) to claim that they can essentially know the future in a very tangible way. It does this by assuming that the future can be known by examining the past.

Without this axiom the whole edifice of mainstream theory rests on very shaky grounds. Yet, it should be clear to anyone that given that the theory is supposed to explain human behaviour it is unlikely that the future will correlate with the past because people and institutions tend to change and evolve over a given period of time.

Okay. An "ergodic" economy is predictable, because the future is similar to the past. So a nonergodic system is unpredictable.

This must be similar to the "unit root" thing. A system either has or does not have a unit root. In the one case, there is every reason to expect GDP to return to trend after a major setback. In the other case, there is no reason to expect it.

The economy is either ergodic or it is not. In the one case, there is every reason to assume tomorrow will be similar to today. In the other case, there is no reason to assume such a thing.


Pilkington continues:

Yes, often past behaviour will help us understand future behaviour – apply this in a simple psychological way to anyone you know and you will find it to be true – however, it should be quite clear that all future behaviour cannot be wholly explained by past behaviour. Clearly it should be quite obvious that the same should apply when we consider large aggregates of individuals and yet mainstream economics steadfastly refuses to accept this.

Now, broadening the topic, I think of the world in terms of business cycles, large and small. Overlapping cycles, such as Schumpeter described.

Lots of economists have described lots of cycles. I don't remember most of them, but I accept the idea of cycles generally. I think in terms of four or five:

1. The business cycle, where we get a recession every nine or ten years on average, give or take. It doesn't matter exactly how long the cycle is. It doesn't matter that it varies in length. People have recognized this cycle since the time of Alexis de Tocqueville, if not before. So, since 1935-1840 or before.

2. The Kondratieff wave, or the "long wave". I use the words "wave" and "cycle" interchangeably. The long wave, I think that's the same one Greenspan spoke of when he said you get one of these major financial crises every 80 to 100 years. (Maybe not. Maybe these are two separate cycles. That would make five, then.)

3. The Price waves described by David Hackett Fischer in his book The Great Wave: Price Revolutions and the Rhythm of History. Fischer describes

four very long waves of rising prices, punctuated by long periods of comparative price equilibrium. This is not a cyclical pattern. Price revolutions have no fixed and regular periodicity. Some were as short as eighty years; others as long as 180 years. They differed in duration, velocity, magnitude, and momentum.

(Excerpt from a very large PDF, a powerpoint type presentation that highlights key points from Fischer's book.)

4. The Cycle of Civilization, pretty much as described by Arnold Toynbee -- but driven by economic forces. Specifically: driven by the human desire to accumulate wealth. Call it the "economic security" motive. Call it "self interest".


Assume a system at equilibrium. Posit a disturbance to the system. Feedback arises from the disturbance. There are two kinds of feedback. One kind helps the disturbance dissipate, so the system returns to equilibrium. The other kind makes the disturbance bigger, so the system moves away from equilibrium.

Both disturbances may come into play in the same system. If they alternate, the effect may be to create a cyclical pattern. Wikipedia provides an example of stock prices, which I summarize:

1. A disturbance: Stock prices begin to rise.
2. People react by trying to get in early.
3. People getting into the market makes the disturbance bigger. Prices rise more.
4. But there is "the knowledge that there must be a peak". People get out early.
5. People getting out slows the increase of stock prices and creates a peak.
6. Now the disturbance is different: Stock prices begin to fall.

The process continues, driving prices to a bottom. Then the disturbance toggles again, and prices begin to rise.

The pattern thus created is a cyclical pattern, a repeating rise and fall of (in this case) stock prices. The cyclical pattern is generated by the plans and preferences of the people taking part in the process.

Cycles arise naturally from economic activity.


Davidson's article (it would be a 3 or 4-page printout) is a bit long for me, but very readable. He writes, for example:

Logically, to make statistically reliable probabilistic forecasts about future economic events, today’s decision-makers should obtain and analyze sample data from the future.

It's funny because it's true.

Davidson writes:

In simple language, the ergodic presumption assures that economic outcomes on any specific future date can be reliably predicted by a statistical probability analysis of existing market data.

Okay. I'm not ergodic, I guess. I don't make predictions. (Or maybe I'm a monkey wrench that brings the whole ergodic system down: If somebody can't foretell the future, the ergodic system fails!)

Wow, the whole "in simple language..." paragraph is great. Here's the rest of it:

By assumption, New Classical economic theory imposes the condition that economic relationships are timeless or ahistoric ‘natural’ laws. The historical dates when observations are collected do not affect the estimates of the statistical time and space averages. Accordingly, the mainstream presumption (utilized by both New Classical economists and New Keynesian economists) that decision-makers possess rational expectations imply that people in one’s model process information embedded in past and present market data to form statistical averages (or decision weights) that reliably forecast the future. Or as 2011 Nobel Prize winner Thomas Sargent [1993, p. 3], one of the leaders of the rational expectations school, states “rational expectations models impute much more knowledge to the agents within the model (who use the equilibrium probability distributions)… than is possessed by an econometrician, who faces estimation and inference problems that the agents in the model have somehow solved”.

If capitalism is the high point of the cycle of civilization -- the 150-year "limiting point" Keynes described as "the greatest age of the inducement to invest" -- and if Toynbee's picture of history is generally correct, then yes: It is unsafe to assume that tomorrow will be like today. I'm reminded of something Robert Heilbroner wrote. Heilbroner did not expect business civilization to survive another 500 years.

Today, it seems, nobody does.

Paul Davidson:

Keynes’s uncertainty concept implies that the future is transmutable or creative in the sense that future economic outcomes may be permanently changed in nature and substance by today’s actions of individuals, groups (e.g., unions, cartels) and/or governments, often in ways not even perceived by the creators of change.

In other words, as Sarah Connor put it in the picnic table: no fate. The cycle of civilization is not set in stone. It is a pattern that tends to emerge from the aggregate behavior of individuals. I would add that Toynbee was right: the dynamic is "challenge and response", and civilizations die by suicide.

The economy is challenging us, and if we fail to find the right response, it's over.

So if you want to preserve capitalism, you might want to start by reconsidering your assumptions. And even if you don't.



Okay. "Ergodic" means the outcome is known, or that you can calculate all the probabilities for all the possible outcomes. Uncertainty means you can't.

Look! -- Look! -- Look at this:

In the classical (ergodic) theory, where all outcomes are conceptually calculable, there is never a need to keep options open. People will therefore spend all they earn on the products of industry (Say’s Law) and there can never be a lack of effective demand to prevent the system from reaching full employment.

See where Davidson's going now?

You know, I know Paul Davidson is right, that he has his Keynes right, because Davidson boils his argument down to Say's law. And Keynes said

The classical theorists resemble Euclidean geometers in a non-Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straight as the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required today in economics.

And, writing of Say's law, Keynes said

It is, then, the assumption of equality between the demand price of output as a whole and its supply price which is to be regarded as the classical theory’s ‘axiom of parallels’.

Paul Davidson is saying that, too.