Real World Experience In Free Market Essay

Free Market Fantasies: Capitalism in the Real World

Noam Chomsky

Delivered at Harvard University, April 13, 1996

(transcription courtesy of William Greene)

For those who are interested in the real world, a look at the actual history suggests some adjustment — a modification of free market theory, to what we might call “really existing free market theory.” That is, the one that’s actually applied, not talked about.

And the principle of really existing free market theory is: free markets are fine for you, but not for me. That’s, again, near a universal. So you — whoever you may be — you have to learn responsibility, and be subjected to market discipline, it’s good for your character, it’s tough love, and so on, and so forth. But me, I need the nanny State, to protect me from market discipline, so that I’ll be able to rant and rave about the marvels of the free market, while I’m getting properly subsidized and defended by everyone else, through the nanny State. And also, this has to be risk-free. So I’m perfectly willing to make profits, but I don’t want to take risks. If anything goes wrong, you bail me out.

So, if Third World debt gets out of control, you socialize it. It’s not the problem of the banks that made the money. When the S&Ls collapse, you know, same thing. The public bails them out. When American investment firms get into trouble because the Mexican bubble bursts, you bail out Goldman Sachs. And — the latest Mexico bail out, and on and on. I mean, there’s case after case of this.

In fact of the leading — top — hundred leading transnationals in the Fortune list of transnationals — there was a recent study of how they — how they related to the States in which they- they’re all somewhere, you know, so they’re all mostly here — in some National State, it turns out that all hundred of them had benefited from industrial policies, meaning, State intervention in their behalf. All hundred had benefited from the State in which they’re based. And twenty of the hundred had been saved from total disaster, that is, collapse, by just State bail-out. When people talk about globalization of the economy, remember that the nanny State has to be very powerful in order to bail out the rich. And nothing is changing in that regard. Twenty out of a hundred, again, were saved from collapse by this, including a number here.

Well, that’s really existing free market theory. There are many examples of it quite close to home. So, we could start with our own Governor, Governor Weld, who is described by the Boston Globe as a libertarian with a religious belief in free markets. And then a couple of days later, they reported that through various scams he had- his administration was able to sharply increase Federal subsidies to Massachusetts, so that- way beyond what they were before, so that he could parade as a fiscal conservative. And that’s pretty common.

Just the year before, you may recall, if you have long memories, they had to close Georges Bank — the richest fishing area in the world — because it was being overfished, thanks to a combination of deregulation and subsidies to the fishing industry, which have that odd consequence that you tend to get overfishing. So it looked as if the ground fish were wiped out, and they had to close it off. It didn’t take long for the religious libertarian fanatic, William Weld, to take the next jet plane down to Washington, hat in hand, asking for a Federal bail-out. They wanted the Federal government to declare it a natural disaster. And the reason was, as he explained, with, presumably, some scientists in tow, that there was some strange kind of predatory fish which no one had yet found, but they would find it, don’t worry. So some kind of predatory fish had come and, sort of, wiped out all the, you know, the Cod and the Haddock, and all those things. So it was a natural disaster, and therefore the general public had to, sort of, pay off the results of deregulation and subsidizing the fishing industry. Well, that’s the way to be a libertarian with religious fervor.

Another one is the leader of the conservative revolution, Newt Gingrich. Nobody is more passionate about the market than he is, in particular about what he — his own district, which he calls a Norman Rockwell world of jet planes and fiber optics, as indeed it is. Except, if you ask where jet planes and fiber-optics came from, you discover that the public paid for them, and still pays for them. And in fact he manages to get more Federal subsidies for his district than any suburban county in the country outside the Federal system. So, you can have conservatism flowering among the malls, and so on.

Or you can go back to the Reaganites, who were also very passionate about free markets for everyone else. Meanwhile, they boasted to the American business community, correctly, that they had done more- that they had instituted more protection than any post-war American administration, in fact, more than all of them combined. They had doubled import restrictions, blocking- and helped — and poured public funds into major industries to enable them to recapitalize, to protect the — in fact reconstruct, the steel industry, and the automotive industry, and semiconductors, and so on, which would have disappeared if they had opened the markets.

The Thatcherites in England were about the same. Government expenditures relative to GNP stayed pretty constant, although, anything that went to the general population collapsed. Meanwhile, military industry shot up, arms sales were booming — that’s all publicly subsidized stuff — arms sales to nice guys like Saddam Hussein, and General Suharto, and others.

Well, that’s really existing free market theory.

What are the core policies?

Well, the Washington consensus — which is basically designed for the Third World to make it that way, and keep it that way — it’s now being applied not just to the Third World countries, but to the rich industrial societies, with the United States and Britain in the lead. However, it’s with a twist.

Since it’s being applied at home, this is really existing free market theory that’s being applied at home, meaning nuanced. So, powerful government to protect the rich, and market discipline and tough love for everyone else. And you see that very clearly. Go through the various elements of the Washington consensus.

The first one is to-about reducing government. Well, that’s false. We’re not reducing government, we’re switching it — shifting it around. So, social spending is indeed way down since the 1970s when this stuff started — accelerated after 1980, but it was starting in the mid 70s. The — kind of a benchmark example is AFDC, the main support system. That was cut virtually in half from about 1970 to 1990, with obvious effects on poor families and children, and so on. It was a part of a general war against women and children that was conducted by the conservatives under the name of “family values.” It’s interesting that they were able to get away with that. It tells you something about the intellectual culture.

Well one part was the reduction of AFDC from — by roughly half from about 1970 to about 1990. It’s now, essentially gone. That’s- the purpose of that, as you know, is so that seven million- couple of million — I think five or six million kids, average seven years old can learn responsibility. That’s part of tough love.

Meanwhile, another part of the government has been very stable, and in fact is going up, namely, the Pentagon system, which remains at approximately Cold War levels. In fact it’s higher now than it was under Nixon, although, you know, the big enemy has disappeared, which tells you exactly how much — tells a rational person at least, exactly how much they were worried about the Russian threat. Not only does it remain at Cold War levels, but it’s going up, under the initiative of the fiscal conservatives. The Heritage Foundation, which, you know, sort of a right-wing foundation that designs the budget for the Gingrich army, are calling for an increase in the Pentagon system, as is Gingrich, as indeed was Clinton. So that goes up.

And I should say that cutting of social spending- social spending is being cut very sharply, very much over public opposition. At the time of the 1994 Congressional election — you know, the big landslide — over 60% of the public wanted social spending to increase. Ok. It went very sharply down. What about the Pentagon spending going up? Well that’s- the public is 6 to 1 opposed to that, which gives you some- one- it’s one aspect of a big picture about what’s happening to American democracy, and somewhat of a change, not a huge change.

The- so one part of the system is going up: Pentagon spending. Another part is going down: social spending.

And the same is true in other domains. Like, for example, legal aid for the poor is being slashed and virtually destroyed. On the other hand, the security system, the State — government security system, State and Federal, that’s going up. So, prisons are going way up. The prison population — crime hasn’t really — hasn’t changed for about twenty years, but — and incidentally, U.S. crime rates are not off the spectrum, contrary to what a lot of people believe. Crime rates are sort of at — toward the high end of the industrial world, but not off the spectrum, with one exception, namely, murder with guns. But that’s a special feature of American society which doesn’t have to do with crime rates. Apart from that, crime rates are kind of toward the high end, not going up.

The prison population tripled during the Regan years. It’s going up even faster now. And I think the reason is another aspect of the Third World model, namely, the superfluous population. There is a big superfluous population — they don’t contribute to wealth protection. Well, we’re civilized folks. We’re not like the people that we fund in Colombia who go out and murder them. So, we throw them into jail. And that’s going way up, even more. And there’s also kind of like a side benefit to this. Putting more and more people in jail — and in fact, under harsher and harsher conditions — has an — is a technique of social control for everybody else.

I mean when you’re — if you’re — you know, someday down the road if you decide to run a dictatorship, and you want to really harm people, it’s kind of like Hitler in Germany or something, you know that you’re going to carry out policies that are going to cause people a lot of harm, you’ve got to control them somehow. And there aren’t many ways to do it. Everyone hits on the same ways. What you do is engender fear, and hatred, and you know, make them hate the guy who looks a little different, or whatever it may be, and then you punish those bad guys because they’re really awful, and, you punish them really hard, and so on. And that makes people even more frightened. You can just see that happening right around you. And building up the perception of crime — crime has a, like a, what they call in literary theory a subtext — you’re supposed to understand, “criminal” has the word — little word “black” in front of it. Just like “welfare mother”, you know “black”- “rich black welfare mother.” And criminal means, you know, that black guy who’s coming after you. So what you want to do is — this has the dual effect of getting rid of the superfluous population — basically unskilled workers — close race/class correlation — and also demonizing them, so everybody else is scared and frightened and they’ll be willing to accept what’s happening to them too, and not look at where the source is.

So that part of the — that — the drug war is basically for this, it has almost nothing to do with drugs, but it has plenty to do with criminalizing an unwanted population, and scaring everybody else.

And so does the harshening of prison conditions. Which is really — it’s — the United States is off the map on this. We’re in violation of international conventions, constantly condemned in human rights forums, and getting much worse. The reinstitution of chain gangs was of course bitterly condemned. But you know, that’s that bad South, Alabama. Well, it’s now in Illinois. The State Senate of Illinois last — a week or two ago legislated chain gangs — not for violent criminals, incidentally — for people who are found with drugs, or, you know, robbed a store, or something like that. The Chicago press pointed out that this carries a — this is kind of reminiscent of slavery. But the legislator, the Senator — State Senator who put it through said that this is just another aspect of what he called tough love. And then he explained that some people work better under humiliation. So it’s really good to restore elements of slavery, and again, the subtext is everybody else gets scarred. You know, those guys have to walk around like slaves in chains, we must be in real danger, so therefore, we’ll accept what’s happening to us. That’s the logic.

So prisons are going up and it’s — and that has a lot of side benefits apart from just getting rid of the superfluous population. It is a source of cheap labor. So, prison labor is going way up. Cheap labor, you don’t have to worry about unions, no benefits, they don’t get out of line. And that also, naturally, undercuts wages elsewhere. So what — just like forcing welfare mothers to work — you know, raising children isn’t work, as anybody knows who’s had children — so you have to drive them to work. Kind of like people who go to, you know, Fidelity Investment to figure out scams about how to deal with the security market. You really want these people to work. But since there’s no jobs for them, they’re going to work at low-paid, or publicly subsidized wages, which will undercut other wages. The same with prison labor.

In fact the scale of prison construction — which is a kind of Keynesian stimulus to the economy anyway — but its scale has become so enormous that even high-tech industry, you know, the guys who are usually just ripping off the Pentagon system, they’re beginning to look at it, figuring out — recognizing that high-tech surveillance devices, and so on, may be another way to, sort of, get — to transfer public funds to make sure that high-tech industry keeps moving. It’s reached — it’s not at the scale of the Pentagon, but it’s going up.

Well, that’s one aspect of what’s called, reducing government — modifying government, to be precise.

Another aspect of it is what’s called “devolution” — reducing — moving governmental power from the Federal to the State level. And that has a kind of a rationale which you hear all over the time — place. For example there was an op-ed a couple of weeks ago in the New York Times by John Cogan — Hoover Institute at Stanford, who has pointed out what he called a philosophical issue that divides the Democrats from the Republicans. The philosophical issue is that the Democrats believe in big government and entitlements, and the Republicans believe in getting power down closer to the people, to the States, because they’re kind of populist types.

Well, it takes about maybe three seconds’ thought to realize that moving power down to the States, in funding and so on, is just moving it away from the people, for a perfectly elementary reason: there’s a hidden part of the system — of the power system that you’re not supposed to know about, or think about, and that’s private power.

Now, it takes a big corporation, like say, General Electric or Microsoft to sort of pressure the Federal government, but even middle-sized guys have no problems with State governments, they can control them quite easily. And in case anyone was too dull to figure this out by themselves, the same day as Cogan’s op-ed in the New York Times, which is a typical one, there was a story in the Wall Street Journal about Massachusetts, which had a headline that read: What Fidelity Investment Wants It Usually Gets. And then the story went on to say that Fidelity Investment, the biggest investment firm in Massachusetts, wanted even more subsidy and support from the State government than it already gets, and it was threatening if it didn’t it would move over the border to Rhode Island, where it just owns the place. So therefore, the passionately libertarian Governor quickly rearranged, you know, tax subsidies, and one thing or another, so that Fidelity got what it wanted.

Well Fidelity couldn’t have done that with the Federal government. It couldn’t have said, you know, “you give us even more or we’re going to move to Switzerland” or something. I mean, other guys can do it maybe, but not Fidelity.

Raytheon, which is the biggest manufacturing producer, did the same thing. Raytheon — incidentally Fidelity is not — it’s not that Fidelity is poor, they just announced record profits a couple days ago. Same with Raytheon — just announced record profits, but you know, having big problems, so they wanted even a bigger tax subsidy, and — direct subsidy, and tax write-offs, which just means transfer of taxes to — from the State of Massachusetts, and they threatened that if they didn’t get them they were going to go to Tennessee, so of course they got them. The legislature passed a special law giving what they called defense industry special extra subsidies.

Notice that Raytheon is publicly subsidized in the first place. That’s where its money comes from. But now it has to be additionally subsidized so that its profits will be even higher than the record profits it just made. Same with Fidelity. And that’s the kind of game anybody can — you know, even — even way down to much smaller businesses can play with the States.

The consequences of devolution are quite straightforward. It means that any funding that goes to, say, block grants that go to the States, you can be reasonably confident that they’ll end up in the deep pockets of rich people, not, you know, in the hands of hungry children, or poor mothers, or anything like that. That’s how you get power down to the people. Ok. That’s devolution.

In fact quite generally, when you look at it, what’s called “government cutting” is more or less cost transfer. It’s almost never reduction, sometimes it’s increase.

So let’s take what’s — take health reform. “Reform” is a word you always ought to watch out for. Like when Mao started the cultural revolution it wasn’t called a reform. Reform is a change that you’re supposed to like. And watch — so as soon as you hear the word reform, you kind of reach for your wallet and see who’s lifting it. Anyhow, there are things called “health reforms.” And health reforms are supposed to, you know, cut government costs. Well they do cut one kind of cost, but of course they raise another kind of cost.

There’s a very respectable outfit called the National Bi-Partisan Leadership Council, headed by two ex-Presidents, Ford and Carter, and it just did a study of the cost-transfer effects of the planned health reforms. It concluded that they would add about ten billion dollars a year extra costs, but those extra costs will come from wages, and higher premiums. Which means it’s a highly regressive tax on the poor. Highly regressive tax, you know, if it comes from wages and premiums of course. And that’s ten billion dollars a year. They also estimated that it will increase the number of uninsured by fifteen to twenty percent up by — this is by the year 2002 — so up to about 54 million by the year 2002. Well that’s a cost. A big cost, unmeasurable cost. And so you find all the way across the board. And furthermore it’s no big secret.

So, like, the Wall Street Journal had a headline which pointed out that — when the reforms were, you know, moving through Congress — it said: Rich Gain, Poor Lose, Tradeoffs For The Middle Class. Which is right. That’s exactly what the reforms are intended to do. You have to remember, by “Middle Class” they mean the people right below the very rich. So they don’t mean the median, you know, they’re not talking about people with thirty thousand a year income, they mean — so what it really means is: great for the rich — super-rich, tradeoffs for the near-rich, tough love for everybody else, which is most everyone. When you close public hospitals, and that sort of thing, you know exactly who’s going to suffer.

Well, let’s go to — what are — take, say, New York, which has a conservative Governor and a conservative Mayor. And they’re carrying out very extensive conservative tax cuts, because they’re fiscal conservatives.

The tax cuts, the New York Times pointed out in a small item, all benefit business. So, by accident, all the tax cuts benefit business. Well, there are also tax increases, which are compensating for the tax cuts. But they don’t call them tax increases. What they call them is, the phrase is: reduction of subsidies for public transportation and for tuition in public universities.

Well “subsidy” is another interesting word, kind of like reform. It’s a subsidy if public funds are used for public purposes. That’s called a subsidy. It’s not called a subsidy when they go to private wealth. That’s reform. So the — so they’re cutting down subsidies for public transportation. Well, that’s just a tax. If you pay 20 percent more for getting on the subway, that’s a tax. Same if you pay higher tuition at City College. And that’s a highly regressive tax. So, who rides the subways, and who goes to City College?

So what they’re doing is shifting- is cutting taxes for business — for the rich, and increasing taxes for the poor, which are going to compensate for that. And that’s called fiscal conservatism, and cutting government. Well, so it is across the board. Take- I’ll come to other examples, but if you think about it, all the — take a look — a close look at the things that are called cutting government, and you notice that they quite characteristically have this property.

The next element of the Washington Consensus is making the tax system more regressive. Ok, we don’t have to talk about that, it’s stated openly. The thing that isn’t stated openly is the reason.

This is supposed to be in order to increase investment and give everyone jobs. But it’s a really weird way to do that. I mean, the country is already awash in capital. The people whose taxes are being cut don’t know what to do with their money. If you want to increase growth, there’s another approach that might be used: stimulate weak demand by progressive taxes. That is, put more money into the hands of people who can spend it. That increases growth — that would increase growth, but that’s not the right way to do it. The right way to do it is by cutting financial gains so that you can have even more speculation against currencies. The- so that’s the second part, make the tax system more regressive. What about deregulation?

Well, same effect. Deregulation is a cost shifting measure. So for example if you deregulate — if you allow industries to — as they have done already, to deposit toxic wastes without cost, because you have deregulation, it increases their profits, but it also increases water and sewage rates, which is a regressive tax on everybody else who’s got to pay that. Also, it has further costs. Some of them you can’t estimate. For example, the costs in, say, health, and quality of life, and so on. No way to give numbers to those. And there’s also going to be the eventual cost of cleanup. But that’s going to be a public cost, remember. Incidentally, a good one, because when you clean up the wastes, that increases the Gross National Product, and we all like to see that go up. But, the public will pay those costs.

So what it is, is just another form of radical cost shifting: increase wealth for the rich, and decrease it for everyone else. So, it fits the experiment’s design. In general, it’s kind of like a short-term profit gain for some, a very small some, and a big cost for everyone else. What about deregulating the labor market?

Well, same process. Actually that was done by simply criminal behavior. The best review of this I know is in Business Week. The Reagan administration, as they point out, essentially informed the corporate world that they were not going to enforce the laws. There are laws, you know, much hated laws like the Wagner Act, that give you the right to organize, and the Reagan administration simply informed business they weren’t going to enforce them.

So the number of illegal firings went up by about a factor of six. And similarly across the board. They also informed business they were not going to enforce the OSHA regulations — health and safety regulations. So the number of days lost to injury, and the number of injuries, and so on, also shot up. And in fact, that was a great way to undermine unions, and the right to organize — a whole pile of policies like that — which was part of deregulating labor markets.

Another part of deregulation of labor markets is to make them more — what’s called, more flexible. Meaning, you don’t have any security, and no guarantee, the number of temporary workers goes right up — way up, no benefits, you never know if you’re going to have a job tomorrow. That’s really good for the economy. That’s good for having jobs.

Some of the most profitable corporations, the ones whose- way up on the Fortune 500 list, and booming, are the ones that, what they call, sell manpower, you know, like Manpower Incorporated, selling temps. Which is terrific for making labor markets flexible. It happens to destroy everybody’s life, but that doesn’t really matter.

It’s — again, the similarity to the Third World is very close. Back in nineteen — this is what’s called “economic health.” When you — when this is carried — happens, you call it an “economic miracle”, another technical term.

So for example, Brazil. There’s a terrific economic miracle under the neo-Nazi Generals that we installed with great self-adulation back in the 60s. And by 1971 it had become the Latin American darling of the business community. And the President, the General who ran the place, pointed out that the economy is doing fine, it’s just that the people aren’t.

Well we just — we have a Nobel Prize winner, who just won the Nobel Prize last yea r- last time — Robert Lucas of Chicago, and he was interviewed by the Wall Street Journal, and said, we’ve been doing great, and have been for a long time. He didn’t even bother to add what the Brazilian General did: it’s only the people who aren’t doing well. What he means by “we” is the top five percent, or maybe top ten percent. And that’s right. We’ve been doing great, we’re doing fine, the economy’s fine — by now we don’t even worry about the fact that the people aren’t doing so well, like — I won’t bother repeating the statistics which you know, and he knows perfectly well.

Ok, that’s economic miracles. We’re now beginning to get one ourselves.

What about privatization?

Well, again, the effects of that are obvious. So, say, in the latest economic miracle in Mexico, privatization meant, as usual, handing over public assets to friends of the President, or you know, other rich people, or international investors, at a fraction of their cost. And in fact in Mexico the number of billionaires during the economic miracle went up even faster than the percentage of people on the poverty line, as some were doing well, and the people didn’t happen to be doing so well. In fact it was a catastrophe for them, even before the collapse. So that’s privatization. What about property rights — increase of property rights?

That’s very important, in fact it’s a critical aspect of the — what are called, misleadingly, the free trade agreements, which actually have strong protectionist elements in them. The Uruguay Round, and NAFTA, and so on. And one of them is increase of intellectual property rights. I won’t go into the details, but what it amounts to is guaranteeing that major corporations have a monopoly on the technology and knowledge of the future. And they extended those to the — by various devices, so that it’s about fifty years before you can interfere with owned property, which comes from public subsidy, usually through research, and then is handed over to some private corporation, and nobody else is allowed to touch it.

So increasing property rights has a big effect — highly protectionist measure which is central to the new trade agreements, and has a long-lasting effect, way down the road on organizing the international economy in who gains and who loses. Last element of the Washington Consensus is reducing trade barriers. And here there’s another scam that you ought to keep your eyes on.

What’s called “trade” in economics is a very odd notion. So, for example, if Ford Motor Company moves parts from Indiana to Illinois for assembly, and then moves them back to Indiana, that’s not called trade. But if Ford Motor Company takes parts made in Indiana and moves them across the border to Mexico, where you can get much cheaper labor and you don’t have to worry about, you know, pollution and so on, and they get reassembled in Mexico and then sent back to, say, Illinois for value-added, that’s called “exports and imports.” It never had anything to do with the Mexican economy, or, in fact, any economy, it was all internal to the Ford Motor Company, but it’s exports and imports.

So, how big an element is that? Well, about fifty percent of U.S. trade. So about fifty percent of what’s called U.S. trade is actually internal to individual corporations. Meaning, controlled by a very visible hand, with all sorts of methods around for distortion of markets, and you know, robbery, and so on and so forth. About the same for Japan. And for the world, you know, it’s hard to get numbers, but what’s estimated for the world is around forty percent of trade.

Agreements like, say, the Uruguay Round, you know, GATT, if that increases what’s called trade, what it actually does is increase investor rights. That is, it increases the power of transnational corporations. You have to really look pretty closely to figure out what the effect is on trade in any meaningful sense. For example, it may increase cross-border operations, but decrease trade, in a meaningful sense of trade, meaning something that’s not under the control of, kind of, corporate mercantilism. Going on with this, it’s perhaps worth noticing that the very concept of capitalism, and markets, has virtually disappeared.

So for example, if you take the current issue of Foreign Affairs, there’s an article by Joseph Nye of the Kennedy School, I think maybe he’s Dean of the Kennedy School, who explains that there’s a big new weapon in the hands of American diplomats. American diplomats, he says, has a — diplomacy has a force multiplier. And the reason is because of the attraction of democracy and free market enthusiasms in the United States. That’s given — those things have given the U.S. a real force multiplier. Then he spells it out. It comes from Cold War investments in high technology: electronics, aviation, telecommunications, and so on. That’s our free market enthusiasms and democracy.

Well, where did electronics and, you know, aviation and telecommunications come from? Well, from public funds. They didn’t have anything to do with the free market. They came from public funds, which were transferred to high-technology industry, under the conscious guise, deceit, of security. And it was conscious.

So, Truman’s first Secretary of the Air Force, back in 1948, pointed out to Congress that the word to use is not “subsidy”, the word to use is “security.” And in fact the whole system was designed that way, and stays that way. So that’s the tribute to democracy and free markets. The tribute to democracy and free markets is: you rob the public by deceit to pay- put- to enrich the rich. That’s free markets and democracy. And it’s published without comment.

Another article in- and probably nobody notices, you know, because the concept of capitalism, just like the concept of democracy, is just gone. Nobody knows what it is. Democracy means: deceive people into doing what the rich people want. And markets means: making sure — make sure the public subsidize the rich.

Or to take another example, take, say, the Wall Street Journal, which you’d think would be the last holdout of somebody who remembers what capitalism is. Well they had a front — lead article a couple of weeks ago, on various strategies that States — meaning, like, States of the Union — were using to try to be more business friendly. And they picked two examples, Virginia and Maryland, who are sort of competing to see who can most sponsor entrepreneurial values, and be most business friendly, and so on. And they said, well for a while it looked like — they have somewhat different strategies, that’s why they were describing them — for a while Maryland was doing better, then it turned out Virginia is doing better- now Virginia is doing better, they’re more business friendly, more gung-ho about business, and so on.

Alright, you read the article. Turns out it’s not Virginia and Maryland. What it is, is the suburbs of Washington, some of which are in Virginia, and the others of which are in Maryland. And what are the two business strategies- entrepreneurial strategies? Well, the suburbs of Washington figured they could rip-off the National Institute of Health and others to develop Biology-based industries, so they were looking for Biotechnology, and so on. They figured that’s going to be the big cash cow. And Virginia, which is more business friendly, decided that the old cash cow, the Pentagon, would probably be the best way to rip-off public funds. So they were concentrating on electronics and telecommunications, and so on. And it turned out that Virginia had the better strategy- the better business strategy. They made a better guess about which public funds to rob. And that’s what it means to have entrepreneurial values. And it’s, again, reported without comment.

This just continues, virtually without a break. The New — I’ll give you one last example.

The New Yorker had a rather good article, actually. You know the — by now the story about what’s happening to the economy and to the population, which used to be what, you know, crazies on the Left talked about, it’s now, sort of, hit the public, you know, so you can — you read it in the newspapers. The New Yorker had an article in which they reviewed the figures on decline of real wages, and you know, increase in profits, and the story you’re familiar with, by a guy named Thomas Cassidy. Wasn’t a bad article, actually, he sort of repeated the familiar facts. And then he ended up by saying, look no one’s to blame for this, it’s just the market in its infinite and mysterious wisdom. It just has these effects and there’s nothing you can do about it. Then he gave three examples, exactly three examples in the article, of the market in its infinite and mysterious wisdom, namely: Grumman, McDonald Douglass, and Hughes Aircraft.

Now, you know, maybe this is some kind of subtle irony that I’m missing, but these are three prototypes of publicly subsidized corporations. Grumman, Hughes, McDonald Douglass? They wouldn’t exist for two minutes if it wasn’t for huge public subsidy.

So that’s the market in its infinite and mysterious wisdom.

When Clinton was announcing his grand vision of the free market future at the A.P.E.C. conference in Seattle, he did the same thing. It was in the Boeing terminal, that’s where he announced it, and he gave Boeing — Boeing — as the example of the grand vision of the free market future, and there were big headlines in all the newspapers, and a lot of applause about our love of the free market, and so on. It’s not necessary to comment.

But it is kind of interesting. What it means is, that the concept of capitalism and markets has disappeared as fully as the concept of democracy, which is an interesting fact about the modern period, and a kind of a natural effect of, you know, of applying the Washington Consensus at home. Because you really have to drive out any understanding of what’s going on, namely, that it’s really existing free markets that are being imposed. Well, all of these current measures share one fundamental principle — and I guess we’re at the heart of it — well, two related fundamental principles. One is: they transfer wealth to the wealthy. And the second is: they transfer decision-making power to the wealthy. So, all of them have the effect, just think them through, what all — every one of them has the effect of putting more power to make decisions into the hands of unaccountable private tyrannies, what we call “corporations.” Basically totalitarian institutions — but they’re mostly unaccountable. And that’s the effect. Think through the examples. Every case of the Washington Consensus applied at home has exactly this effect.

And a good part of the propaganda system has the same goal. In this case surely conscious.

So the propaganda system is designed, has been for years, to demonize unions, which makes a lot of sense. Unions are a democratizing force in which the mass- one of the few ways in which the large mass of the population can pool limited resources and work together for some common good. So that’s that bad thing: democracy. So naturally you want to demonize and destroy unions, and that’s been going on forever.

And the other leading propaganda theme — and I don’t mean by that, you know, like, just what you hear in the newspapers- read in the newspapers and so on, like the entertainment industry and television and everything else — is anti-politics. Meaning, setting up a picture — it’s called anti-politics — the picture — but a very specific kind of anti-politics — you have to establish the image, you know, get into people’s heads, that the Government is the enemy- the Federal Government. State Governments are okay, because they can be sort of controlled by business anyway, so it doesn’t matter. But the Federal Government is sometimes a little too big to be pushed around, so it’s the enemy. And it cannot be, nobody can dream of the possibility, that the Government is of, by, and for the people. That’s impossible. It’s an enemy to be hated and feared.

Not that there aren’t a lot of things wrong with it, but that’s not — what’s wrong with it, from their point of view, is it has a big defect: it’s potentially influenceable by the population, and big enough to stand up against private power. And that’s the defect.

So, you have to regard it as the enemy. It cannot be of, by, and for the people. It’s a kind of a, Them versus Us business. “Them” is the Government which is the enemy. “Us” is all of us nice people, you know, sober working man, his loyal wife — maybe, extra job these days — the hard-working executive toiling twenty hours a day, you know, for the benefit of all, the friendly banker who’s out there trying to find — to give you money. That’s “Us.” And then there’s “Them.” “Them” is the outsiders, the un-Americans, you know, the agitators, the union organizers, big government, and so on. And it’s sort of, Us versus Them. That’s the picture.

That has been rammed into people’s heads for at least fifty or sixty years by intensive propaganda everywhere. Movies, television, textbooks — just constant. And not by accident. This is- this part is all extremely conscious. We have a huge public relations industry which spends billions a year — dollars a year on exactly this sort of thing, and consciously. They even tell you about it. Well why is it happening now, not, say, thirty years ago?

One proposal is: it’s the market in its mysterious wisdom. We can put that aside. This is perfectly conscious social policy, and also, hence, under social control. Second is: we live in lean-and-mean times, we’ve got to tighten our belts. Complete nonsense. I mean, all you have to do is look at the business press. They’re just ecstatic, you know, and have been for years.

Business Week just came out a couple of days ago with the annual issue on the top one-thousand corporations. The headline is: 1995 Was One For The Books. America’s Most — and subline: America’s Most Valuable Companies Grew Even More Valuable By A Record Thirty-Five Percent. That’s these lean-and-mean times we’re in. Another headline in Business Week reads — The Problem Now: What To Do With All That Cash, as the coffers of corporate America are overflowing with surging profits. Another one talks about the Government, really great Government. It says, the Gingrich Congress represents a milestone for business — never before have so many goodies been showered so enthusiastically on America’s entrepreneurs. The headline of that one, incidentally, is Return To The Trenches. You know, like, we’ve got to ask more- feeding frenzy has to go on from the nanny State.

Fortune magazine, you know the other big business journal, I mean, they can’t even find the adjectives in the last couple of years to describe what’s going on. One year it’s “dazzling”, you know. The next year “stupendous.” I mean, I’m waiting for the Fortune 500 issue to see what adjectives they come out with next week. What they’ve been — double-digit profit growth for an unheralded four years, with pretty stagnant sales, and, fortunately, wages going down.

CEO salaries are going through the roof, and it’s uncorrelated with performance. That’s another interesting aspect of it. There have been, now, studies of it, so it’s just some other thing, it has nothing to do with markets, or anything else. The — I mean, while wages continue to decline, as does family income, and so on.

Well, you know, nobody who even looks at the business press can believe that there are lean-and-mean times. As I said, the country’s just awash with capital. Their problem is they don’t know what to do with it. So, therefore, get more.

Another theme that’s around now is, you have to have what’s called “downsizing” in order to be competitive.

Well, the Bureau of Labor Statistics came out with its figures — up to the last year they have them for it, 1993 — from 1983 to 1993 the category of executives, managers, and administrative personnel grew 30 percent. Ok. That’s downsizing. The fastest growing white collar population happens to be security guard. Well, yeah, that’s connected with turning it into a Third World country. You take a walk down San Salvador, you know, you’ll see plenty of security guards. You know, rich people have to be protected. And furthermore, all these prisons you’re throwing people into, they need security guards. So, yeah, there’s — they’re administrative personnel, and that’s increasing, but so are- same in corporations. So there’s no downsizing going on, except for working people. That’s quite different. Why is it happening now? Anyway those are- let’s go back to why it’s happening now.

Well, fact is, it’s always going on, just depending on the weapons at hand. Business, American business particularly, is highly class-conscious, and very open about it, incidentally. And it’s always fighting a bitter class war.

You go back a century ago, into what were called “the gay 90s” — when incidentally, the international economy was about as — the international economy was pretty much a s- like it is now in terms of capital flows, and so on, it hasn’t become more globalized in terms of trade and capital flow, and so on, than it was then, maybe less so — the — about a century ago it looked as if the game was over. You know, they were talking about the end of history, perfection had been reached in the Devil-take-the-hindmost society, where everybody’s for themselves, and, enrich yourselves, and so on. It was monstrous for the working people. Very brutal in fact, here. That was a century ago.

Well, you know, it didn’t end. You know, in Europe particularly, the social contract was slowly imposed — not easily. It didn’t happen here. By the “roaring 20s”, as they were called, labor had no voice. This is the, you know, the age of mass-production of automobiles, and so on. Labor was out of it. It was a business-run society, almost completely, and it looked permanent. Again, you know, utopia of the masters, end of history, all this talk.

In the 1930s it proved to be wrong. There was a lot of popular organizing, popular protest. It rammed through elements of the social contract that had been achieved in Europe decades earlier. And that just caused hysteria in the business community. You read the business press, it was talking about, you know, the hazard facing manufacturers, and, the rising political power of the masses, and, how we’re going to face disaster unless we figure out some way to reverse this, and, control their minds, and, control them, and so on.

A huge propaganda campaign began right after the Wagner act was passed — 1935. In the — in those — in the next two years the National Association of Manufacturers, it’s public relations budget multiplied by a factor of 20, as they recognized that force alone is not going to be enough. The U.S. has a very violent labor history, and plenty of workers were getting killed, but it was clear that this wasn’t going to be enough. They had to have huge propaganda. It was sort of put on — that’s when all this “harmony” business that I was talking about got designed. You know, it’s a specific design as to how to carry out what they called scientific methods of strike-breaking by controlling communities, and so on. Well, it was put on hold during the War, and then it picked up right after the Second World War was over, with an enormous propaganda campaign. I mean, you can’t believe the scale until you look at it, and the purpose was very explicit.

The purpose was to win the everlasting battle for the minds of men, which have to be indoctrinated with the capitalist story, as we sell our preferred way of life, and on and on; these are all just quotes from mainstream PR literature. And it was very substantial, and aimed precisely at what I described. They describe what they’re doing, and you can see it in the propaganda, the schools, the entertainment industry, everything else.

Well, what happened in the 1970s?

What happened is, there were some changes in the international economy, and in technology and so on, which just put new weapons into the hands of the masters.

One crucial factor, which everyone points to, is an enormous growth in financial capital — financial transactions — it just boomed — short range financial transactions. That came about, partly, because of the dismantling of the post-war Bretton Woods system of regulated currencies which kind of made currencies free-floating. The Nixon administration just dismantled it. Partly it came about for technical reasons. I mean, the telecommunications revolution, which was of course publicly subsidized, at that point made it possible to transfer funds very rapidly. So, like, you can — by now it’s estimated at around a trillion dollars a day just shift up and back from one market to another — very short term transactions. All aimed — and at a huge — and, aimed at something: they’re all aimed at low growth, and high profits, and low wages. And that’s — that is a factor that’s driving policy in that direction. I don’t think it’s by any means an uncontrollable factor, but it is a — it’s definitely a factor. And that’s just put a lot — and this — the changes in the composition of capital transactions are very striking.

Around- from about maybe — the time when you have data, like, late 19th Century, up until about 1970, rough estimate was that about ninety percent of capital transfers had to do with the real economy, you know, with investment and trade, ten percent speculation. By 1990, the figures had reversed. By 1995, the latest UNCTAD — you know, U.N. Economic Commission estimate was about five percent real economy, ninety five percent speculation — short term speculation, like, against currencies, which is, essentially, aimed at driving down growth and increasing profits and lowering wages.

This was understood very quickly — by the late 70s. And there were proposals made, for example by James Tobin — Yale economist Nobel Prize winner — at an American Economic Association Presidential Address 1978, simply — suggested a simple reform: low tax, very low tax, on short-term financial transactions, just to slow it down, you know, throw a little sand in the gears. Probably work, it’s been called the Tobin Tax, but it’s not getting anywhere because the weapon is a very important one. That weapon has been used very efficiently for all the purposes that have been described.

And there are other things.

The financial crisis of 2007-2009 should have been sufficient
empirical evidence to indicate that the axiomatic basis of the
mainstream theory needs to be replaced.

John Kay has written two excellent Financial Times articles and a summary paper for the INET website. In these articles Kay attempts to explain why mainstream economic theory does not provide a “science” approach to learning about the economic world in which we live. Kay indicates that the claim by mainstream economists’s (e.g., Lucas, Cochrane) for rigor, consistency, and mathematics in economics has created the basis for the low reputation of economists - especially since the financial crash of 2008 was not foreseen by their theory.

John Kay’s argument suggests that the love of rigor and mathematics and the use of computer models has encouraged the use of efficient market theory. Whether they declare themselves Monetarists, Rational Expectation theorists, Neoclassical Synthesis [Old] Keynesians or New Keynesians, the backbone of their theories is the efficient market analysis where the future can be known.

To stimulate discussion of Kay’s articles, I wish to address two aspects of Kay’s writings that I think should be clarified. The first involves content where what is missing from the Kay articles is the explicit discussion of the difference between a nonergodic stochastic process and an ergodic stochastic process for “knowing” the future. The second, and related aspect , (2) involves Kay blaming the messenger (the use of the deductive axiomatic logical analysis and mathematics by mainstream economists) for the message of the Lucas mainstream theory. The message that Kay rejects is that markets are efficient and that the Ricardian equivalence theorem makes fiscal stimulus policies useless– at least in the long run. But as Kay notes “Ricardian equivalence requires that households have a great deal of information about future budgetary options”. The message is wrong because in the real world, not only do households not have much information about the future, but neither do budgetary policy makers. The erroneous message based on the assumption of people having significantly reliable knowledge about the future is the result of accepting bad axioms as the basis for their classical theory. It is not the fault of using the deductive method and mathematics per se.

The ergodic axiom

First, let’s take up the ergodic- nonergodic stochastic process distinction. Paul Samuelson [1969] has written that if economists hope to move economics from “the realm of history” into “the realm of science” they must impose the “ergodic hypothesis” on their theory.[1] In other words Nobel Prize Winner Paul Samuelson has made the ergodic axiom the sine qua non for the scientific method in economics. Lucas and Sargent [1981] have also claimed the principle behind the ergodic axiom is the only scientific method of doing economics.

Following Samuelson’s lead, most economists (e.g., Lucas, Cochrane, Sargent, Stiglitz, Mankiw, M. Friedman, Scholes, etc.) and economic textbook writers either implicitly or explicitly have assumed that observable economic events are generated by an ergodic stochastic process. What is this ergodic axiom? For a technical explanation of the difference between ergodic and nonergodic stochastic processes, the reader should read Davidson (2009).[2] For our discussion here we merely need note that, in essence, the ergodic axiom imposes the condition that the future is already predetermined by existing parameters. Consequently the future can be reliably forecasted by analyzing past and current market data to obtain the probability distribution governing future events. In other words, if future events are assumed to be generated by an ergodic stochastic process (to use the language of mathematical statisticians), then the future is predetermined and can be discovered today by the proper statistical probability analysis of past and today’s data regarding market “fundamentals”. If the system is nonergodic, calculated past and current probability distributions do not provide any statistically reliable estimates regarding the probability of future events.

New Keynesians such as Stiglitz accept the ergodic axiom as the basis of the economic system but then add additional ad hoc assumptions to try to tame this presumed knowledge of the future approach to better reflect what they believe is reality. Stiglitz, for example, in his asymmetric information theory assumes that some market participants cannot make the proper statistical calculations because they do not perceive the correct information about the future. In other words, Stiglitz imposes the asymmetric information condition that there are some decision makers who act while lacking the correct information about the (presumed to exist today) probability distribution of future events. Consequently these decision makers misread the future and thereby mess up the beauty of the efficient market system.

Samuelson, Lucas and others adopted the ergodic axiom because they want economics to be in the same class as the “hard sciences” such as physics or astronomy. For example the science of astronomy is based on the presumption of an ergodic stochastic process governs the movement of all the heavenly bodies from the moment of the “Big Bang” to the day the universe ends. Accordingly probability analysis using past measurements of the movements of heavenly bodies permit astronomers to predict future solar eclipses within a few seconds of when they actually occur. Nothing Congress, the President of the United States, the United Nations, or environmentalists can do will alter the predetermined dates and time for future eclipses. In an ergodic world, all future events are already predetermined and beyond change by human action today.

John Kay’s Financial Times articles, however, indicated that the future of the economic system is “created” by peoples current reactions to politics, other people’s reactions, policy decisions government debates, etc. This implies that economics is a nonergodic stochastic system. Actions by people and governments today can create future economic events. In a nonergodic system past probability calculations whether based on time series or cross sectional data cannot provide statistical significant estimates of future probabilities.

Keynes’ uncertainty, Soros’ reflexivity, and the ergodic axiom

In his The General Theory, John Maynard Keynes stated that classical economists

“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.”[3]

In this analogy comparing Euclidean geometry in a non-Euclidean world to classical theory in our world of experience, Keynes was alluding to the fact that in the classical analysis the future is presumed to be known and therefore free markets are efficient since they produce full employment (the equivalent of the “parallel lines”). Yet significant and persistent unemployment (the “unfortunate collisions”) occur in the real world. Accordingly, classical economists rebuking the lines in the real world for not keeping straight is equivalent to blaming the workers for their unemployment problem because workers would not accept lower wages.

In creating a “nonEuclidean” economic theory to explain why these unemployment “collisions” occur in the world of experience, Keynes uses the logical deductive method but he had to deny (“throw over”) the relevance of several classical axioms for understanding the real world. The classical ergodic axiom which assumes that the future is known and can be calculated as the statistical shadow of the past was one of the most important classical assertions that Keynes rejected.[4]

Keynes’s general theory is a deductive method of analysis. Keynes’s concept of uncertainty about the economic future requires the economic system to be generated by a nonergodic process. At the time of his writing The General Theory, Keynes did not know of the ergodic stochastic theory that was being developed by the Moscow School of Probability in the 1930s. Nevertheless in his criticism of Tinbergen’s [econometric] method , Keynes [1939][5] wrote that Tinbergen’s method is not valid for any economic forecasting because economic data “are not homogeneous” over time. Non homogeneity is a sufficient condition for nonergodicity.

George Soros has explained why he believes the efficient market theory is not applicable to real world financial markets. In an article entitled “The Crisis and What To Do About It” that appeared in the December 4, 2008 issue of the New York Review of Books Soros wrote: “we must abandon the prevailing [efficient market] theory of market behavior”. Instead Soros insists that we should recognize that there is a connection “between market prices and the underlying reality [that] I [Soros] call reflexivity”.

What is this reflexivity? In a letter to the Editor published in the March 15-21, 1997 issue of The Economist Soros objects to Paul Samuelson insistence on applying the ergodic axiom to economics because Soros argues the ergodic hypothesis does not permit “the reflexive interaction between participants’ thinking and the actual state of affairs” that characterizes real world financial markets. In other words, the way people think about the market can affect and alter the future path the market takes. Soros’s concept of reflexivity, therefore, is the equivalent of Keynes’s throwing over of the ergodic axiom.

Kay mentions Taleb’s Black Swan concept in his writings. It should be noted that Knight’s vision of uncertainty and Taleb’s Black Swan concept are both based on the ergodic presumption for the economy. Taleb’s Black Swan is an already predetermined outcome but the Black Swan event is so far out in the tail of the ergodic probability distribution that its occurrence is so rare that it is never likely to be observed– except in the long run when we will all be dead. Similarly Knight’s applied his uncertainty concept to an event that is “in a high degree unique”[6] and hence so far out in the distribution as to be observed perhaps only once in several lifetimes.

For Keynes, as well as for Soros, the belief that intelligent people “know” that they cannot know the future is an essential element in understanding the operation of our economic world. For decisions that involved potential large spending outflows or possible large income inflows that span a significant length of time, people “know” that they do not know what the future will be. They do know, however, that for these important decisions, making a mistake about the future can be very costly and therefore sometimes putting off a commitment today in order to remain liquid maybe the most judicious decision possible.

Our modern capitalist society has attempted to create an arrangement that will provide people with some control over their uncertain economic destinies. In capitalist economies the use of money and legally binding money contracts to organize production, sales and purchases of goods and services permits individuals to have some control over their future cash inflows and outflows and therefore some control of their monetary economic future. It also provides other parties (business firms) to engage in money sales contracts with the legal promise of current and future cash inflows sufficient to meet the business firms’ costs of production and generate a profit.

Households and business entrepreneurs willingly enter into money contracts because each party thinks it is in their best self interest to fulfill the terms of the contractual agreement. If, because of some unforseen event, either party to a contract finds itself unable or unwilling to meet its contractual commitments, then the judicial branch of the government will enforce the contract and require the defaulting party to either meet its contractual obligations or pay a sum of money sufficient to reimburse the other party for damages and losses incurred. Thus, as the biographer of Keynes, Lord Robert Skidelsky has noted, for Keynes “injustice is a matter of uncertainty, justice a matter of contractual predictability”. In other words, by entering into contractual arrangements people assure themselves a measure of predictability in terms of their contractual cash inflows and outflows, even in a world of uncertainty.

Money is that thing that government decides will settle all legal contractual obligations. An individual is said to be liquid if he/she can meet all contractual obligations as they come due. For business firms and households the maintenance of one’s liquid status is of prime importance if bankruptcy is to be avoided. In our world, bankruptcy is the economic equivalent to a walk to the gallows. Maintaining one’s liquidity permits a person or business firm to avoid the gallows of bankruptcy. Thus, liquidity is at the center of the operations of our monetary economy and therefore financial markets that are well organized and orderly permit decision makers to maintain liquidity in case some unforseen future event should make it otherwise impossible to meet a future money contractual obligation unless they can readily sell a liquid asset for money in an orderly market.

Blaming the messenger for the mainstream message

If the future is nonergodic, then what Kay says is apropos about mainstream economic theory creating a completely artificial world remote from reality-since the theory requires the ergodic axiom. But mainstream economists are not wrong in the need for rigor in economic theorizing. Kay seems to state that Lucas and others arguments for rigor and consistency creates the useless economic models that make mainstream economists look so poorly. As Kay states “Rigour means that the only valid claims are logical deductions from specified assumptions [i.e., axioms]. Consistency is therefore an invitation to ideology, rigour an invitation to mathematics” Kay therefore argues that “this curious combination of ideology and mathematics is the hallmark of what is often called ‘freshwater economics’… Consistency and rigour are features of a deductive approach, which draws conclusions from a group of axioms – and whose empirical relevance depends entirely on the validity of the axioms”.

Instead of checking on the validity of the axioms of both efficient market theorists and Old and New Keynesians, Kay complains that such logical deductions describe only “complete artificial worlds” while ignoring an induction approach which is “based on experience and careful observation”

Unfortunately, I believe that Kay’s analogy here is not a correct one. What Kay should be objecting to is the underlying classical axioms that are completely inapplicable to the real world. The question that Kay needs to explore further is how do we humans gain knowledge of the world in which we live?

Since biblical times humans have tried to understand the world about them and what caused things that humans observed to happen. In general the human mind believes that there must be a cause for any event we observe.

For most of the history of mankind, it was believed that the design of God or the Gods was the cause of anything that happened in the world of experience. Beginning in the 17th century, however, philosophers believed that explanations of events that one observed could be developed on the basis of reasoning of the mind rather than religious belief. This was the beginning of the intellectual movement historians call The Enlightenment or The Age of Reason where order and regularity was seen to come from the human analysis of observed phenomena. The power of reason was not in the possession of truth, but in the acquisition of truth.

Any understanding of the world as humans perceive always be the creation of the human mind. Reasoning involves the mind creating a deductive theory to explain what people observe happening about them (using inductive views). For example, Sir Isaac Newton saw an apple fall from the bough of a tree to the ground. Newton explained why the apple always falls to the ground by the theory of gravity.

A theory is the way humans describe real world observations on the basis of a model that starts with a few axioms. An axiom is an assumption accepted as a universal truth that does not need to be proved. From this axiomatic foundation, the theorist uses the laws of logic to deduce conclusions that explains what we observe in the world of experience. All theories are generally accepted in some tentative fashion. Theories are not ever conclusively established and can be replaced when events are observed that are deviations from the current existing theory. Thus, the financial crisis of 2007-2009 should have been sufficient empirical evidence to indicate that the axiomatic basis of the mainstream theory needs to be replaced.

Economic theory is an analytical device where the economic theorist builds a model by starting with some axioms that he/she accepts as a self evident truth. The tools of logical deduction are then used to reach one or more conclusions. These conclusions are then presented to the public as the explanation of economic events that are occurring in the world of experience. The theory can then be used to suggest the cure for any real world economic problems.

Accordingly, it is perfectly acceptable to have rigour and even math in economic models – as both Marshall and Keynes had. But the axioms underlying the model must be thoroughly examined to see if they are applicable to the real world. What Kay is objecting to is not rigor, but to the imposition of axioms, such as the ergodic axiom, that have no relationship to the world we live in.

Keynes’s general theory is rigorous and consistent – and once one recognizes that the future is uncertain in terms of a nonergodic stochastic process, then one can understand that to self-interest of each individual is to protect themselves from an uncertain future where bankruptcy can occur if one cannot meet ones’s money contractual obligations in a capitalist system.

Thus money contracts (inflows and outflows) are used by individuals to protect themselves from adverse unmanageable net cash flows. The purpose of liquid assets[7] traded on organized and orderly financial markets is to provide a security blanket against one’s inability to meet a contractual obligation outflow.

Thus when the market for mortgage backed derivatives that were advertised to be “as good as cash” i.e., perfectly liquid (and triple A rated) collapsed, the loss of so much liquidity caused panic (a reflexivity response) in other markets for assets that had been previously thought to be very liquid. Asset holders in many markets tried to make “fast exits” and the result was a financial collapse and crisis.

In sum, Keynes’s liquidity theory of the operation of financial markets is a rigorous, logically deductive system that appears to be applicable to the real world in which we live and should replace the artificial world model of Lucas and other mainstream economists.

[1] P. A. Samuelson,[1969] “Classical and Neoclassical Theory” in Monetary Theory, edited by R.W. Clower (Penguin Books,, London) p.12.

[2] P. Davidson (2009), The Keynes Solution: The Path To Global Economic Prosperity (Macmillan/Palgrave, New York).

[3] J. M. Keynes (1936), The General Theory of Employment, interest, and Money, Macmillan, London, p. 16.

[4] The other classical axioms Keynes threw over were (1) the neutrality of money axiom as it related to questions of inflation, and (2) the gross substitution axiom as it related to the zero substitution between liquid assets and real producible durables. See Davidson [2009].

[5] J. M. Keynes [1939],”Professor Tinbergen’s Method” Economic Journal, 49, reprinted in The Collected Writings of John Maynard Keynes vol. 14, edited by D. Moggridge [Macmillan, London, 1973].

[6] F. Knight, (1921), Risk, Uncertainty and Profit (Houghton Mifflin, New York) p.233

[7] Keynes has an entire chapter in the GENERAL THEORY entitled “The Essential Properties of Interest and Money” in which he specifically indicates that all liquid assets have certain essential mathematical properties, namely (1) the elasticity of production is zero and (2) the elasticity of substitution between liquid assets and durable producible goods is zero. Keynes specified these elasticity properties by induction via his knowledge of financial markets.

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