Zombie Economics: How Dead Ideas Still Walk Among Us

John QuigginPrinceton, Princeton University Press, 2010, 238 pp., $24.95 hardcoverISBN 978-0-691-14582-2

Beyond the Invisible Hand: Groundwork for a New Economics

Kaushik BasuPrinceton, Princeton University Press, 2011, 312 pp., $29.95 hardcoverISBN 978-0691137162

Modern economic thought is usually said to begin with Adam Smith. While theinquiry presented in The Wealth of Nations was primarily concerned with issuesof growth and distribution, it was the metaphor of the invisible hand that cameto serve as the central point of reference for mainstream economics. Accordingto this premise, the individual pursuit of self-interest through market exchangewill, with a few caveats, result in socially favorable outcomes. While much ofcontemporary economic theory and economic policy-making is rooted in thisframework, its limitations have repeatedly been criticized. As Abba Lerner(1972, p. 259) remarked: ‘An economic transaction is a solved politicalproblem. Economics has gained the title of Queen of the Social Sciences bychoosing solved political problems as its domain.’

The recent crisis and the fact that the economic profession has had little tocontribute in understanding it, has led some to reconsider the conventionalwisdom created by the Smithian framework. Zombie Economics by JohnQuiggin and Beyond the Invisible Hand by Kaushik Basu are part of thisbroader intellectual reform project.

A comparative reading of the two publications though indicates that thisproject can proceed along two rather different paths. If the mainstream approachis considered to be a degenerative research program, i.e. as not creating newknowledge but instead being primarily concerned with protecting its corebeliefs from critique by explaining away any empirical anomalies, there shouldbe ample reason to abandon it altogether. On the other hand, if Smith actuallydid provide a useful conceptual apparatus for economic analysis and the shortfallsof mainstream economics are simply due to an insufficient understanding of thefull implications of the market mechanism, the task at hand should lie in extendingthe explanatory capacity of the prevailing framework. Put more markedly, is ittime for economics to part ways with Smith and homo oeconomicus, or shouldit continue to focus its attention on the invisible hand with renewed rigor?

Zombie Economics, a very readable account of the development of main-stream economic theory and its nexus with policy-making during the past threedecades, falls into the first of the two camps sketched out above. The individualchapters consider five ideas, all of which are central to what Quiggin callsmarket liberalism: the notion of the Great Moderation, the Efficient Market

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Hypothesis, New Keynesian dynamic stochastic equilibrium modeling, trickle-down economics, and the policy prescription of privatization.

According to the preface, the writing was motivated by the following passagein Akerlof & Schiller’s Animal Spirits (2009, p. 5): ‘Explanations in terms of smalldeviations from Smith’s ideal system are . . . clear, because they are posed within aframework that is already well understood. But this does not mean that these smalldeviations from Smith’s system describe how the economy actually works. . . . Inour view, economic theory should be derived not from the minimal deviationsfrom the system of Adam Smith but rather from the deviations that actually dooccur and can be observed.’ Quiggin correspondingly argues that the recentfinancial breakdown and the ensuing economic crisis should not be conceptualizedas a temporary disturbance of a state of general equilibrium, but rather as afundamental failure of the invisible hand per se. While the ideas and argumentsunderpinning neoliberal policies have been discredited by recent experience, theacceptance and the influence of free market economics persist among policy-makers and academics alike. Thus, Quiggin (p. 4) sets out to ‘kill these zombieideas once and for all.’

In this regard, George A. Romero’s 1968 film Night of the Living Dead pro-vides two useful insights. First, doing away with anything undead is not easy. And,second, things will not necessarily improve just because one has got rid of thezombies. Quiggin is certainly aware of the first complication, but does not dedicatemuch attention to the second. Except for a short call to reconsider the case for amixed-economy (p. 77) and for ‘collective risk management through thewelfare state’ (p. 209), not much is said about the way forward. Having identifiedNew Keynesian macroeconomics as one of the main culprits and, aware of theflaws of the hydraulic Keynesian models of the 1950s, Quiggin resorts to alargely unspecified ‘newer Keynesianism’ (p. 121).

The story told in Zombie Economics is problematic in two regards: first, itsidealist approach and, second, its lack of a theory of scientific progress.

Keynes’s popularized remark that the world is ruled by little else than the ideasof economists and political philosophers sets the tone for the analysis. The funda-mental cause of the recent systemic eruption, it appears, is to be found in a set ofabstract economic theories, i.e. ‘[t]he zombie ideas that brought the global financialsystem to the brink of meltdown, and have already caused thousands of firms to failand cost millions of workers their jobs . . .’ (Quiggin, p. 2). A large part of whatfollows this remark conveys the impression that the fate of society lies in thehands—or rather in the mind—of the economist. There are, of course, various chan-nels through which economic expertise and policy-making are interlinked; theimpetus, however, does not run strictly from the former to the latter. Unfortunately,Zombie Economics tends to blur the boundary between the history of economicthought on the one hand and the economic and political history of the neoliberalperiod on the other. Moreover, Quiggin’s account lacks a coherent treatment ofhow changes in the realm of ideas occur. The zombie metaphor suggests that theproduction of scientific knowledge does not proceed according to the successiverejection of falsified theories. Reflections on the actual structure of scientific pro-gress though are, with a few exceptions, relegated to the footnotes.

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In one instance, evoking Popper’s demarcation criterion, Quiggin argues—not unconvincingly—that the Efficient Market Hypothesis cannot be consideredto be a scientific statement: ‘If the Great Depression, the dotcom boom andbust, and the current Global Financial Crisis are all consistent with the EfficientMarket Hypothesis, the hypothesis can’t tell us much of interest about anything’(p. 66). Successive attempts by its proponents to render the hypothesis immuneto empirical refutation have left it without any explanatory power. In anotherinstance, writing on dynamic stochastic equilibrium modeling, Quiggin shifts thefocus to the sociology of the economics profession and its conventions: ‘Sincethe properties of general equilibrium solutions have been analyzed in detail fordecades, modeling “general equilibrium with a twist” is a problem of exactly theright degree of difficulty for academic economists. The problem is hard enoughthat solving it requires, and exhibits, the skills valued by the profession, but notso hard as to be insoluble, or soluble only by abandoning the framework ofindividual maximization’ (p. 104). At this point, a more detailed investigation ofthe dynamics of epistemic communities (Kuhn, 1970) and the growth and stagnationof research programs (Lakatos, 1970) would have been desirable.

Despite these omissions, Zombie Economics is a recommendable book.Catering to a non-expert audience, the strength of the text lies with the breadthof the issues covered rather than the depth of the presentation. Thus, in additionto curious but untrained readers of economic writing, students of any level inthe social sciences should benefit greatly from the history of economic thoughtpresented in Quiggin’s work.

Beyond the Invisible Hand by Kaushik Basu falls into the second of the twocamps mentioned above. The book’s starting point is the adaptation of Smith’sconjecture into modern economics in the form of the First Fundamental WelfareTheorem; Basu refers to it as the Invisible Hand Theorem (IHT). According toBasu, a dogmatic interpretation of Smith’s original insight has been detrimentalto the development of an adequate understanding of how economies function,why some economies fail, and the role of markets and policy intervention.

A standard formulation of the IHT is given by Basu (p. 19) as follows: ‘If wehave a competitive economy, where all individuals choose freely according totheir respective rational self-interest, then (given a few technical conditions) theequilibrium that will arise will be Pareto optimal.’ While this is typically under-stood to imply that non-interference with voluntary market exchange willpromote individual freedom and lead to socially optimal outcomes, the normativeimplications of the IHT are far from unambiguous. Consider the true set of actionsavailable to an agent. In addition to all the elements in the regular budget set, thistrue set includes all other actions that might not be legal or otherwise sociallyaccepted, but that are, in principle, still available to the agent. Then, the IHTcan be restated as follows:

If we have a competitive economy, where the freedom of individuals is restrictedso that they are not allowed to choose from all alternative actions available tothem but instead are simply allowed to choose a point from their budget set, then(given a few technical conditions, as before) the resultant equilibrium will bePareto optimal. (Basu, p. 25; emphasis added)

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This formulation suggests the need for a restriction of individual choice that isdiametrically opposed to the conventional wisdom of welfare analysis. Thepossibility of such a dual interpretation of the IHT calls into question the usualdichotomy of the market as the realm of freedom and the state as the realm ofcoercion. Basu’s argument demonstrates that any pure notion of a ‘free market’should be regarded as a social construct, that is, as being contingent on collectivebeliefs about what kind of choices are socially desirable.

A discussion of the limitations of the orthodox interpretation of the IHT withrespect to issues of evolving feasible sets and preferences, incentive compatibility,and the role of social and cultural norms sets the stage for the core contributionmade in Basu’s monograph. Chapters 4 to 7 consider how a revision of thestandard axioms of welfare analysis can produce new insights about the interplayof market mechanisms and policy interventions. These chapters focus on therelevance of formal institutions (laws and regulations) and informal institutions(group identities, self-reinforcing stereotypes, and norms of trust and altruism)in determining socio-economic outcomes.

The type of reasoning advanced by Basu is best exemplified by the chapterentitled ‘The Economy According To Law: Kafka’s Invisible Hand.’ Here, theauthor argues against the traditional game-theoretical depiction of the effect oflaws on economic outcomes, i.e. modeling a prisoner’s dilemma with the additionof a fine for certain actions. Basu (p. 61) maintains, however, that ‘[t]he fact thatsome law exists or does not exist cannot in itself alter anybody’s payoff.’ Rather,laws need to be enforced by payoff-maximizing players as well. The differentlevels of the enforcement process, i.e. the rule of law, constitute a set of games.A traffic violation, for instance, might be penalized by a police officer. Failureto enforce the violation, in turn, has to be disciplined by a higher rankingofficer, and so on. Ultimately, there is no individual player left to make sure therule of law as such is in effect. Quis custodiet ipsos custodes?

Basu’s answer to this paradox suggests that we should view the law as a focalpoint (Schelling, 1960) that influences individual behavior, and thereby social out-comes, by changing the players’ expectations of how others will behave. In orderfor a law to be effective, there needs to be a shared belief that its content, and moregenerally law-abiding behavior as such, is accepted by the majority. Put formally,this implies that ‘[i]f an economy has several Nash equilibria, then even if the lawpicks a Nash equilibrium . . ., it may not be realized because it may not be focal’(Basu, p. 67). In addition to the invisible hand of the market and the visible hand ofthe state, human behavior hence is coordinated by social consensus.

Basu’s argument about the social acceptance of laws highlights that for aneconomy to function properly self-interested behavior, formal institutions andshared beliefs need to be in tune with each other. This insight broadens thehorizon for social inquiry considerably. Beyond the Invisible Hand, consequently,does not provide any definite conclusion, but rather a number of suggestions for afuture research agenda.

The books under review advance two rather distinct frameworks for scientificinquiry. Beyond the Invisible Hand provides a rigorous mode of alternative micro-economic inquiry. The author’s use of game-theoretical reasoning constitutesan honest attempt to move away from the strict adherence to methodological

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individualism prevalent in mainstream economics. While Basu’s central contri-bution is to show that beyond the world of prices there lies a realm of institutionsand social norms, his approach is firmly rooted in the idea that the self-interestedbehavior of atomistic individuals tends to generate benign economic outcomes.

Quiggin, on the other hand, prefers to move away from the paradigm of theinvisible hand. Zombie Economics presents a critique of the latter in terms of ahistorical account and advocates for economic theory and policy to start from aconsideration of aggregate economic phenomena. Regardless of whether theseapproaches are reconcilable, both authors share two laudable concerns: first, toturn economics into a socially more useful body of thought and, second, toreconsider, in an undogmatic fashion, the rationale for state intervention.

Johann K. JaeckelNew School for Social Research

Email: johann.jaeckel@gmail.com# 2012 Johann K. Jaeckel

References

Akerlof, G. & Shiller, R. (2009) Animal Spirits: How Human Psychology Drives the Economy, andWhy It Matters (Princeton: Princeton University Press).

Kuhn, T. (1970) The Structure of Scientific Revolutions, 2nd edn (Chicago: University of ChicagoPress).

Lakatos, I. (1970) Falsification and the methodology of scientific research programmes, in: I. Lakatos& I. Musgrave (Eds) Criticism and the Growth of Knowledge (Cambridge: Cambridge UniversityPress).

Lerner, A. (1972) The economics and politics of consumer sovereignty, American Economic Review(Papers and Proceedings), 62, p. 2582266.

Schelling, T. (1960) The Strategy of Conflict (Cambridge, MA: Harvard University Press).

Thorstein Veblen and the Revival of Free Market Capitalism

Janet T. Knoedler, Robert E. Prasch & Dell P. Champlin (Eds)Edward Elgar Publishing, 2007, 264 pp., £69.95 hardcoverISBN 978-1-84542-540-1

The book collects ten papers along with an editors’ introduction. As the editors, whoare well-known institutionalists, explain in their introductory chapter, ThorsteinVeblen was a fascinating and unique American economist. Veblen is not merelythe founding figure of institutional economics; his singularity is also derived fromhis attempts to understand the general features of the modern era. By applyinghistorically grounded theory, Veblen tried to explain how the emerging industrialorder shapes both an economy and society. His work addresses almost all of theimportant issues that have affected human beings since the dawn of modern capit-alism; such as consumption, finance, capital private property, the place of science,the machine process, economic change, business enterprise and habits. Contributorsof the book re-examine the various issues that Veblen analyzed. They also ‘consider

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