Economics and the schools that teach it have been wrong for such a long time that its students have collectively embraced a mythical model that does not account for the role of money, banks, debt or land.
Renegade economist and friend of the show, Professor Steve Keen recently took the stage at the Sunday Papers event in London to discuss what you’re not being told about the global economy.
Professor Steve Keen, the renegade economist who ‘imperfectly’ predicted the 2008 Global Financial Crisis was recently interviewed on-stage by Renegade Inc co-founder and presenter, Ross Ashcroft, at the Sunday Papers Live event in London about the economic myths embraced by most classical economists, politicians, central bankers, investors and the public at large.
“I don’t believe in fairy stories,” said Professor Keen. “As much as I might enjoy looking at them on the walls I am not going to base my economic theories on fairy stories.”
The professor says economic theory involves a whole range of fantasy concepts which are framed in terms that sound sensible, but are in fact, utterly wrong.
“Who here thinks they are rational?,” he asked the crowd.
“Can you predict the future? Then you’re not rational according to economic theory, I’m sorry.”
Neoclassical economic theory claims that the human being is a rational self-serving profit maximising unit. It claims to prove the market can handle anything.
Classical economists model the economy based on the concept of rational consumers maximising utility and firms maximising profits. Their vision of the world claims that equilibrium is reached and the world functions best if there is no government, no trade unions and no monopolies.
Professor Keen says mainstream economist change reality to fit their model.
University campuses used to be about education, challenging people exposing them to ideas they didn’t necessarily have in the first instance. But Professor Keen says economics actually leads away from this possibility.
“Economics starts by inculcating a view of how you should think about the economy that rules out a whole range of alternatives,” he said.
“It rules out thinking about the sort of work that I do, working from the top down, looking at the overall economy and modelling that way. They say ‘no, you’ve got to start from the isolated individual and you have to talk about individuals for maximising utility’. We’re talking about them as consumers or firms who are maximising profits.
“In their mind that is the definition of a perfectly functioning system, but it is not the definition of the world in which we live.
“Once you’ve got the mathematical structure of trying to do that, you have a very hard time treating anything else as a sensible analysis of capitalism. They rule out a whole lot of other ways of thinking.”
Classical economist make their models work by ignoring certain factors or variables.
“They call it ‘simplifying assumptions’, says Professor Keen.
He says economists and students of economics must urgently learn the difference between a simplifying assumption and a fantasy.
He described the practice of economics as a ‘game’ and a ‘cult’.
“Think about the economy during the global financial crisis,” he said. “The Federal Reserve’s own modelling said not only was it not going to happen, its models predicted 2008 was going to be a tremendous year for the global economy…
“Imagine you go to the doctor and you get a fantastic diagnosis, no problem at all, then two weeks later you die of cancer,” says Keen.
The professor already had working demonstrating that this was very much not going to be the case for 2008 and the chief economist of the Federal Reserve described his predictions as ‘quite benign’.
“That’s how bad they are,” he said. “They didn’t take my the report as ‘holy shit we’ve gone the wrong way. We’ve got to change’. Now they claim we have to revise what we think economics is about.”
The neo-classical mentality has captured a vast consensus of people in positions of power, from politicians, to central bankers, to those who work at firms like Goldman Sachs
Keen describes the consensus as “dangerous” because their theories are “simplified, simplistic and, frankly, wrong.” But still universities persist with teaching this stuff so it remains an acceptable consensus.
You might be surprised to discover that classical economic theory does not account for the role of money, banks or debt.
“Imagine capitalism with no banks, no debt, and no money,” says Professor Keen. “You’re getting pretty close to being a neoclassical economist.”
“Neoclassical economists are not experts on money but experts in finding reasons to believe you can model capitalism as though money banks and debt don’t exist.
“And then you give them the right to control the banking system.”
It also eliminates land from their modelling.
Most people regard Adam Smith as the father of economics. But Professor Keen regards him “as the guy who led us astray”.
Smith’s early economic education began in France when he came into contact with a group called ‘the physiocrats’, (named for Francois Connay, the physician to the French King; hence physio-Croats) who correctly claimed all wealth comes from land.
“But Smith buggered it up by saying it’s not land that is the source of the growth in wealth, but labour specialisation,” says Professor Keen.
“In effect he even jumped over where the surplus comes from in the first place. How can we get more stuff every year? He jumped over that question.
“The physiocrats claimed that where there’s a sense of possibility of ‘stuff’, it comes from the sun: The plants absorb it, the farmers then harvest it and the rest of us convert into different forms. But the fact that there is physical stuff we can all consume, comes from the sun. And that’s correct. That’s correct according to the physical laws of thermodynamics. But Adam Smith began by saying it was specialisation of labour that increased this thing, ignoring where it came from in the first place.
“Then the neoclassicals came along and said it’s labour combined with capital, so labour + capital together = output. That has always been wrong. So all economics schools have always been wrong, until last year.”
The Professor took a spot-poll of the room, asking the audience whether they thought it a sensible that the government should be saving money.
“That means the government should be taxing more than it spends,” says Keen. “Does that sound sensible? Putting money away for a rainy day?”
He explained that when people agree with that claim, they are projecting the experience of the individual in a household, to a social and federal level.
He proceeded to explain why we should not compare household and personal budgets to the budget of the whole economy.
“Let’s say your income is 200 pounds a year and you’re spending £200 a year, so you’re making zero and saving nothing,” he explained.
“I want to save money so I’m going to work the same amount that £200 earns, but I’m going to spend £10 less.”
He divided the room into three groups: Toms, Dicks, and Harriets.
“Tom earns £100 from Dick and £100 from Harriet and spends the same on them. Then he decides he’s going to save money, meaning he’s going to spend £10 pounds less. Now what that means is you’re spending £190, £95 each on Dick and Harriet, and they still spend £100 on you. What’s happened to Dick and Harriet? They have both earned £5 less from Tom. They’re now negative £5. Tom’s attempt to save money has reduced the total income by £10.
“If you keep on doing it, the process of that is zero. This is what the government is essentially doing.
“The only way the government can save money is for one of us to spend. If you want to have the aggregate savings increase, the amount of money in your bank account every year, there has to be someone, somewhere, doing the opposite.”
The amount of dollars the government saves is directly equal to somebody else’s loss of income.
When the government saves, it is literally taking money out of the economy.
Keen described the economy as a warehouse, where each individual, business or organisation is trying to save a part of it for themselves.
“The only way we can get more money in this room is by somebody dumping it into the room, producing it externally,” said Professor Keen.
“There are two people or two organisations that can produce money in a capitalist economy. One is the banks. But for every dollar they give you, they record in another building that you owe them a dollar. So there’s no increase in your area. (Well, if you borrow off a bank you can get a nice bubble out of it. You guys rode a nice bubble in 2007, but you can’t accumulate more net worth).
“But the government can do the same thing. So if the government’s dumping money inside this warehouse every year, it might be through a welfare recipient or contractor or whatever else. It doesn’t come with the matching debt for you.
“Say the amount of money in the warehouse goes up. If you want the government to save money it’s saying ‘let’s take money out of this warehouse and we’re going to try to save at the same time’. It’s frankly impossible.”
Watch the full interview above to understand the myths we have been taught about money and how the economy works.