A Must-Read Article!

Paul Krugman, the nobel-prize winning economist and NY Times columnist who sometimes goes in for more polemic than he should, has just written an excellent and quite long article about the economics profession, its past and future. It is rare that I just say "go read this," but that's what I'm urging. Among other things, he seems to praise Larry Summers, which is a big thing for him to do since they have been otherwise perceived as rivals.

Here's his conclusion after considerable detail: "So here’s what I think economists have to do. First, they have to face up to the inconvenient reality that financial markets fall far short of perfection, that they are subject to extraordinary delusions and the madness of crowds. Second, they have to admit — and this will be very hard for the people who giggled and whispered over Keynes — that Keynesian economics remains the best framework we have for making sense of recessions and depressions. Third, they’ll have to do their best to incorporate the realities of finance into macroeconomics." Please, don't comment on this post without reading the article.
My take on this piece that he's basically correct that the efficient market hypothesis, in both strong and weak forms, has simply failed too often to continue to be the basis of macroenomic social science.

However useful rational actor assumptions are, and they are very useful, particularly for micro theory, macroeconomics has to deal with the fact that there is enough irrational behavior to distort the macroeconomic world. The engine of this needs to be explored, not assumed away. One thing to focus on is the source of capital accumulation - profit. Profits should be very modest in a world of perfect competition. One might suggest that profits, which lead to the accumulation of capital that drives capitalism, depend in no small measure on the inefficiencies in the market. Perfect competition pushes profits toward a minimum level; imperfect competition allows extraction of much higher rents for some. The ability to produce a product and sell it consistently at 50% profit to you is a source of great capital accumulation, but depends on imperfect market forces. Arbitrageurs should eliminate large profits, the ability to buy something at X price and sell it immediately at X+Y price for Y profit. When that doesn't happen, large profits can be reaped over sustained periods. Thus, relatively small amount of irrational behavior may take on oustized importance in the economy for the simple reason that it is a main source of capital accumulation.