New paper posted

I have posted a new paper, co-authored by Owen Sims, on critical nodes in directed networks. It addresses the appropriate definition of what exactly critical nodes or middlemen are in the general class of directed networks. We also discuss the link with contestability in networks.

Visit the network analysis page for more information and PDF files of the paper.

Thinking about networks and platforms

I just posted a new paper with Dimitrios Diamantaras on how middlemen compete in a network environment. We view a middleman here as an explicit provider of a two-sided interaction platform. FRom that a theory of competitive behaviour is developed as ambiguous decision making in a game theoretic framework. Here the middleman is ambiguous whether she is contested in her middleman position or not.

Interestingly we conclude that there emerges a mixed picture. In many cases the middleman will continue to extract maximal rents, but if competition is “normal” and effective, then middlemen can actually engage in a more competitive fashion, as expected through a standard Bertrand-like argument.

Visit the economic theory page for details.

Modern Political Economics: Chapter 6

I continue to read “Modern Political Economy: Making sense of the post-2008 world” by Yanis Varoufakis, Joseph Halevi and Nicholas Theocarakis, published in 2011 by Routledge. Here I discuss Chapter 6.

Chapter 6 is a very critical assessment of marginalism and neo-classical economics that came forth from the marginalist “revolution” in economic theorizing in the 1870s. The marginalists (Jevans, Menger and Walras) deviced a subjective theory of value. This approach argues that the value of a commodity is the outcome of interaction between demand and supply for that commodity in a perfectly competitive market. This reasoning was extended into a broader theory referred to as neo-classical economics and, ultimately, into a general theory of market systems, which can be referred to as the neo-Walrasian paradigm in economics.

The authors mainly criticise marginalism from their perspective on the “inherent error”. The critique mainly focusses on the inherent problem that a subjective theory of value does not allow the development of a proper theory of growth.

No mention here of a “lost truth”, even though marginalism itself has morphed into the neo-Walrasian paradigm and more recently into a broad theory of subjective interactive decision making, called game theory, that now extends these fundamental subjective principles to all decision making processes. (Think “Freakonomics” here.)

In my opinion this chapter shows how limited the critical perspective of the authors is. It mainly restricts itself to a very classical viewpoint on what economics should be and is, therefore, very Marxian in nature. I think that marginalism’s main construction error is the required commodification of all economic interaction and the exclusion of value-generating interaction (such as most services) from its perspective. Using marginal valuation, requires that the traded substance is in principle measurable using a continuous scale. Most things that we do in our real lives are not subject to such simplistic measurement; they are naturally “discrete”.

Modern Political Economics: Chapter 5

I continue to read “Modern Political Economy: Making sense of the post-2008 world” by Yanis Varoufakis, Joseph Halevi and Nicholas Theocarakis, published in 2011 by Routledge. Here I discuss Chapter 5.

This chapter considers and restates Marxist theories of the classical capitalist economy. Clearly, it continues from the previous chapter. As usual in the Marxist approach, the focus is completely on production processes and neglects the consumption side of the economy. This chapter is written in the same somewhat cumbersome style as the previous chapter.

The chapter opens with a discussion of the dual nature of labour. A producer purchases in the market labour time or labour power, while the worker contributes labour input, which is uncontrollable by the producer through the labour contract. So, while labour time or power can be traded in a market, the value-generation labour input occurs after the labour time has actually been acquired by the producer. In modern terms, the latter refers to the principal-agent problem of the labour relationship. The dual nature of labour explains economic profit in Marx’s theory. Profit is a permanent and essential feature of capitalism that signifies its dynamism. The dual nature of labour allows producers to claim the residual value of its inout every time that labour time is traded. Thus, profit is based on the difference between its use value (labour input) and its exchange value (labour time or power). The capitalist reaps the generated surplus and covers rents and interest from it.

This theory of labour results into an explanation of economic cycles, which in turn goes to the centre of the Marxian argument that economic crises are necessary episodes in capitalist development. Indeed, mechanisation of the production processes results into higher wages, leading to lower residuals for capitalists. This triggers layoffs and higher unemployment and ultimately an economic crisis. During the downswing wages fall and profits rise again.

The flaws of this reasoning are well recognised: the analysis omits the effects on the demand or consumption side of the economy and the socio-economic institutions. The authors also reason that if the analysis is extended to amore realistic multi-sector model, the results are less straightforward and do not lead to the desired political conclusions as aimed for by Marx.

Next, the authors embark on the usual link of the failure of Marxian economics and the issue of”inherent error”. Marx tried to build a theory that combines an explanation of value and economic dynamics and development. His failure is another example of this problem of inherent error in economics. But important insights from his analysis were subsequently forgotten, in particular the idea that capitalism is inherently unstable and subject to natural crises and the insight that labour has a dual nature.

I would like to add a few of my own observations to this about the theories that have been discussed in the chapters in this book thus far. First, all theories rest on the dogma that a single commodity has a unique price, reflecting its “true value”. This implies there is a global trade platform in which this price is established, presumably the “market”. There is no empirical evidence for that. In fact, goods are infinitely differentiated and trade at many different prices.

Second, if we take this differentiation as given, then it follows that power structures in economic organisations are infinitely diverse as well. Any model of capitalism indeed needs to take into account all sectors in the global economy simultaneously. This was also recognised by Marx in the third volume of “Capital” as pointed out by the authors.

Therefore, our understanding of capitalism needs to be amended with an understanding of economic organisations and human embeddedness in these organisations. Economic organisations are dualistic in nature as well: They facilitate interaction, but simultaneously they constrain our freedom to act. More advanced economies with higher productivity require more complex, deeper organisations. These deeper organisations are indeed facilitating larger wealth creation, but at the same time they are more constraining through the exercise of control (“power”). Thus, tragically human enterprise constantly faces a battle between facilitation or freedom and organisational functionality or power. This duality also might be viewed as a fundamental cause for economic and political crises in our societies. Our economy is founded on a perpetual pendulum between empowerment and freedom.

Modern Political Economics: Chapter 4

Continuing to read “Modern Political Economy: Making sense of the post-2008 world” by Yanis Varoufakis, Joseph Halevi and Nicholas Theocarakis, published in 2011 by Routledge. In this and next posts I will collect my comments, chapter by chapter. Here I discuss Chapter 4.

This chapter starts strangely enough with an excursion into the science fiction world of “the matrix”, a world ruled by machines that exploit human beings for their heat source. The authors develop this into a two-sector model that exceeds the complexity of the Ricardian one-sector corn model. This modelling exercise results into a growth equation that describes a stable growth path of the economy. Ultimately, the growth rate is fully determined by the exogenously given growth rate of the determining scarce resource, being the heat source. The model, thus, depicts an economy which is fully controlled by a central authority. This authority selects weights for the various factors fully to set the stable growth path determined by the external heat source.

The authors then ask some philosophical questions about machine economies versus human economies. Can one talk about “value” in a machine economy? The conclusion is that such an ontological question has no true answer. We need to hypothesise about what value means. The authors now hypothesise (claiming Ockham’s Razor) that only freedom of decision making leads to the human conditions to lead to value rather than function. So, for the authors value is directly linked to human decision making and needs. It also presupposes freedom of such human decision making: Free thinking as well as a modicum of freedom of action.

This then brings up the very important question: What is freedom? In particular, in the context of the matrix economy this is a very interesting ontological question! I think that freedom itself is a social construct. Indeed, our free thinking is always constrained by the social mores and society’s constraints through its social norms and rules. Thus, freedom is. Function of socio-economic embeddedness of all actors. In that regard, history shows that human freedom is always constrained and never completely accessible; it is a social construct.

This shows the slippery slope that we enter if we engage in thinking about machines versus humans in the matrix economy…

This slippery slope is however followed further by the authors by stating that economics only becomes necessary in a world in which there are pools of free human labour that are employed in social production organisations. Hence, economics is useless to describe all ancient economies, the feudal economy as well as the traditional Asian economies. This seems a fallacy to me.

The main argument used by the authors is that free human labour pools resulted into wealth creation at an unprecedented scale. Again the linearisation of history hits us in the face here. Was the wealth level generated in the Roman Empire not only matched again at the end of the 19th century? And does economic theory not treat labour as any other input, making it non-distinguishable from any other economic intermediary? What use is economics in that regard then if it treats human labour as if it is not subject to free will and self-consciousness? It seems the authors only confuse matters and have only thought this through to a certain level. Their philosophical reasoning remains wanting.

The authors argue that the incompleteness of the incompleteness of the human labour contract and the moral hazard nature of the employment relationship actually define the human condition. I only note that this subject is a rather limited part of certain fields in economic theory, like game theoretical labour economics; it certainly does not enter sufficiently into macroeconomic reasoning. There labour just remains another commodity traded in a market.

Subsequently the authors move to the discussion of Marxian political economics based on these insights. The global economy can be viewed as thoroughly Smithian, while the underlying counter processes are Hegelian. Marx brings these two lines of reasoning together: Free human labour becomes irrevocably enslaved by capital (machines) and this commodification of human labour results in economic crises such as 1873, 1929 and 2007-08. Only the move away from the Smithian adoration of physical or outer wealth in favour of the Hegelian dialectic dynamic to achieve a higher consciousness and inner wealth would result in a more stable society.

This chapter is therefore a call to develop a much deeper understanding of economic dynamic processes. Only through understanding such processes, we get a handle on how to improve our society to regulate unwanted deep crises such as listed above. I fully agree with this sentiment.

Modern Political Economics: Chapter 3

I am currently reading “Modern Political Economy: Making sense of the post-2008 world” by Yanis Varoufakis, Joseph Halevi and Nicholas Theocarakis, published in 2011 by Routledge. In this and next posts I will collect my comments, chapter by chapter. Here I discuss Chapter 3.

Condorcet’s Secret refers to the fact that the complicated economic organisation of society obscures or veils the distribution of power. In feudal society there is the least veiling of power, since land owners take their share post-production rather than pre-production. In an industrial society this is different due to the complication of reward before and during completion of trading process; supply chains need to be supported by an advanced social financial organisation based on debt instruments.

French Physiocrats introduced the idea of surplus related to exploitation of a single productive sector, namely the agricultural sector. This neglects the role of cities as essential hubs in the networks founded on advanced social division of labour.

This reasoning was extended through the work of Adam Smith and David Ricardo. The latter resorted to a single sector “corn model” to solve this inherent error problem. Both classical thinkers based their theory of value on labour inputs, due to their contemporary situation in which all economic value was clearly underpinned to the subsistence compensation of labour in terms of foodstuffs. Hence, all economic commodities and activities were directly linked to corn as a means to replicate labour. This links again directly to Ricardo’s corn model as a metaphor for economic thought. Even today our thinking is very much tainted by thinking about the economy as a single commodity or sector. Extension to multiple sectors turns out to be impossible, as is the case with the corn model. This again refers to the Inherent Error in economics, which still remains clouded and unexplained, even though the authors spend quite a bit of space on debating it again in this chapter.