Research Desk (August 21, 2025)

Prof. Steve Keen, a renowned critique of neoclassical economics and a strong and vocal proponent of new economics using complexity and system dynamics came all the way from Netherlands and UK to Malaysia for an intensive 3-day workshop at International Islamic University of Malaysia. The workshop was organized by the Center of Islamic Economics at the International Islamic University of Malaysia from August 19 to August 21, 2025.

The workshop was well attended by the academics from the finance, economics and business administration departments at the Faculty of Economics and Management Sciences. The workshop participants also included the PhD and Masters students at the Faculty of Economics and Management Sciences and Institute of Islamic Banking and Finance at the International Islamic University of Malaysia. Participants from INCEIF Malaysia and Bank Negara Malaysia also joined in their individual capacity.

Prof. Mohamed Aslam Haneef, Deputy Rector, Research, Innovation nd Development at IIUM started the workshop with his welcoming remarks highlighting the need for change in the way the field of economics is being developed and taught. He highlighted the vision of the International Islamic University of Malaysia to instigate debates about economic discourses for reform.

Prof. Steve Keen started his series of lectures of the workshop by debunking the loanable funds theory of banking first. He said that it is incorrect to think that banks lend out money from the cash received in the form of deposits. They create fiat money out of thin air. After the removal of required reserve ratio in some jurisdictions including USA, there is theoretically no limit to how much money the banks can create.

He provided empirical simulations using the data in his well-developed software Ravel to illustrate the non-trivial nature of money and banks in the economy. The neoclassical model takes banks as shadow institutions and treat money as neutral in the standard models.

Prof. Keen also emphasized the role of debt and financial instability in economic crises, challenging the efficient-market hypothesis that assumes that markets are inherently stable. Prof. Keen shared apprehension on bank lending for speculation and consumption of imports. It is not only unproductive, but also creates asset bubbles and have negative effects on the real economy.

Prof. Keen highlighted that the economy does not operate in a static setting and equilibrium is not a stable state. The dynamics and complexity cannot be accommodated in simple neoclassical models which focus on perfect markets and instantaneous convergence to a unique and stable equilibrium. He argued that complexity in the real-world dynamics cannot be captured through simplistic models. 

Prof. Keen debunked the market economics by criticizing the very foundations of demand and supply. He showed how in many ways neoclassical economics has wrong micro foundations, is empirically false and shallow in addressing the global challenges analytically. Prof. Keen challenged the fundamental concepts like supply and demand curves.

He criticized the unrealistic assumptions used to aggregate utility by going from individual preferences to social ones. The standard approach only works with a single consumer and one commodity, but traditional economics demonstrates their necessity and then continues unchecked. He argued that any change in relative prices will have an effect on income distribution as well. Neoclassical economics makes unrealistic assumptions about the constancy in income distribution and homothetic preferences across cross sectional units. The axioms of consumer preferences required for “well behaved preferences” are also violated by the consumers in inductive studies.

On supply curves, Prof. Keen argued that rather than facing costs that increase with output, firms mostly face falling marginal costs. Prof. Keen cited several real world empirical studies which have documented it as a regular occurrence rather than an abnormality. This means that there is no ‘supply curve’ in the way mainstream economists define it. This subsequently destroys the basis for calculations of output and employment.

Prof. Keen points out that many core concepts in mainstream economics lack empirical support, citing examples like the demand curve and the theory of the firm. Firms put together capacity, technology and inputs pre emptively rather than actually making decisions at the margin in the literal sense.

Prof. Keen argued that in the real world, firms set prices, segment markets, engage in price discrimination, and different pricing strategies in different stages of the product life cycle. While the microeconomics and industrial economics acknowledge this in microeconomics, the macroeconomics built around the representative agent fails to incorporate any form of realism in the micro foundation, market structure and the financial system.

Prof. Keen gives example of how neoclassical economics is bad at forecasting. Not only it failed to predict the great financial crisis, it also makes unrealistic forecasts about the effect of climate change on the economy by wrongly extrapolating about the future by taking stock of only the past and current data. Such extrapolations lead to highly misleading estimates about the small impact of global warming on the GDP.

The estimates by the economists show that even at worse, the GDP would hardly be affected even if the temperature becomes warmer by 5 degrees centigrade. Such wrong estimates are highly misleading and affect the very sustainability of humans and other species. Rather than dealing with climate change effectively, such misleading estimates promote business as usual.

On production function, Prof. Keen explained that without energy, nothing can be produced, and yet energy is ignored in the ‘production functions’ used by mathematical modellers from all schools of economics—and not just the dominant neoclassical economists. The total factor productivity is calculated as a residual and appears as a black box. The use of frictions and shocks with gravitation towards the idea of stable equilibrium is a no-starter in modelling the real world complex economy.

Prof. Keen explained that rather than being a science, neoclassical economics is little more than an ideology whose main aim is to justify and rationalise the existing market economy system and neo liberal ideology. He gives example of China where monetary, capital and economic control administered by the well-coordinated government achieved miraculous turnaround in the last 40 years. Prof. Keen thinks that it is the private debt which goes in speculation that creates instability.

He thinks that there is unnecessary apprehension about government deficit. He agrees with some features of modern monetary theory and thinks that increase in money supply which is channeled into building productive capacity can bring about increase in production and employment without inflation.

Prof. Keen also explained that much of the theory focuses on static analysis rather than dynamic analysis. Even though, the frontiers of the discipline have started using dynamic exposition and tools of analysis, they remain an extension rather than the original core.

Prof. Keen argued for a fully dynamic economics, using tools such as differential equations and not just linear algebra. He highlighted the fact that the problem with economics is not mathematics but rather inappropriate mathematics and wrong way of looking at the data. Prof. Keen’s approach is critical, yet constructive. Rather than throwing baby with the bath tub, he offers a solution to move forward by taking stock of what we have and improving mathematics and analysis.

As Prof. Keen argues, neoclassical economics is based on a “dynamically irrelevant and factually incorrect instantaneous static snap-shot” of the real capitalist economy.  Equilibrium analysis simply presents an unreal picture of the real world. Economics treats a dynamic system as a static one, building models rooted in the concept of equilibrium when a non-equilibrium analysis makes obvious sense.

He had developed a software and tools of analysis to incorporate complexity in economic modelling. The Ravel software helps in visually building the economy without daunting mathematics at the forefront. It also incorporates stocks and flow approach using double entry bookkeeping to see the dynamics more closely and deeply. The software also has several powerful analytical features which ease the analysis as compared to the standard spreadsheet tools. The interface is user-friendly, interactive, visual, fast and flexible. The software is not only handy for economists, but also analysts who want to run simulations and data analysis.

Prof. Keen provided many reasons to be confident in looking at alternatives to neoclassical. The key takeaways are that money should not be seen as a commodity, private debt creation should be within limits and focused on asset creation, government shall put money in productive capacity, limit imports to the limit of exports or thereabout rather than borrowing in foreign exchange and limiting financial sector share in GDP to allow more share in pie to the workers and firms.

These are all ideas resonating quite well with Islamic economics as well. Prof. Keen has paved the way of thinking about the economy in a new way incorporating system dynamics and complexity.