Posts Tagged ‘neoclassical’

oligopoly

One story that can be told about today’s announcement is the Royal Swedish Academy of Sciences’ own explanation: that French economist Jean Tirole has been awarded the The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for 2014 because he “has clarified how to understand and regulate industries with a few powerful firms.”

The other story is: Tirole has shown how much the real world of capitalism—industries that are dominated by a few firms that have extensive market power, which can charge prices much higher than costs and block the entry of other firms—differs from the fantasy taught in countless introductory courses in economics: a world of perfectly competitive firms, which have no negative effects on society and which therefore don’t need to be regulated.

In addition, Tirole (in “Intrinsic and Extrinsic Motivation,” an article with Roland Bénabou, published in the Review of Economic Studies) has challenged a central tenet of neoclassical economics, that individuals always respond positively to managerial supervision and incentives. He has demonstrated, instead, that both close supervision and monetary rewards can often times backfire, especially in the long run: they can undermine intrinsic motivations, thus explaining why workers find behavioral punishments and rewards both alienating and dehumanizing.

Last year, the Academy tried to have it both ways, offering the Prize to both Eugene Fama and Robert Schiller. This year, the message is both clearer and yet unspoken: the neoclassical model of perfect competition and individual incentives bears no relation to the kinds of capitalism that exist anywhere in the world.

And the policy implication: we’ll all be better off if we take over the large firms and let workers run them for society’s benefit.

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I have often argued that neoclassical macroeconomics is obsessed with class—and biased against the working-class—even when class is not explicitly represented in the models. That’s because, as I explained here,

neoclassical economists blame workers and their downwardly rigid wages for creating and maintaining high levels of unemployment. If the labor market is flexible, a fall in the price of labor is presumed to eliminate involuntary unemployment. If it’s not, then other means are necessary, such as austerity policies that raise unemployment, thus creating pressure to decrease nominal (and, with them, real) wages with the promise of eventually restoring full employment.

As it turns out, Mark Thoma also understands that macroeconomic policy has class implications.

Which mistake is more costly – raising rates too soon versus too late – is not just a technical question about which of the two mistakes is easiest for policymakers to reverse. We also need to ask who will be hurt the most if the Fed makes a policy error on one side or the other. If the Fed raises rates too soon, it is working class households who will be hurt the most by the slower recovery of employment. If it raises rates too late allowing a period of elevated inflation, it is largely those who lend money, i.e. the wealthy, who will feel the impact. Thus, one mistake mostly affects working class households who are very vulnerable to negative shocks, while the other hurts those most able to withstand economic problems. . .

Why do we hear so much about the need to raise interest rates now rather than later, or get the deficit under control immediately despite the risks to households who are most vulnerable to an economic downturn? Those who are most in need – those least able to withstand a spell of unemployment or other negative economic events – have the least power in our political system.

With the decline in unions and other institutions that used to give workers a voice in the political process along with rising inequality that gives even more power to those at the top, the problem is getting worse. No wonder policy has been tilted so much in favor of those at the top. Fiscal policy in particular has been far too responsive to the interests of those with political power rather than those in greatest need.

If we are going to be a fair and just society, a society that protects those among us who are the most vulnerable to economic shocks, this needs to change. The necessary change won’t come easily, the entrenched political and economic interests will be difficult to dislodge.

But the current trend of rising inequality in both the economic and political arenas along with the rising economic risks faced by working class households due to globalization, technological change, and a political system that increasingly neglects their interests is not sustainable. If these trends continue unabated, change will come one way or the other. The only question is how.

And, of course, one of those possible changes is for the working-class to abolish class entirely.

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As if to illustrate the point I made the other day (about earnings at the top being themselves distributions of the income captured by capital), Seth Ackerman put together the chart above (from data in Simon Mohun’s recently published article on unproductive labor) comparing the sum of profits and managerial compensation to non-managerial compensation, both as shares of total net income.

Indeed, in a direct rebuttal of the neoclassical marginal-productivity theory of distribution, capital’s share of income has been growing at the expense of labor’s share since the late-1970s.

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Gary Becker’s recent death has provoked widespread praise (for example, from Peter Lewin through Justin Wolfers to Amita Etzioni) for his role in initially creating and then extending “economics imperialism.”

The basic idea (as presented on Wikipedia, by Edward P. Lazear [pdf], and in this interview with Becker himself) is that economics imperialism refers to an “economic analysis of seemingly non-economic aspects of life,” such as crime, law, the family, racial discrimination, tastes, religion, and war.*

Actually, that’s wrong. Economics imperialism is not the economic analysis of supposedly noneconomic behaviors and institutions; it’s the extension of neoclassical economics to those domains. Economics imperialism is, in this sense, the highest stage of neoclassical economics.

There are lots of different ways of making sense of the economic dimensions of our individual and social lives. What Becker and his followers set out to do was to analyze various aspects of individual decisionmaking and social institutions through the lens of neoclassical theory. This has meant reducing those decisions and institutions to individual, rational, self-interested calculations of costs and benefits, under conditions of scarcity, such as to arrive at efficient, equilibrium solutions.

The imperialist extension of neoclassical theory to supposedly noneconomic phenomena was predicated on the formation of a neoclassical monopoly within the discipline of economics. Once that monopoly over teaching, research, publications, and funding was achieved within the traditional domain of the discipline in the postwar period, it became possible to branch out and colonize the rest of the space of social theory. (I should note that the monopoly of neoclassical theory within the discipline was never complete, and has been contested throughout the postwar period.) That’s what economics imperialism was all about: to attempt to create a theoretical monopoly across the social sciences by exporting the methods of neoclassical economics to other domains. This is what made it different from the previous period, when it was the conclusions of neoclassical economics that were exported to other disciplines; now, it was the method that was being exported.

The result, of course, was not to unify social theory across the disciplines but to create new divisions within the disciplines. It’s no longer a battle between, say, economists and sociologists but, instead, between neoclassical economists and sociologists, on one hand, and non-neoclassical economists and sociologists, on the other. Much the same is true in political science, anthropology, psychology, and so on. And it’s not just a battle over the use of some of the key concepts and tools closely identified with neoclassical economics (such as mathematical modeling, rational choice, equilibrium, and so on) but over the actual entry points of social analysis. Because, in the end, that’s what Becker’s neoclassical analysis privileges: the reduction of the social space to the decisions and actions of individual subjects.

The real challenge to economics imperialism—inside and outside the discipline of economics—is, as Louis Althusser put it, the idea of a process without a subject.

 

*What I didn’t remember, or perhaps never knew, is that Becker understood his work to be a critique of and an alternative to Marxism (or at least what he took to be Marxism). It’s right there at the beginning of his Nobel lecture [pdf] and the interview with Religion and Liberty:

R&L: You are sometimes called an “economic imperialist.” What is meant by this?

Becker: That refers to my belief that economic analysis can be applied to many problems in social life, not just those conventionally called “economic.” The theme of my Nobel lecture, based on my life’s work, is that the horizons of economics need to be expanded. Economists can talk not only about the demand for cars, but also about matters such as the family, discrimination, and religion, and about prejudice, guilt, and love. Yet these areas have traditionally received little attention in economics. In that sense, it’s true: I am an economic imperialist. I believe good techniques have a wide application. Adam Smith and many others believed that as well.

On the other hand, my economic imperialism doesn’t have anything to do with crude materialism or the view that material status is the sum total of a person’s value. That view has much more in common with Marxist analysis.

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I know. I wrote I wouldn’t be able to comment on Thomas Piketty’s book, Capital in the Twenty-First Century, until I found the time to read it, which won’t happen until the semester is over.

But the debate about the book is taking off and I simply don’t have the patience to wait until my lectures are over and final grades turned in. So, permit me, for the time being, to comment on the commentary.

Thomas Palley has observed that “Neoclassical economists have always talked of capital (K). The forbidden subject is capitalism.” Yes, but, even in talking of capital, they have a problem, one that was addressed during the 1960s in the Cambridge capital controversy. As Joan Robinson argued (and as my students used to learn in Principles of Microeconomics), capitalist income (total profit as the return on capital) is defined as the rate of profit multiplied by the amount of capital. But the measurement of the “amount of capital” involves adding up quite incomparable physical objects – adding the number of assembly-lines to the number of shovels, for example. That is, just as one cannot add heterogeneous “apples and oranges,” we cannot simply add up simple units of “capital,” unless one knows the price of capital, which is the rate of profit. Thus, you can’t use the amount of capital (as in the neoclassical aggregate production function) to determine the rate of return on capital—unless you already know the rate of profit.

That’s the thorny problem Paul Krugman simply sidesteps in defending Piketty’s use of the aggregate production function. Even Paul Samuelson had to concede the validity of Robinson’s critique.

But Krugman is right in arguing “you really don’t need to reject standard economics either to explain high inequality or to consider it a bad thing.” I agree. What’s interesting is that, as Piketty shows, it’s possible to analyze and criticize inequality using some of the tools of neoclassical economics. Not easy but it’s possible. Which means that neoclassical economists, for the most part, choose not to try to analyze and criticize inequality. In other words, the fact that they don’t spend much of their time—in teaching, research, and offering policy advice—in analyzing and criticizing the grotesque levels of inequality we’ve seen in recent decades is, in part, an ethical question. They could but they don’t.

And that’s perhaps an even more damaging critique of mainstream economics than the capital controversy itself.

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Back in 2009, in the midst of the Great Crash (and therefore at the start of the Second Great Depression), a colleague and friend asked me whether I expected the teaching of economics to change. His view was that, since mainstream economics had so miserably failed in both predicting the crash and providing a guide as to what to do once the crash occurred, it was obvious the economics being taught to students had to fundamentally change. My answer was that, while the need for a change was obvious, I didn’t see it happening—and it probably wouldn’t happen (thinking back to the emergence of the Union of Radical Political Economics in the late-1960s) unless and until students of economics demanded a different approach.

Well, in various places (starting almost a decade before the current crises, with the eruption of the Post-Autistic Economics movement in June 2000), students have been demanding a fundamental change in the way economics is being taught. The latest effort to move that project along is a report from the University of Manchester Post-Crash Economics Society. Here are some of their key findings, which refer to how economics is taught at Manchester but clearly have much wider relevance, in and beyond the United Kingdom:

  • Economics education at Manchester has elevated one economic paradigm, often called neoclassical economics, to the sole object of study. Other schools of thought such as institutional, evolutionary, Austrian, post-Keynesian, Marxist, feminist and ecological economics are almost completely absent.
  • The consequence of the above is to preclude the development of meaningful critical thinking and evaluation. In the absence of fundamental disagreement over methodology, assumptions, objectives and definitions, the practice of being critical is reduced to technical and predictive disagreements. A discipline with a broader knowledge of alternative perspectives will be more internally self-critical and aware of the limits of its knowledge. Universities cannot justify this monopoly of one economic paradigm.
  • The ethics of being an economist and the ethical consequences of economic policies are almost completely absent from the syllabus.
  • History of economic thought is an optional third year module which students are put off taking due to it requiring essay writing skills that have not been extensively developed elsewhere in the degree. Very little economic history is taught. Students finish an economics degree without any knowledge of momentous economic events from the Great Depression to the break-up of the Bretton Woods Monetary System.
  • When taken together, these points mean that economics students are taught the economic theory of one perspective as if it represented universally established truth or law.

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Let’s leave aside for a moment whether the participants were the right ones to call on (I would have turned to plenty of better commentators, who have read both Marx and contemporary scholarship on Marxist theory, to offer their opinions) or even whether they get Marx right (very little, as it turns out).

What’s perhaps most interesting is that the New York Times felt the need at this point in time to host a debate on the question “was Marx right?” and, then, that most of the participants admit that Marx did in fact get a great deal right.

The problem is, of course, that at this point in time mainstream economics (in either its neoclassical or Keynesian varieties) is not a particularly good guide for analyzing or proposing solutions to the key economic problems of soaring inequality, massive unemployment, and generalized insecurity of a broad mass of the population in the United States and in other high-income countries. So, I suppose it’s not surprising people continue to turn to Marx for ideas about how to make sense of the economic contradictions that caused the Second Great Depression and the new contradictions that right now are preventing a full recovery of capitalism.

In the end, what is key to Marx is not this or that prediction (of which, as it turns out, there is very little in the texts, although there certainly are lots of tendencies that critics are hard put to ignore or effectively counter) but, instead, the idea of critique. Because what Marx set out to do over the course of the three published volumes of Capital was provide the cornerstones for a far-reaching critique of political economy. And the method of that critique—a two-fold critique, of mainstream economic theory and of capitalism as a system—is what endures, precisely as a challenge to what passes for serious economic analysis today.

Marx, then, was surely right about one thing:

if constructing the future and settling everything for all times are not our affair, it is all the more clear what we have to accomplish at present: I am referring to ruthless criticism of all that exists, ruthless both in the sense of not being afraid of the results it arrives at and in the sense of being just as little afraid of conflict with the powers that be.