Posts Tagged ‘neoclassical’


Hans Haacke, “The Invisible Hand of the Market” (2009)

Mainstream economists have attempted to model and disseminate the idea of the invisible hand, especially in their textbooks.*

And, not surprisingly, many others—from heterodox economists to artists—have challenged the whole notion of the invisible hand.

But one of the best critiques of the invisible hand I have encountered can be found in Kim Stanley Robinson’s story, “Mutt and Jeff Push the Button” (which appears in Fredric Jameson’s recent book, An American Utopia: Dual Power and the Universal Army).

Here’s a longish extract:

“So, we live in a money economy where everything is grossly underpriced, except for rich people’s compensation, but that’s not the main problem. The main problem is we’ve agreed to let the market set prices.”

“The invisible hand.”

“Right. Sellers offer goods and services, buyers buy them, and in the flux of supply and demand the price gets determined. That’s the cumulative equilibrium, and its prices change as supply and demand change. It’s crowdsourced, it’s democratic, it’s the market.”

“The only way.”

“Right. But it’s always, always wrong. Its prices are always too low, and so the world is fucked. We’re in a mass extinction event, the climate is cooked, there’s a food panic, everything you’re not reading in the news.”

“All because of the market.”

“Exactly. It’s not just there are market failures. It’s the market is a failure.”

“How so, what do you mean?”

“I mean the cumulative equilibrium underprices everything. Things and services are sold for less than it costs to make them.”

“That sounds like the road to bankruptcy.”

“It is, and lots of businesses do go bankrupt. But the ones that don’t haven’t actually made a profit, they’ve just gotten away with selling their thing for less than it cost to make it. They do that by hiding or ignoring some of the costs of making it. That’s what everyone does, because they’re under the huge pressure of market competition. They can’t be undersold or they’ll go out of business, because every buyer buys the cheapest version of whatever. So the sellers have to shove some of their production costs off their books. They can pay their labor less, of course. They’ve done that, so labor is one cost they don’t pay. That’s why we’re broke. Then raw materials, they hide the costs of obtaining them, also the costs of turning them into stuff. Then they don’t pay for the infrastructure they use to get their stuff to market, and they don’t pay for the wastes they dump in the air and water and ground. Finally they put a price on their good or service that’s about 10 percent of what it really cost to make, and buyers buy it at that price. The seller shows a profit, shareholder value goes up, the executives take their bonuses and leave to do it again somewhere else, or retire to their mansion island. Meanwhile the biosphere and the workers who made the stuff, also all the generations to come, they take the hidden costs right in the teeth.”


*As I have discussed before, the invisible hand is a powerful metaphor “for which neoclassical economists have worked very hard to invent a tradition beginning with Adam Smith.” Smith himself only used the term twice in his published writings—once in The Theory of Moral Sentiments and again in The Wealth of Nations—and never to refer to a self-equilibrating market system, which is the way the term is used by mainstream economists today.

P&B 13.5 Monopoly Smaller Output & Higher Price

It’s the most obvious criticism of mainstream, especially neoclassical, economics.

All of the major models and policy proposals of neoclassical economics—from the theory of the firm through the gains from trade to the welfare theorems—are based on the assumption of perfect competition.

But, as is clear in the diagram above, if there’s imperfect competition (such as a single seller or monopoly), the price is higher (PM is greater than PC), the quantity supplied is lower (QM is less than QC)—and, in consequence, excess profits are not competed away and the amount of employment is lower. (Of course, the monopolist can increase demand, and therefore output, through advertising, which for mainstream economists makes no sense for perfectly competitive firms since they are presumed to be able to “sell all they want to at the going price.”)


The existence of imperfect competition by itself undoes many of the major propositions of neoclassical economics—including (as I explained back in April) the idea that there’s no such thing as a free lunch (since, as in the Production Possibilities Frontier depicted above, point A inside the frontier represents an inefficient allocation of resources, and no new resources or technology would be required, just the elimination of monopolies and oligopolies, to move to any point—B, C, or D—on the frontier).

Readers may not believe it but imperfect competition is mostly an after-thought in mainstream economics. It’s there (and extensively modeled) but only after all the heavy lifting is done based on the presumption of perfect competition—and then none of the major theoretical and policy-related propositions is revised based on the existence of imperfect competition. (The usual mainstream argument is either imperfect competition isn’t extensive or, even if prevalent, imperfectly competitive firms act much like perfectly competitive firms, not restricting output or raising prices by very much. Therefore, perfect competition remains a valid approximation to real-world economies.)

market share

Now, however, imperfect competition seems to have returned as an area of concern—in the White House Council of Economic Advisers and in the Federal Reserve Bank of Minneapolis. The irony, of course, is that the market power of a few giant firms in many industries has been growing after decades of neoliberalism and the celebration of free markets.

As James A. Schmitz, Jr. explains for the Minneapolis Fed, new research

shows that monopolies are not well-run businesses, but instead are deeply inefficient. Monopolies do drive up prices, as conventional theory suggests, but because they also reduce productivity, they often ultimately destroy most of an industry’s profits. These productivity losses are a dead-weight loss for the economy, and far from trivial.

The new research also shows that monopolists typically increase prices by using political machinery to limit the output of competing products—usually by blocking low-cost substitutes. By limiting supply of these competing products, the monopolist drives up demand for its own. Thus, in contrast to conventional theory, the monopolist actually produces more of its own product than it would in a competitive market, not less. But because production of the substitutes is restricted, total output falls.

The reduction in productivity exacts a toll on all of society. But the blocking of low-cost substitutes particularly harms the poor, who might not be able to afford the monopolist’s product. Thus, monopolies drive the poor out of many markets.

The last time monopolies came to the fore in the United States was during the first Great Depression, when Thurman Arnold (from 1938 to 1943) ran the Antitrust Division at the Department of Justice, “taking aim at a broad range of targets, from automakers to Hollywood movie producers to the American Medical Association” in order to protect society from monopoly.

Is it any surprise that now, in the midst of the second Great Depression, attention is being directed once again to the idea that gigantic national and multinational corporations with growing market power are responsible for reducing productivity and crushing low-cost substitutes, thus hurting workers and the poor?

One possibility is to get tough again with antitrust legislations and rulings, and try to restore some semblance of competitive markets. The other is to resist the temptation to turn the clock back to some mythical time of small firms and perfect competition and, instead, through nationalization and worker control, transform the existing firms and allow them to operate in the interest of society as a whole.


The U.S. economy is a remarkable success according to the standards of neoclassical economic theory. Yet, for “prime-age” men, who need to work to provide for themselves and their families, it is increasingly a failure.

That’s the clear lesson from the latest report from the Council of Economic Advisors (pdf) on “The Long-Term Decline in Prime-Age Male Labor Force Participation” (which has been taken up and discussed in a wide variety of news media, from the Financial Times [ht: bn] to the New York Times).

On one hand, the United States, more than any other advanced country, has labor market institutions that represent a neoclassical economist’s free-market dream.

The United States has the lowest level of labor market regulation, the fewest employment protections, the third-lowest minimum cost of labor, and among the lowest rates of collective bargaining coverage among OECD countries. . .In the United States, governments and institutions (such as labor unions) place relatively few barriers in the way of employers who want to change who they employ and what they pay.

That’s exactly what labor markets look like in neoclassical models and what neoclassical economists recommend as the best, “flexible” labor-market policy. It’s a world in which it’s easy to hire and fire workers, which is supposed to facilitate matches between employers who want profits and individuals who want to work.

And yet, on the other hand, the labor-force participation rate of men between the ages of 225 and 54 has been declining since the late-1950s—from a peak of 98 percent to close to 88 percent today (which means the United States now ranks third lowest, above only Israel and Italy, among 34 OECD nations). And the rate for men with a high-school degree or less had plummeted even more, to 83 percent.

In a world in which selling their ability to labor is the principal way for workers to earn enough income to purchase the commodities necessary to support themselves and their families, the extraordinary success in creating neoclassical labor markets in the United States has resulted in a complete failure from the perspective of working people. As a result of declining wages (and, in addition, high incarceration rates, which makes finding a job that much more difficult), prime-age men are simply being forced by employers to drop out of the labor force.*

Now, the decrease in the labor-force participation rate for male workers has not escaped the attention of other mainstream economists and policymakers, as the long-run decline has tremendous implications for economic growth.** Fewer workers (especially since the labor-force participation rate for prime-age women, which had been increasing, leveled off after 1990 and since 2000 has also started to decline) means, in the absence of large productivity gains, less output and slower rates of growth. Therefore, they propose policies that seek to create more flexibility for prime-age men and women within the labor market, to increase their labor-force participation rates.

The alternative, of course, is to create more flexibility for workers outside the labor market—by giving them more say in the enterprises where they work and by creating a universal basic income for all—so that they’re no longer forced to have the freedom to sell their ability to work to a small group of employers.

That kind of flexibility beyond the labor market represents the only real way of solving the failures of neoclassical economists and of the economic and social system they celebrate.


*As the report notes, “The direct effect of increased incarceration is to actually increase the reported participation rate because the official statistics cover only the non-institutionalized population and omit prisoners, people in long-term care, and active duty members of the Armed Services.” But the indirect effect runs in the opposite direction, as these men face substantially lower demand for their labor after they are released from prison.

**Even the International Monetary Fund has recently warned about the negative implications for U.S. economic growth of declining labor force participation—along with slow productivity growth, an increasingly polarized society with income gains concentrated among the wealthiest Americans, and too many people living in poverty.


Every economic theory includes—or, at least, is haunted by—the distinction between productive and unproductive labor. The distinction serves as the basis of all their major claims, from the most basic theory of value to the conception of who deserves what within capitalism.

The distinction began with the French Physiocrats, especially François Quesnay, who in his 1758 Tableau Économique made a distinction between the “Productive” Class (which consisted of agricultural producers) and two other groups: the “Proprietary” class (which consisted of only landowners) and the “Sterile” class (which was made up of artisans and merchants). The idea was that all new value was created only by agricultural producers, not by industry or commerce.

It was then picked up by Adam Smith, who criticized the Physiocrats for overlooking the important contribution of manufacturing to the wealth of nations. While Smith broadened the concept of productive labor (to include both agriculture and industry), he retained the notion of unproductive labor (especially the “menial servants” he worried industrial capitalists would waste their profits on, thus undermining their “historic mission” to accumulate capital).

Karl Marx, in his critique of Smith, took over the distinction between productive and unproductive labor but then transformed it. For him, labor was productive to the extent that it produced surplus-value; all other labor (e.g., the labor of corporate managers as well as that of personal servants) was considered unproductive labor.*

Neoclassical economists, for their part, sought to abolish the distinction between productive and unproductive labor, based on the idea that any labor (when combined with physical capital and land) that contributes to a nation’s wealth should be considered productive.**

And, of course, there’s John Maynard Keynes, who, after the crash of 1929 and in the midst of the first Great Depression, referred to the “rentier,” the “functionless investor,” who contributed nothing but was still able to capture returns based on the scarcity of capital. Keynes therefore imagined a time when, with the aid of the state, capital would become abundant, which would mean “the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital.”

This brief survey of the history of economic thought is just a prelude to Branko Milanovic’s response to Ricardo Hausmann’s invoking of the distinction between productive and unproductive labor (in saying, with reference to Venezuela, “This is the crazy thing about the system. A lot of people are putting in effort [to buy the goods and resell them], and none of that increases the supply of anything. This is perfectly unproductive labor.”):***

That statement made me stop. “Perfectly unproductive labor”? But that “unproductive labor”, as every economist knows, improves the allocation of goods. The goods flow toward those who have greater ability to pay and since we tend to associate greater ability to pay with greater utility, the goods, thanks to bachaqueros’ activities, are better allocated. If one argues that bachaqueros activity is unproductive because it “does not increase the supply of anything” then one should argue that the activity of any trade or intermediation is unproductive because it does not produce new goods, but simple reallocates. The same argument could be used for the entire financial sector, starting with Wall Street. The entire activity of Wall Street has not produced a single pound of flour, a single loaf of bread or a single sofa. But why we believe that financial intermediation is productive is that it allows money to flow from the places where it would be less efficiently used to the places where it would be used more efficiently. Or for that matter from the consumers who cannot pay much to the consumers who can. Exactly the activity done bybachaqueros.

Milanovic is right: if “bachaqueros” are unproductive, why isn’t the labor of the financial sector? Or, more generally, of FIRE (finance, insurance, and real estate)? Or of CEOs and other corporate managers?

That’s exactly the reason neoclassical economists generally don’t make a distinction between productive and unproductive labor. They want to see it all as productive: manufacturing, services, commerce, and finance; factory workers, office workers, and CEOs. The difference, in Hausmann’s case, is he wants to criticize the socialist economic policies of the Venezuelan government. So, the veil falls and even he, against the dictates of his own economic theory, invokes the distinction between productive and unproductive labor.

But once that door is open, who knows what ideas might follow? What happens if we begin to conceive of many kinds of labor and whole groups of economic agents within contemporary capitalism not only as unproductive, but as parasitical and even downright destructive?


*But note, because this point is often missed, Marx is not making a distinction between goods and services. Both can and often do involve productive labor.

An actor, for example, or even a clown, according to this definition, is a productive labourer if he works in the service of a capitalist (an entrepreneur) to whom he returns more labour than he receives from him in the form of wages; while a jobbing tailor who comes to the capitalist’s house and patches his trousers for him, producing a mere use-value for him, is an unproductive labourer.  The former’s labour is exchanged with capital, the latter’s with revenue.  The former’s labour produces a surplus-value; in the latter’s, revenue is consumed.

**However, there are forms of labor—such as that performed in households—that are not included in the usual neoclassical-inspired national-income accounts. One can argue, then, that neoclassical economics does retain some notion of unproductive labor.

***Hausmann, a former minister of planning of Venezuela and former Chief Economist of the Inter-American Development Bank, currently Professor of the Practice of Economic Development at Harvard University (where he is also Director of the Center for International Development) views Venezuela as “the poster child of the perils of rejecting economic fundamentals”—because the Venezuelan government has had the temerity to attempt to achieve economic and social goals by sidestepping and regulating “the market.”


Mark Tansey, “Triumph Over Mastery” (1986)

Reading the current debate about how we should approach the teaching of introductory economics, it’s clear the participants actually need to go back and take Epistemology 101.

Now, I’m the first to argue we need to change how we approach Econ 101 (as readers of this blog know). It’s a key course, because it’s the only economics course most college and university students will ever take: it’s where they’re introduced to the kinds of approaches and policies academic economists work with; it’s also a space to discuss the economic dimensions of individual and social life, both historically and in the contemporary world. Given the hundreds of thousands of students who every year are exposed to economics through such a course, its content is crucial.

The course, however, is also often badly taught. That’s in part because the material is many times presented in a mind-numbing manner, as a set of ideas and facts that need to be memorized in order to pass quizzes and exams. But, even more important, it’s because many of those ideas and facts—from the effects of minimum wages to the patterns of international trade—serve to naturalize both mainstream economic theory and the economic and social system celebrated by mainstream economists. In other words, students are generally taught that the limits of debate are defined by the parameters of mainstream economics.

I know, then, I should welcome a debate about what we should teach in Econ 101—but, as it turns out, not this one. Michael R. Strain wants to keep things pretty much as they are:

An economics 101 textbook is a treasure. The information therein captures the leaps forward in intellectual history, in our understanding of society — indeed, in our understanding of daily life. . .

Look. Understanding society and the economy is tough business. Economics 101 textbooks have a large responsibility to do that right and well. Does the theory of comparative advantage presented in 101 tell you most of what you need to know to understand the Trans-Pacific Partnership trade agreement? Nope. But that’s a ridiculous standard to hold for an intro class. Are economics 101 textbooks perfect? Of course not, and they can and should be improved. But existing 101 textbooks are one of the best tools society has to prepare young people for responsible and informed citizenship.

James Kwak, following Noah Smith, argues Econ 101 should be based on a combination of the mainstream theoretical models Strain wants to focus on (which, in Kwak’s view, provide “some incredibly useful analytical tools”) with empirical studies.

A friend and labor economist said to me that when thinking about the impact of a minimum wage, the natural starting point is the supply-and-demand diagram, because it’s so powerful—but you don’t stop there. The model is incomplete, like all models, and if you don’t realize that you will make mistakes.

Professional economists know all this, and hence many think that models need to be balanced by empirical research, even in first-year classes. Strain doesn’t buy this because “economists’ empirical studies don’t agree on many important policy issues.” I don’t understand this argument. The minimum wage may or may not increase unemployment, depending on a host of other factors. The fact that economists don’t agree reflects the messiness of the world. That’s a feature, not a bug.

Here’s the problem: both sides of the current debate (Strain as well as Kwak and Smith) treat theory and facts radically separate from one another. Thus, for them, there is one theory (separate from the facts) and one set of facts (separate from the theory).

This is where Epistemology 101 comes in. If the participants in the current debate took such a course, they’d learn that the idea of separate theories and facts forms the basis of only one theory of knowledge (which comes in two forms, rationalism and empiricism). But they’d also learn there’s an alternative theory of knowledge, according to which there are different theories and different sets of facts. Each theory has its own set of facts (and, of course, its own validity criterion). And, of course, these different theories and sets of facts interact and change over time.

From the perspective of the second theory of knowledge, then, the professors of Econ 101 would introduce students to different economic theories (neoclassical supply and demand, to be sure, but also other theories that serve as criticisms of and alternatives to neoclassical economics) and different sets of facts (including wages that are equal to the marginal productivity of labor as well as wages that are equal to the value of labor power, after which there is exploitation). And they would include the complex, discontinuous history of those theories and facts, including the debates amongst and between them.

Now, that would be an introductory economics course worthy of the name—and one that is consistent with Epistemology 101.


We know that the so-called gig economy—in the form of such online platforms as Uber and Airbnb—offers more alternatives in terms of finding transportation and renting property. But it doesn’t overturn the unequalizing dynamics of contemporary capitalism. In fact, it probably makes things even more unequal.


What about the online platforms for workers, like TaskRabbit and HourlyNerd? They, too, represent a new kind of freedom—and, at the same time, a new way for employers to take advantage of workers.


A June 2015 report from the McKinsey Global Institute makes clear the advantages for employers: more output (by up to 9 percent), lower costs (by up to 7 percent), and higher profits (by up to 5.4 percent). The idea is that digital platforms enhance recruiting and personalize various aspects of talent management (including training, incentives, and career paths) in the case of high-skilled workers, and improve the screening and assessment of job candidates (thus allowing them to “make better predictions about candidates’ ability to perform tasks as well as the likelihood of their timeliness, reliability, and commitment”) for companies with large low-skilled workforces. It also makes it easier for employers to contract workers for particular projects and then let them go, until the next project (requiring a different group of workers) comes up. So, with better matching, screening, and flexibility, workers produce more, cost less, and create more profits for their employers.

It sounds like a dream come true for employers.* And it is!

The problem, of course, is to sell the new digital labor platforms to workers, both blue-collar and increasingly white-collar. Here’s how McKinsey does it:

Online talent platforms can bring a new dimension to profiles of individual workers: their soft skills, traits, and endorsements from colleagues and superiors. The accumulated ratings and feedback provided to contingent workers through online marketplaces could be valuable, particularly for young people with little other work experience as they seek permanent employment. Accumulating and codifying these reputational elements can help individuals distinguish themselves in the job market and can help employers identify people who are a better fit for the positions they are filling.

In other words, it’s all about freedom and control.

And that’s important to recognize, because capitalism does represent the birth of a new freedom—for example, compared to feudalism and slavery. Under feudalism, workers (serfs) were tied to their employers (lords) in order to gain access to land (and, if the serfs violated those ties, for instance by attempting to attach themselves to a different lord’s demense, there was always the blacklist). As for slavery, workers (slaves) were owned as human chattel by their employers (slaveowners) and could not work for anyone else unless they were rented or sold by their owners (and subject to torture if they didn’t work hard enough).

Capitalism, in contrast, means that workers own their ability to work and are free to sell it to any employer. But it also mean, because their ability to work isn’t worth anything to them unless they sell it to someone else for a wage or salary, workers are forced to have the freedom to sell their ability to work to another group, their employers. (And the employers, of course, appropriate the surplus those workers create—just as their predecessors did from their workers under feudalism and slavery.)

Nothing in the new digital platforms changes that. Workers are still forced to have the freedom to sell their ability to work (and to produce a surplus for someone else, or they won’t be hired). The only thing that’s changed is the amount of data and the kind of analytics that are available to their employers (concerning the positions employers are filling, the skills required, and the paths workers have followed in education or previous positions).

But workers beware: “As data collection and analysis become more sophisticated, users will have to be mindful that every online interaction can affect their professional reputation.” What’s new for workers is they’re now forced to have the freedom to also watch what they do online.

And that’s why workers—both on and off the job—are increasingly being turned into jack rabbits.


*It’s also the fulfillment of a dream for neoclassical economists, who in their models spend a great deal of time on issues of job search, screening, and matching—for them, when those issues are solved, the perfect labor market.

The problems surrounding the central institution of capitalism—the corporation—are so widespread and enormous they’ve even provoked concern in sympathetic quarters, such as the Harvard Business School.

This past November, Harvard hosted a conference during which participants attempted to grapple with the tensions between Milton Friedman’s theory of the firm—according to which firms can and should only benefit society by focusing on maximizing shareholder value—and the growing political influence of corporations after Citizens United—when it has become increasingly easy for firms to tweak the rules of the game in their favor.

Now, for the rest of us—citizens, nonmainstream economists, and academics in disciplines outside of business and economics—both the history of corporations and the prevailing neoclassical theory of the firm present so many problems it’s hard to believe Friedman’s ideas are still taken seriously. Long before Citizens United, corporations have exercised a great deal of influence both inside (over their workers) and outside (in politics and in the wider society). That’s why the corporation has been a contested institution—legally, economically, politically—since its inception. Similarly, the neoclassical theory of the firm (initially in its “black box” form, then when the owner-manager agency problem was raised) has swept most of the serious problems under the theoretical rug.*

But for the scholars gathered at Harvard, the key issue (as presented in the brief paper coauthored by Harvard Business School faculty members Paul Healy, Rebecca Henderson, David Moss, and Karthik Ramanna [pdf]) was a relatively narrow one:

if firms have the power to generate profits not only by producing socially beneficial goods and services, but also by tilting public policy and the “rules of the game” to their advantage (whether through aggressive lobbying, effective use of the revolving door between political and corporate appointments, or campaign contributions), then the core assumption that firms can maximize social value by maximizing shareholder value may not hold, and framing managerial responsibility as simply a matter of maximizing shareholder value may well be inappropriate.

Having read the paper, it is extraordinary that there’s no real history—no story about the invention of the corporation as a legal “person,” no Louis Brandeis or the Progressive movement, no Knights of Labor or United Mineworkers, no mention of the role of International Telephone & Telegraph in overthrowing Salvador Allende in Chile, no Massey Energy killing 29 miners in the Upper Big Branch mine. It’s as if the problem of corporate power only emerged after the 2010 Citizens United decision.

Still, from the perspective of neoclassical economics, even that problem looms large. According to the reigning paradigm (which guides much policy and is taught to hundreds of thousands of students every year), under conditions of perfect competition, free markets (including firms that maximize shareholder value) lead to Pareto-efficient outcomes. But if corporations (whether single firms or industries) can shape the institutions of the market (or the rules and ethical customs that help to maintain them), then all bets are off: “Maximizing shareholder value by deliberately distorting critical market institutions or regulations for private advantage seems unlikely to lead to the maximization of social value.”

That’s why the participants in the Harvard conference were caught between the real implications of Citizens United (that corporations can increasingly bend the social rules to their private advantage) and their continued adherence to the neoclassical theory of the firm (according to which maximizing shareholder value also maximizes social value).

I suppose it’s no surprise, then, which won out at the Harvard conference:

“I went into the conference with the understanding that one could question the premise of the Neoclassical paradigm in economics through logical arguments—e.g., the inconsistencies between Friedman’s assumptions and Stigler’s theory. I left with a sense that logical arguments on their own are unlikely to carry the day, because the Neoclassical paradigm is so powerfully ingrained into the discipline, into the fabric of modern economics,” says Ramanna.


*Including the problem neoclassical economists share with many of their heterodox counterparts, namely, what exactly does it mean that corporations maximize profits or shareholder value? First, how do we define profits or shareholder value, i.e., what is the appropriate metric, over what time horizon should it be defined, and how should it be measured? Second, corporations do many different things, such as exploit workers, give lavish pay to top managers, attempt to eliminate rivals, chart particular short-run and long-term growth path, buy favors and influence legislation, hoard cash, accumulate capital, and so on—why reduce all of what they do to a single dimension?