Posts Tagged ‘neoclassical’


Mark Tansey, “Invisible Hand” (2011)

Yesterday, I explained that the 2016 Nobel Prize in Economics Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel was awarded to Oliver Hart and Bengt Holmstrom because, through their neoclassical version of contract theory, they “proved” that capitalist firms—employers hiring labor to produce commodities in privately owned corporations—were the most natural, efficient way of organizing production.

It should come as no surprise, then, that mainstream economists—initially in tweets, then in full blog posts—have heaped praise on this year’s award.


Paul Krugman couldn’t believe Hart and Holmstrom hadn’t won the prize already, while Justin Wolfers considered them “an unarguably splendid pick.”

Tyler Cowen also expressed his conviction that the new Nobel laureates are “well-deserving economists at the top of the field.” (He then explains, in separate posts, the significance for neoclassical theory of Hart’s and Holmstrom’s research on the theory of the firm.) The other member of the Marginal Revolution team, Alex Tabarrock, follows up by criticizing the one instance in Hart’s work in which he actually criticizes private enterprise. Hart (in a piece with two other economists) argues one of the downsides of private prisons is that they sacrifice quality for cost—but, according to Tabarrock, “private prisons appear to be cheaper than public prisons but they are not significantly cheaper and the quality of private prisons is comparable to that of public prisons and maybe a little bit higher.”

And then there’s Noah Smith, who follows suit by praising “the new exciting tools that have been developed in the micro world,” including by the new Nobel laureates. He refers to that work in microeconomics as the “real engineering”—as against macroeconomics, “whose scientific value is still being debated.”

The fact is, the value of both areas of mainstream economics is still being debated, as it has been from the very beginning. There is nothing settled (except, perhaps, in the minds of mainstream economists) about either the theory of the firm or the causes of recessions and depressions, the determinants of a commodity’s value or the prospects for long-term capitalist growth, whether the labor market or the economy as a whole is in any kind of equilibrium.

Smith overlooks or ignores those debates, most of which occur between mainstream economists and other, nonmainstream heterodox economists. But then, in attempting to explain why this year’s prize went to microeconomists, Smith displays his real misunderstanding of the history of economics—arguing that “macro developed first.”

Economists saw big, important phenomena like growth, recessions and poverty happening around them, and they wrote down simple theories to explain what they saw. The theories started out literary, and became more mathematical and formal as time went on. But they had a few big things in common. They assumed the people and the companies in the economy were each very tiny and insignificant, like particles in a chemical solution. And they typically assumed that everyone follows very simple rules — companies maximize profits, consumers maximize the utility they get from consuming things. Pour all of these tiny simple companies and people into a test tube called “the market,” shake them up, and poof — an economy pops out.

Here’s the problem: macroeconomics didn’t develop first. Indeed, it wasn’t invented until the 1930s, when John Maynard Keynes published The General Theory of Employment, Interest, and Money. This should not be surprising, given the fact that the world was in the midst of the Great Depression, with at least 25 percent unemployment, after neoclassical microeconomists (following their classical predecessors, Adam Smith, David Ricardo, and Jean-Baptiste Say) had attempted to prove that markets would always be in equilibrium, which of course ruled out economic depressions and massive unemployment. Oops!

Since then, we’ve seen a mainstream tradition that combines (in different, shifting ways) neoclassical microeconomics and Keynesian macroeconomics—a tradition that failed miserably both in the lead-up to and following on the second Great Depression.

But no matter, at least from the perspective of mainstream economics, because its leading practitioners—sometimes from the macro side, this year from the micro side—continue, as if by contract, to be awarded Nobel prizes.


source (pdf)

On one hand, Dave Elder-Vass is absolutely right: “we should see our economy not simply as a capitalist market system but as a collection of ‘many distinct but interconnected practices’.”*

As I have explained before, that view of the “iceberg economy”—which has been highlighted in the work of J. K. Gibson-Graham—represents a fundamental challenge to neoclassical economists, for whom

the entire economy is visible and consists of capitalist markets—or unwarranted constraints on capitalist markets, which should be eliminated. According to iceberg economists, capitalist markets are only the tip of the iceberg, and there’s a proliferation of noncapitalist economies below the waterline.

But Elder-Vass also uses it against Marxists who, in his view, see “one central mechanism in the economy: the extraction of surplus from wage labour by capitalists” and leave out ethical issues.

The problem is, while Elder-Vass credits J. K. Gibson-Graham, especially their book The End Of Capitalism (As We Knew It), with the idea that unified, totalizing metaphors of the economy (like a “capitalist market system”) can make it difficult to think outside the box and imagine alternatives, he forgets that Gibson-Graham themselves used the categories of the Marxian tradition—including the idea of class defined in terms of surplus labor—to decenter the economy.**

He also overlooks the fact that Gibson-Graham (as well as others who have worked with and alongside them in the larger Rethinking Marxism tradition) have insisted on the ethical dimensions of the Marxian critique of political economy—which includes, but of course is not limited to, a critique of the social theft associated with capitalist and all other forms of exploitation (that is, areas of the economy—whether capitalist, slave, feudal, and so on—in which those who perform surplus labor are excluded from appropriating their surplus labor).

In fact, according to two of Gibson-Graham’s close associates, Jack Amariglio and Yahya Madra, ethics are central to Marx’s critique of capitalism and mainstream economics.*** But Marx’s commitment to communism is not governed by an actual model or a fixed morality. Rather, they argue,

The ethical is embodied in Marx’s enduring faithfulness to sustaining a critical position toward the existing state of affairs, not in his particular and changing dismissals of capitalism or in his obscure, partial formulations of the shape communism might take. The lesson of Marx is that, facing the abyss of an unknown communism, the ethical is the will to risk a different social organization of surplus.

To put it in terms of the iceberg economy, the ethical is the will both to recognize the noncapitalist forms of economy below the waterline and to risk a different social organization in which capitalist exploitation ceases to be the exclusive or even predominant mode of appropriating and distributing the surplus.

Contrary to Elder-Vass, then, seeing the economy “not simply as a capitalist market system” is consistent with the Marxian critique of political economy, including the ethical stance that is informed by and embodied in that critique.


*I will try to be careful here because I have not yet had a chance to read Elder-Vass’s book,  Profit and Gift in the Digital Economy. I am relying, instead, on Daniel Little’s review of the book and Elder-Vass’s response.

**Gibson-Graham also borrowed from other traditions, such as feminism, queer theory, and poststructuralism to create their iceberg economy.

***See their entry on “Karl Marx” in the Handbook of Economics and Ethics, ed. J. Peil and I. van Staveren, 325-32 (Edward Elgar, 2009).


According to the norms of both neoclassical economic theory and capitalism itself, workers’ wages should increase at roughly the same rate as their productivity.* Clearly, in recent years they have not.

The chart above, which was produced by B. Ravikumar and Lin Shao for the Federal Reserve Bank of St. Louis, shows that labor compensation has grown slowly during the recovery of the U.S. economy from the 2007-09 recession. In fact, real labor compensation per hour in the nonfarm business sector was 0.5 percent lower 20 quarters after the start of the recovery, while labor productivity had increased by 6 percent.

Clearly, the gap between worker compensation and productivity has grown during the current recovery.


But the authors go even further, showing that the gap in the United States between compensation to workers and their productivity has been growing for decades.

labor productivity has been growing at a higher rate than labor compensation for more than 40 years. As Figure 3 shows, labor productivity in 2016:Q1 is 3.8 times as high as that in 1950:Q1; labor compensation, on the other hand, is only 2.7 times as high. In other words, the gap between labor productivity and compensation has been widening for the past four decades. The slower growth in labor compensation relative to labor productivity during the recovery from the two most recent recessions is part of this long-term trend. (reference omitted)

The data in Figure 3 show that the productivity-compensation gap—defined as labor productivity divided by labor compensation—has been increasing on average by approximately 0.9 percent per year since 1970:Q1. Based on this long-term trend, the gap would have been 51 percent higher in 2016:Q1 compared with 1970:Q1; in the data, the gap is actually 47 percent higher.

The fact is, labor compensation has failed to keep up with labor productivity after the Great Recession. But, as it turns out, there’s nothing unique about this period. The gap has been growing for more than four decades in the United States.**

Clearly, the recent and long-term trends of productivity and labor compensation challenge the norms of neoclassical economics and of capitalism itself. But we are also seeing the growth of another gap—between the promises of both neoclassical theory and capitalism and the reality workers have faced for decades now.


*Neoclassical economics—in particular, the marginal productivity theory of distribution—is based on the idea that the factors of production (land, labor, capital, and so on) receive in the form of income what they contribute to production. So, for example, as labor productivity increases, real wages should also rise. Similarly, capitalism is based on the idea of “just deserts.” That idea—that everyone gets what they deserve—is essential to the very idea of fairness or justice in the way the economy is currently organized.

**The authors’ analysis is based on the gap between labor compensation and productivity. If we look at real wages (as in the chart below) instead of compensation (which includes benefits, and therefore the portion of the surplus employers distribute to pension plans, healthcare insurers, and others), the gap is even larger.


According to my calculations from Fed data, since 1979, productivity has grown by 60 percent while real wages have increased by less than 5 percent.


A constant refrain among mainstream economists and pundits since the crash of 2007-08 has been that, while the state of mainstream macroeconomics is poor, all is well within microeconomics.

The problems within macroeconomics are, of course, well known: Mainstream macroeconomists didn’t predict the crash. They didn’t even include the possibility of such a crash within their theory or models. And they certainly didn’t know what to do once the crash occurred.

What about microeconomics, the area of mainstream economics that was supposedly untouched by all the failures in the other half of the official discipline? Well, as it turns out, there are major problems there, too—especially given the obscene levels of inequality that both preceded and have resumed since the crash erupted, not to mention the slow economic growth that rising inequality was supposed to solve.

In particular, as I have written many times over the years, the idea that a rising tide lifts all boats—along with its theoretical justification, marginal productivity theory—needs to be questioned and ultimately abandoned.

But you don’t have to take my word for it. Just read the latest essay by Nobel Prize-winning economist Joseph Stiglitz.

Stiglitz first explains that neoclassical economists developed marginal productivity theory as a direct response to Marxist claims that the returns to capital are based on the exploitation of workers.

While exploitation suggests that those at the top get what they get by taking away from those at the bottom, marginal productivity theory suggests that those at the top only get what they add. The advocates of this view have gone further: they have suggested that in a competitive market, exploitation (e.g. as a result of monopoly power or discrimination) simply couldn’t persist, and that additions to capital would cause wages to increase, so workers would be better off thanks to the savings and innovation of those at the top.

More specifically, marginal productivity theory maintains that, due to competition, everyone participating in the production process earns remuneration equal to her or his marginal productivity. This theory associates higher incomes with a greater contribution to society. This can justify, for instance, preferential tax treatment for the rich: by taxing high incomes we would deprive them of the ‘just deserts’ for their contribution to society, and, even more importantly, we would discourage them from expressing their talent. Moreover, the more they contribute— the harder they work and the more they save— the better it is for workers, whose wages will rise as a result.

Then he argues that three striking aspects of the evolution of the United States and most other rich countries in the past thirty-five years—the increase in the wealth-to-income ratio, the stagnation of median wages, and the failure of the return to capital to decline—call into question the neoclassical story about the distribution of income.

Standard neoclassical theories, in which ‘wealth’ is equated with ‘capital’, would suggest that the increase in capital should be associated with a decline in the return to capital and an increase in wages. The failure of unskilled workers’ wages to increase has been attributed by some (especially in the 1990s) to skill-biased technological change, which increased the premium put by the market on skills. Hence, those with skills would see their wages rise, and those without skills would see them fall. But recent years have seen a decline in the wages paid even to skilled workers. Moreover, as my recent research shows, average wages should have increased, even if some wages fell. Something else must be going on.

As Stiglitz sees it, that “something else” is a combination of rent-seeking (especially land rents, intellectual property rents, and monopoly power) and increased exploitation (especially the weakening of workers’ bargaining power, based on weak unions and asymmetric globalization).*

The result is that the rising tide has only lifted a few boats at the top and left everyone else behind.

But Stiglitz is not done. He also explains that not only is growing inequality not necessary for growth; it actually has negative effects: it leads to weak aggregate demand (and, in an attempt to solve that problem, asset bubbles), less equality of opportunity (thus lowering growth in the future), and lower levels of public investment (since the rich believe they don’t need things like public transportation, infrastructure, technology, and education).

It should be noted that the existence of these adverse effects of inequality on growth is itself evidence against an explanation of today’s high level of inequality based on marginal productivity theory. For the basic premise of marginal productivity is that those at the top are simply receiving just deserts for their efforts, and that the rest of society benefits from their activities. If that were so, we should expect to see higher growth associated with higher incomes at the top. In fact, we see just the opposite.

Neoclassical marginal productivity theory was never a plausible explanation of the distribution of income in capitalist societies. And, as Stiglitz explains, it is even more questionable in light of the spectacular growth of inequality in recent decades.

The only conclusion is that we live in strange times—when the illusion of a rising tide that lifts all boats (and, with it, trickledown economics, “just deserts,” and the like) has been shattered, and yet mainstream economists continue to teach (and use as the basis of economic policy) its theoretical underpinnings, marginal productivity theory.

There’s nothing left but to declare that both mainstream macroeconomics and microeconomics—as basic theory and a guide for economic policy—have failed. There’s simply nothing there to be fixed. Both mainstream macroeconomics and microeconomics need to be set aside in favor of very different analyses and explanations of capitalist instability and inequality.


*Elsewhere (e.g., herehere, and here), I have raised questions about the rent-seeking argument and showed how it is different from the alternative, surplus-seeking explanation of inequality.



For neoclassical economists (like Gregory Mankiw, in his bestselling textbook, Principles of Microeconomics), the major effect of labor unions is that they cause unemployment, by setting a wage rate that exceeds the equilibrium price for labor. According to this story, while union workers (“insiders”) may benefit, unemployed non-union workers (“outsiders”) lose out.* So, their overall conclusion is, unions ultimately hurt workers and cause increased inequality. Unions should therefore be discouraged.

Over the course of the past three and a half decades, the United States it seems has been following neoclassical economists’ advice: the overall unionization rate has fallen to 11.1 percent, while the rate for private-sector workers is even lower, 6.7 percent in 2015 (according to the Bureau of Labor Statistics).**

But the folks at the Economic Policy Institute [ht: ja] tell a story very different from the neoclassical one. As they see it, it’s the precipitous decline in U.S. labor unions from 1979 to 2013 that has played a key role in hurting workers and increasing inequality. In particular, it has decreased the wages of the vast majority of private-sector, full-time nonunion workers—and nonunion men without a college degree and nonunion men with a high school diploma or less have are the ones who suffered the most. Thus, for example, weekly wages for nonunion private-sector men would be an estimated 5 percent ($52) higher in 2013 if private-sector union density (the share of workers in similar industries and regions who are union members) had remained at its 1979 level. And for nonunion private-sector men with a high school diploma or less education, weekly wages would be an estimated 9 percent ($61) higher if union density remained at its 1979 levels (for a year-round worker, this translates to an annual wage loss of about $3,172). In general, union decline has exacerbated wage inequality in the United States by dampening the pay of nonunion workers as well as by eroding the share of workers directly benefitting from unionization. One of the key ways, therefore, to help workers and to lessen inequality is to encourage the formation and strengthening of labor unions.

What’s particularly interesting about the Institute’s analysis (in addition to their empirical estimates) is their analysis of the various ways unions help workers, especially nonunion workers. Here are some of them:

  • the threat of unionization: nonunion employers worried about a possible unionization drive may match union pay scales to reduce the demand for organization
  • the ripple effect: like minimum-wage increases, union wage rates for production workers can lead to increases in wages for those above them (e.g., their managers)
  • the moral economy: unions help institute norms of fairness regarding pay, benefits, and worker treatment that can extend beyond the unionized core of the workforce

The problem, of course, is that since the late-1970s, the presence and effects of unions within the U.S. economy and society have been on the decline. As the authors conclude:

nonunion employers are increasingly unlikely to fear a threat of unionization. . . responding to possible unionization threats through increasing wages is one pathway through which unions raised pay for nonunion workers in past periods. With organizing efforts at a standstill throughout much of the private sector, typical nonunion employers now have little to fear. Given the ongoing attacks on existing unions, labor leaders are doing all they can to hold onto their remaining terrain.

We contend that unions’ influence on nonunion pay once extended beyond these threat effects. But their ability to maintain wage and benefit standards rested on their political and economic power, and their salience throughout the culture. . .That presence has vanished throughout much of the private sector, rendering unions unable to exert the same political, economic, and cultural influence over the working lives of average Americans, union and not.

The result for all workers, but especially for nonunion workers, has been a prolonged period of stagnant wages—and, for American society as a whole, an increase in inequality that has made the existing economic institutions increasingly fragile and, in the eyes of many, fundamentally illegitimate.


*This is from the PowerPoint Slides for Mankiw’s book by Ron Cronovich:


**While a much higher portion of workers in the public sector are members of unions (35.2 percent), there are many more private-sector workers (113.2 million) than government workers (20.6 million).



We’re been through this before (e.g., here and here). But no matter. Let’s take it up again.

Even as the overwhelming evidence is U.S. corporate taxes have been decreasing and workers’ wages have also been falling (both, in the chart at top of the post, as a percentage of gross domestic income), there are still those who try to convince us corporate taxes should be lowered still further—and workers are the ones who will benefit.


I know. It goes against all logic (and, as it turns out, the empirical evidence). But, according to Kevin Hassett and Aparna Mathur of the American Enterprise Institute, lowering corporate taxes is the only real cure for wage stagnation among American workers.

They’re right about wage stagnation (although they miss the declining share of national income going to workers). But lowering corporate taxes is not going to solve that problem. Raising workers’ wages will.

I wrote above that it was against all logic. Actually, it is consistent with the logic of neoclassical economics, which goes as follows: capital moves to or stays in lower tax zones (states or countries), which boosts the productivity of workers (who are not as mobile), which in turn leads to higher wages (since the presumption is workers are paid according to their productivity). And, on the reverse side, if corporate taxes go up (as some, like me, have argued they should), corporations will shift the burden of the tax to workers, who will then be paid less.

The holes in the logic are, to use the current vernacular, HUUGE. Where corporations decide to realize their profits may shift according to tax rates but that doesn’t mean capital itself moves to those zones. Even if capital moves, it can often replace workers (or leading to the hiring of other, lower-waged workers). And, even if workers become more productive, they’re not necessarily paid more.

And then there’s the evidence—or lack thereof. As Kimberly Clausing explains, “a review of the prior empirical work in this area fails to reveal persuasive empirical evidence of adverse effects on labor.” And that’s because of globalization itself:

First, if corporations are mere intermediaries in global capital markets in which a wide assortment of investors with different tax treatments invest, tax policy changes could affect the ownership and financing patterns of assets more than they affect the aggregate level of investment in different countries. Second, since multinational firms have become increasingly adept at separating the reporting of income from the true location of the underlying economic activities, international tax avoidance itself comes with a silver lining. Mobile firms move profits without needing to substantially alter the underlying investments, whereas immobile firms do not respond like the open-economy actors of modern corporate tax incidence models. In both cases, workers in high-tax countries are relatively insulated from adverse wage effects due to capital reallocation toward low-tax countries.

So, if the logic is faulty and the empirical evidence questionable, what’s left? Merely one more attempt to lower the tax burden on corporations—and thus put private profits even more out of the reach of public claims on those profits.