When we Criticise ‘Neoclassical’ Economics what is the Target?

Criticisms of neo-classical economics have shifted from a marginal to an increasingly mainstream activity.  However some commentators immediately consign any use of the term in a derogatory fashion, like the use of ‘neo-liberalism’ to their waste paper basket.  A serious debate is also hindered by a sometimes loose use of the term ‘neoclassical’.

In the history of economics ‘neo- classical’ has gone through three quite distinct phases and meanings.

Phase One – The Marshall ‘Neo’ Classical Revivial

Marshall saw himself very much in the footsteps of Ricardo and the English tradition of political economy.  His innovation was to apply calculus to attempt to lay it on firmer theoretical foundations and reconcile it with the findings of the marginal revolution.  This was also the view of many of his contemporaries and critics – for example Davenport’s book length study.  Hence Marshall attempted to maintain the concept of ‘real costs’ on his famous two blades of the scissors metaphor.  The success of his attempt was to provide a bridge between the analysis of a single market clearing – the partial equilibrium analysis, expressed graphically in comparative static diagrams, and general equilibrium equivalent, in his schema, to the classical long run analysis.  He viewed these as a continuum rather than as bipolar ‘short’ and ‘long’ run costs.

For nearly 40 years this was dominant and still forms the basis of introductory economics courses today. But it was always poorly theoretically founded.  Costs were taken as given not properly explained, value theory was left behind ( a criticism levied by both Austrians and Marxians).  Marshall developed a firm theory for money demand – the Cambridge cash balance approach, but never a proper theory of money creation,which led to a poor understanding of interest and a failure to challenge the concept of loanable funds.   The supply curve was never properly grounded.  In the very ‘short run’ of sales from inventory/auctions the supply curve is vertical, whilst the derivation of the other supply curves depends on an assumption of general equilibrium, always there lurking in the background seeking to explain the shape of individual firm supply curves but quite how you get to a long run GE supply curve in a perfectly competitive economy (without of course profits) is not explained.  The comparative static approach as Joan Robinson said attempted to show as a process in space which in fact was a process in time, a process which can only be driven by the profoundly disequilibrium forces of profit seeking and entrepreneurial action.    Marshall himself dealt with GE in a cursory way, a single footnote setting out how trivial an issue it was simply a simultaneous equation.  These holes led to the collapse of the Marshallian consensus in the 1930s.

Phase Two – LSE and the Samuelson ‘Neoclassical Synthesis’ 

LSE thinker in the 1930s such as Kaldor and Hicks had come under the influence of the Lausanne School and Walras.  For them as Ian Steedman explains in this paper the ‘Top down’ approach of Marshall was insufficient and instead General Equilibrium was to be explained through the aggregation of firm level curves.  This simply repeated the mistake of Marshall however in the derivation of the supply curve.  The LSE approach however offered the prospect of synthesizing micro and micro-economics and this promise was seemingly fulfilled in Samuelson’s 1937 thesis later published as foundations of Economic Analysis in 1937, Samuelson himself coining the term ‘neo-classical synthesis’.  For him economic has never explained the process by which a economy out of equilibrium shifted into equilibrium, he adopted the le chateliers principle from thermodynamics to show how a ‘shock’ led to a time path back to equilibrium, and how individual utility maximsung functions with a budget constraint described demand curves .  Here the initial state was an assumption to make the maths tractable, however together with the assumptions on the derivation of teh supply curve it too easily led to a background assumption that the economy was always in, or on a path rapidly back to, equilibrium.  We know now that an initial state change can lead to multiple equilibrium future positions, that it does not uniquely describe one.  It can lead to a limit cycle of muluple equilibria with chaotic dynamics between them.

Onto this synthesis was grafted Keynsiansims, at least its American variant.  Keynes like all of the thinkers here set out where he agreed with and disagreed with classical economics.  For him the starting point was debunking the assumption of full employment equilibrium.  Keynes had found a way of describing money within a Marshallian comparative static framework.  The attempt to formalise this by Hicks in IS/LM made it relatively easy to combine in the ‘synthesis’.  Indeed the synthesis was widely adopted because of its political economy relevance.  Ut set out the basis for combining fiscal and monetary policy to stablise capitalism.  However again the weakly founded basis of the supply curve – in this case the money supply curve, allowed for an ideology with completely the opposite policy implications, Freidman’s Monetarism, to be absorbed within the synthesis.

Phase Three – The Chicago School – Lucas and the ‘New’ Neoclassical Economics

For some this Samuelson synthesis was not sufficient.  In particular there was the concern that Macroeconomics was grated on and not properly ‘micro-founded’ .  As the light of keynsianism seemed to wain under the pressuressof 70s stagflation they developed new models which seemed to rule out long term high unemployment equilibriums.  Lucas and his followeers made a number of simplifying assumptions to make this tractable.  The economy was assumed to be permanently in equilibrium with fully rational economic agents that ‘knew the model’.  The element of classicism that this school sought to revive was to make economic growth endogenous.  New classicism was born, morphing into DGSE and New Keynsianism, seeking partially to explain unemployment through ‘sticky prices’ which Keynes himself rejected.  The Great Recession seemed to deal a death blow to a school which presumes that recession are caused by too many people going on holiday at once however it had so firmly em-placed itself in key schools and journals, and the lack of a competing synthesis to replace it Lakatos style, has led to its perseverance.  Some ‘paelo-kenysians, such as Krugman and Delong would simply wind back the clock to phase 2, but that doesn’t help if that school itself has weak foundations.  This is very apparent when the cause of growth is labelled ‘tptal factor productivity’ coming from the ether.

The Need for a New Synthesis

Although Post Keynsiansm has been through going in its criticisms of neoclassism and what in economics is empircially correct it has failed to provide a full sythesis for its replacement.  Instead we have a series of modules, bits and pieces some of which fit neatly together and some don’t.

I think we need to – like Marshall decide what is sound and what is not in classical economics and how to refine it.

Then I think we need to track back to Marshall’s mistake in defining the supply curve and correct it placing the theory of the form and of investment on strong value and capital theory foundations.

Then we will be in a strong position to place the theory of money demand and effective demand on firm foundations so that Keynes insights are firmly placed within and not tacked onto economic theory, ables to explain prices and conditions in all stages in and out of equilibrium.

Note: As I was pulling together ideas for this piece like Mana from Heaven came a tweet from @Rumplestatkin on a new paper he has captured which brilliantly proposes a replacement for the Marshallian supply curve, which applies in all ‘runs’ based on the insight that firms maximise returns not revenues.  In one sense this is simply the classical insight that firms seeks to maximise the rate of profit as measured by capital advanced over time (including capital maintenance-depreciation).  So there is hope if we carefully reconstruct and piece back together the piece of thejigsaw,

2 thoughts on “When we Criticise ‘Neoclassical’ Economics what is the Target?

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