The irrelevance of perfection and imperfection in economics

9780199390632“Many of the central propositions of economic analysis can be derived without any reference to hyperrationality, optimization, perfect competition, perfect information, representative agents, or so-called rational expectations. These include the laws of demand and supply, the determination of wage and profit rates, technological change, relative prices, interest rates, bond and equity prices, exchange rates, terms and balance of trade, growth, unemployment, inflation, and long booms culminating in recurrent general crises…

…I propose that we reject the claim that perfect competition was ever appropriate and refuse the notion that observed outcomes should be attributed to historically arisen imperfections. The economic dynamics of capitalism arise from competition itself. There was never any Garden of Eden, and our current condition does not stem from its loss.”

Anwar Shaikh (2016), Capitalism – Competition, Conflict, Crises

These passages come from the opening paragraphs of the conclusion to Shaikh’s magisterial work. Drawing on the classical political economists such as Smith and Ricardo, as well as Marx, Keynes and many others, he sets out to construct a comprehensive approach to the economics of capitalism which goes beyond theories of perfection and imperfection. This is very appealing to me. I have spent most of my time studying economics focussed on heterodox (non-mainstream) ideas, but have been frustrated by some of the conclusions of post-Keynesian analysis which tends to ignore supply in its relentless focus on aggregate demand, with neoclassical economics doing something of the opposite.

Shaikh’s proposition, drawing on both the economics and business literature, is that profitability regulates both supply and demand in a turbulent, antagonistic process of ‘real competition’, rather than its perfect or imperfect variants. Under real competition, capital flows into those industries with a higher rate of profit, expanding supply capacity relative to demand, which over time tends to bring down prices and those higher profits towards the ‘regulating rate of profit’. The latter is set by the price leaders in the industry, those producing at the lowest cost, and who are most able to expand production.

In less profitable industries, investment in new capital tends to decelerate, reducing capacity relative to demand and increasing prices and profits towards the regulating rate. Regulating profit rates tend to fluctuate around a ‘normal rate’, and industry prices tend to equalize over time: these consequences of real competition are emergent and unintended by the individual firms in the industry. According to Shaikh, real competition is the ‘central regulating mechanism of capitalism’, and successful economic policies have to work within its limiting effects.

Shaikh’s ideas offer a potentially more comprehensive explanation of the trends and dynamics of modern capitalism than many others’, whether orthodox neoclassical or heterodox. I have also recently found new inspiration in the work of Michael Pettis and Mushtaq Khan. I would classify them both as outside the mainstream, incorporating a variety of history, theory and empirical evidence, some of it radical, into their views on economics, finance and development. Integrating the best of these three thinkers’ key works into a coherent whole applicable to the political economy of development remains a major task. I hope to continue drawing on their ideas as fully as possible on this blog.

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