Quote of the week: the problems of neoclassical economics

“[I]t’s very inadequate. I think there are situations in which parts of the theory can give you a little bit of insight. It’s not that I am against the theory, per se, as against the hegemony of the theory. I actually think supply and demand analysis can be a useful sort of heuristic device for some things. Where you get into problems is where you start to believe there are actually supply and demand curves out there in the real world and firms actually draw marginal cost curves to come to their decisions. Then you’re starting to take that a lot too seriously. In the curriculum materials I worked on – people are kind of under obligation to teach certain sorts of things in introductory courses, but I think it makes a big difference whether you treat something as “this is the way the world works” versus “this is the way some people have thought about explaining how the world works”. So, neoclassical theory is one of these tools – I often summarise my views as “broader questions and bigger toolbox”. I think economists should be dealing with things like inequality and climate change, the big questions, and use a bigger toolbox to do that. Neoclassical theory can play a role, can be one of the things in one of the compartments in the toolbox, but it’s clearly inadequate also for a lot of other things like deciding at what rate we should combat climate change. Basing that on a mathematical model and a market interest rate is stupid.”

A. Mearman, S. Berger and D. Guizzo (2019), ‘Julie Nelson’ in What Is Heterodox Economics? Conversations With Leading Economists, Abingdon: Routledge, p.120-121.

Quote of the week: heterodoxy versus the mainstream in economics

“I think heterodox economics is a constructive challenge to mainstream economics; and it has posed that challenge since the 1960s. And heterodox economics is a challenge at the same time to the epistemic hegemony of the economic knowledge centred in Anglo-Saxon mainstream institutions. So it’s not only a challenge to mainstream economics, but a challenge to the institutions which are embodying that mainstream economics. As you know very well, there’s a major humanitarian issue at stake at the moment (sic). Heterodox economics claims that the existing economy based on the idea of the free market does not stand adequately for what the economy should stand for, for human beings let alone other sentient beings. The other major thrust of heterodox economics is that it does not accept the fact that the market as described by neoclassical economics is self-adjusting by converging towards equilibrium. It is not only not self-adjusting but, more seriously, it is not just, from the point of view of heterodox economics. Thus, it has mounted an intellectual challenge to the neoclassical view of automaticity of an adjusting system as well as a philosophical challenge to the view that the societies can be just within the kind of economic system based on orthodox economics.”

A. Mearman, S. Berger and D. Guizzo (2019), ‘Karma Ura’ in What is Heterodox Economics? Conversations With Leading Economists, Abingdon: Routledge, p.87.

Ha-Joon Chang on the nature of economics

Professor Ha-Joon Chang of SOAS, formerly of Cambridge University, is always good value if one favours a critical, open-minded, heterodox and lively approach to economics, or political economy, the term which he favours.

In this short introductory lecture, Chang discusses how to define economics, and briefly explores and compares three schools of economic thought which have been used to justify free markets in today’s economies: the neoclassical, classical and Austrian.

He is critical of the modern approach which defines economics by its methodology and its supposed ability to explain ‘everything’, rather than it being defined by its subject matter, as the study of the economy itself. He notes that the modern approach failed to predict or satisfactorily explain the greatest economic crisis since the Great Depression and was rather complacent in its belief that economic management would prevent such crises from occurring once and for all.

He also favours a pluralist approach to economic theory, using the example of Singapore to argue that no single theory can account for its economic success and distinctive economic structure.

Quote of the week: the failure of the neoclassical consensus and the importance of finance

SmithersEconomicsoftheStockMktIn the spirit of my current series on the ideas of maverick economist Andrew Smithers, this week’s quote comes from his new book The Economics of the Stock Market, which is an attempt to create a model of the financial sector of a capitalist economy and explore its interaction with the real economy of companies, households, investment, savings, growth and so on. This kind of approach has tended to be neglected by the mainstream neoclassical consensus, but it does form a major part of the ideas of many heterodox or non-mainstream economists, particularly post-Keynesians such as Steve Keen, Hyman Minsky and Wynne Godley.

Smithers is very much an independent, eclectic and iconoclastic thinker, and does not readily fit into any particular school of economics. He is unafraid to criticise widely accepted theories and policies, and is very much driven to improve the way economics is done, in order to increase its explanatory power, as well as the potential of economic policy to improve the functioning of the economy itself.

One of his key points in the book is to emphasise the existence of what he calls the ‘corporate veil’, or the recognition that corporations behave differently from households, as they face different incentives. The ‘representative agent’ of the neoclassical model is thus a misleading starting point. Companies do not behave as if run by their shareholder owners (households), so that a model of the private sector needs to contain two distinct sectors at the very least, namely corporations and households, and study their behaviour and interactions.

“The major weakness of the previous consensus is seen by may to lie in the failure to incorporate finance into its economic models. Half the US economy’s output is produced by companies whose behaviour is determined by the fact that their shares are quoted on the stock market. Once this is accepted, the economic model that follows is very different from the neoclassical consensus. Unlike the latter its assumptions are testable and prove robust when tested and it radically changes our understanding of how the economy operates and leads thereby to different policies, largely because it shows that corporations behave differently from households and quoted companies differently from unquoted ones. The failure of the current consensus is shown by its dependence on assumptions  which either are untestable or, if not, fail when tested. The determination to stick to accepted assumptions and ignore the evidence that they are invalid shows that neoclassical economists have much in common with Hobbits who ‘liked to have books filled with things that they already knew, set out fair and square with no contradictions’.

Andrew Smithers (2022), The Economics of the Stock Market, Oxford University Press, p.1.

Quote of the week: on the decline of political economy and the flaws in mainstream economics

“Whatever happened to that approach, of political economy, that set out to analyse the fundamental forces at work in society that were driving the economy, that saw the division of wealth and income between the great social classes as being of fundamental importance in understanding the dynamics of the system, and which recognised and indeed stressed the importance of historical, institutional, cultural and political processes, as well as an appreciation of the motives of individuals that went beyond just utility maximisation for consumers, and profit maximisation for firms? The answer is, such lines of enquiry were thought dangerous, such that towards the end of the 19th century, modern-day, mainstream economics was developed and took hold, focusing on the individual as the object of analysis, rather than on social classes. This process was encouraged by the ethos of the day when it was thought that the emerging mathematical and physical sciences would be able to uncover the mysteries of the world around us, including the economy. We can see in retrospect that this goal was never going to be achieved – and never could be. The economy isn’t a machine, the workings of which can be precisely calculated. As John Maynard Keynes – arguably the greatest economist broadly within the mainstream tradition – recognised and stressed, there are too many unknowns and unknowables, too much depends on consumer confidence and the ‘animal spirits’ of investors.”

Jonathan Michie (2017), Advanced Introduction to Globalisation, Cheltenham: Edward Elgar, p.11-12.

Anwar Shaikh on the contrasting approaches of classical and neoclassical economics

9780199390632In this extract from Anwar Shaikh’s work Capitalism, he draws a striking contrast between the theoretical approaches of his own adopted classical economics, and neoclassical approaches, which dominate the mainstream. He highlights how the classics (and Marx, who he counts as part of this group) more satisfactorily address the real nature of capitalism, starting from its observed patterns and behaviour. Neoclassical economics starts from an idealized vision, a long way from the reality of the economy, in order to act as an apology for capitalism with all its flaws, and then adds “imperfections” to bring the theory closer to the real world. As Shaikh says, this is certainly a strange approach.

“Classical political economy attempted to get underneath the tempestuous surface of capitalism to identify the central tendencies of the actual system. Neoclassical economics took the opposite tack. From the very start, it was focused on the task of constructing a vision of perfect capitalism, optimal, efficient, and thoroughly idealized – all under the guise of “analytical refinement.” Real competition was replaced by perfect competition, the aggressive cost-cutting firm turned into a passive price-taker, and the turbulent movement of real markets was substituted with the smooth path of equilibrium-as-bliss. In the midst of the Great Depression of 1873-1896, Jevons and Edgeworth were refining the list of requirements for “perfect competition,” while Walras was weaving these elements into the general equilibrium model which still dominates orthodox macroeconomics. It is a particular historical irony that Walras, a French socialist who looked to the state for “proper guidance” on the installation and maintenance of “free competition”, would become the patron saint of conservatives who defend corporate capitalism and revile the state…[E]ven those who seek to return to the task of analyzing the actual system generally begin from the Walrasian framework in order to introduce selective “imperfections” here or there.

What a strange manner of proceeding! First, one invents a fictitious idealized world, a veritable Garden of Eden where even the snake of scarcity works for the general good. Most of the effort is then dedicated to explicating the properties of this paradise, although sometimes it becomes necessary to address the clamorous multitudes outside the gates. Then the intellectual problem becomes one of positing particular “imperfections” that can be used to account for otherwise inexplicable behaviors of the obdurate masses. This is the modus operandi of all orthodox economics after Keynes, with differences among the schools arising from disputes about specific attributions of imperfections. Proceeding in this manner ensures that orthodox theory can never be deemed to be wrong: it is only a matter of finding the right set of imperfections to explain each particular “deviation” from the ideal. I do not subscribe to this procedure because I reject its very starting point. I would argue that real macro dynamics is just as different from Walrasian general equilibrium as the classical theory of real competition is from perfect competition. The difference between classical and neoclassical approaches is not about abstraction itself, but rather about the method of abstraction. Abstraction-as-typification begins from the real in order to identify typical patterns and their underlying drivers; abstraction-as-idealization begins from the ideal and inevitably ends up with a vision of the real as a catalogue of imperfections.”

Anwar Shaikh (2016), Capitalism: Competition, Conflict, Crises, Oxford University Press, p.540-541.

Steve Keen on Marx on capitalism: flawed but exciting

Keen-InterviewIt has been some time since I posted a quote from the economics literature that both informs and inspires me. Here is Professor Steve Keen from the conclusion to his new book on the exciting vision of capitalism offered by Marx, in contrast to that of Say, which continues in some way in today’s neoclassical vision.

“Looking back on the fifty years since I first became aware of its flaws, the word that summarizes my feelings about Neoclassical economics today is that it is, as Marx once described the proto-Neoclassical Jean-Baptiste Say, ‘dull’. Its vision of capitalism at its best is a system manifesting the harmony of equilibrium, where everyone is paid their just return (their ‘marginal product’), growth is occurring smoothly at a rate that maximizes social utility through time, and everyone is motivated by consumption – rather than accumulation and power – because, to quote Say, ‘the producers, though they have all of them the air of demanding money for their goods, do in reality demand merchandise for their merchandise’.

What a bland picture of the complex, changing world in which we live!

For all it flaws, capitalism was and remains an exciting social system. For all his flaws, Marx put this best, in his own Manifesto. Though it called for the overthrow of capitalism, The Communist Manifesto was also a paean to the creative and transformative nature of capitalism and its distinctive class, whom Marx called ‘the bourgeoisie’, and we might today call ‘entrepreneurs’. For them, the guiding principle is not ‘merchandise for their merchandise’, said Marx, but ‘Accumulate, accumulate! That is Moses and the prophets!’ In contrast to the staid conservatism of the dominant classes of previous social systems, Marx declared that ‘the bourgeoisie cannot exist without constantly revolutionizing the instruments of production, and thereby the relations of production, and with them the whole relations of society’:

Conservation of the old modes of production in unaltered form, was, on the contrary, the first condition of existence for all earlier industrial classes. Constant revolutionizing of production, uninterrupted disturbance of all social conditions, everlasting uncertainty and agitation distinguish the bourgeois epoch from all earlier ones. All fixed, fast frozen relations, with their train of ancient and venerable prejudices and opinions, are swept away, all new-formed ones become antiquated before they can ossify. All that is solid melts into air, all that is holy is profaned, and man is at last compelled to face with sober senses his real condition of life and his relations with his kind. (Marx and Engels, 1848, emphasis added).

How did Marx’s exciting portrayal of capitalism lose out to Say’s vapid vision?”

Steve Keen (2021), The New Economics – A Manifesto, Polity Press, p.139-140.

Managing inflation today

Contando_Dinheiro_(8228640)Inflation is determined in the interaction of demand and supply for the economy as a whole. Today’s inflation may call for intervention by governments if it is deemed to be “excessive”. While there are a range of policy responses which can help, there are limits to what states under capitalism are able to achieve. Continue reading

Steve Keen’s manifesto for a new economics


A brief review of prominent heterodox economist Steve Keen’s latest book, in which he lays out his vision for the future of economics, arguing that the neoclassical approach has been highly damaging to humanity, and needs to be replaced.

Steve Keen has a new book out, entitled The New Economics – A Manifesto. It is the latest chapter in the author’s tireless efforts to replace neoclassical economics and its damaging dominance of mainstream thinking with what he argues is a more scientific and explanatorily powerful body of thought drawing on post-Keynesian and, more recently, Biophysical economics.

Keen, who has been a heterodox or non-mainstream economist since his student days, has been critiquing neoclassical economics for many years. Post-Keynesianism takes its main inspiration from arguably the twentieth century’s greatest and most influential economist, John Maynard Keynes. It draws on the work of Keynes’ followers at Cambridge University, and those who studied under or have been influenced by them, though post-Keynesians remain a radical minority in the grand scheme of things.

Keen was one of the few economists to correctly predict a major financial and economic crisis in the years leading up to 2008. Not one of these iconoclastic souls was a neoclassical. In the 2011 edition of his book Debunking Economics, he painstakingly deconstructed much of neoclassical theory, and began the task of laying out the monetary economics he felt should replace it. Continue reading

Anwar Shaikh on his “real” economic analysis

Below is an interesting recent talk by Professor Anwar Shaikh, organised by the Cambridge Society for Economic Pluralism, a student-run body which champions a pluralist and interdisciplinary approach to economics. The video is quite long, so if you don’t have the time to watch it all, the first thirty minutes sees Shaikh introduce the ideas in his 2016 magnum opus Capitalism: Competition, Conflict, Crises, and explain the rational behind his original approach.

Shaikh is critical of both neoclassical economics and post-Keynesian alternatives, and instead makes the case for a modern classical approach drawing on Smith, Ricardo, Marx and Keynes, in which the economy is turbulently driven by the forces of “real” competition and profit equalisation. For Shaikh, profit-making is the key aim of business, and it regulates both demand and supply. While neoclassical economics tends to be supply-side, and post-Keynesian approaches demand-side, his classical theory is “profit-side”.

One point he makes that really resonated with me is the notion that one’s theoretical framework must be consistent, even if it gives you results that you dislike. An example of this is the post-Keynesian idea that full employment can be achieved and sustained given the right policies. In his book, Shaikh argues that the historical evidence shows this not to be the case, or at least to be very difficult. I have long wrestled with contrasting Keynesian and Marxist ideas on this issue, and admit that I see full employment as a desirable policy goal under capitalism. I will also admit that the evidence shows that it is hard to sustain for the long term.

I applaud Shaikh’s intellectual honesty, and find it inspiring. Capitalism is not all good, even if it has driven rising living standards for a huge number of the planet’s population. Its evolution tends to be uneven over historical time and across geographical space, giving rise to winners and losers, to inequality and entrenched poverty as well as massive wealth and technological advance. I highly recommend his book, aspects of which I have written about on this blog over the last few years.