Geoffrey Hodgson Defines Neoclassical Economics

I think he offers definitions in other works, too.

"Let us attempt to identify the key characteristics of neoclassical economics; the type of economices that has dominated the twentieth century. One of its exponents, Gary Becker (1967a, p. 5) identified its essence when he described 'the combined assumptions of maximizing behavior, market equilibrium, and stable preferences, used relentlessly and unflinchingly.' Accordingly, neoclassical economics may be conveniently defined as an approach which:

• (1) assumes rational, maximizing behaviour by agents with given and stable preference functions,
• (2) focuses on attained, or movements towards, equilibrium states, and
• (3) is marked by an absence of chronic information problems.

Point (3) requires some brief elaboration. In neoclassical economics, even if information is imperfect, information problems are typically overcome by using the concept of probabilistic risk. Excluded are phenomena such as severe ignorance and divergent perceptions by different individuals of a given reality. It is typically assumed that all individuals will interpret the same information in the same way, ignoring possible variations in the cognitive frameworks that are necessary to make sense of all data. Also excluded is uncertainty, of the radical type explored by Frank Knight (1921) and John Maynard Keynes (1936).

Notably, these three attributes are interconnected. For instance, the attainment of a stable optimum under (1) suggests an equilibrium (2); and rationality under (1) connotes the absence of severe information problems alluded to in (3). It can be freely admitted that some recent developments in modern economic theory - such as in game theory - reach to or even lie outside the boundaries of this definitions. Their precise placement will depend on inspection and refinement of the boundary conditions in the above clauses. But that does not undermine the usefulness of this rough and ready definition.

Although neoclassical economics has dominated the twentieth century, it has changed radically in tone and presentation, as well as in content. Until the 1930s, much neoclassical analysis was in Marshallian, partial equilibrium mode. The following years saw the revival of Walrasian general equilibrium analysis, an approach originally developed in the 1870s. Another transformation during this century has been the increasing use of mathematics, as noted in the preceding chapter. Neoclassical assumptions have proved attractive because of their apparent tractability. To the mathematically inclined economist the assumption that agents are maximizing an exogeneously given and well defined preference function seems preferable to any alternative or more complex model of human behaviour. In its reductionist assumptions, neoclassical economics has contained within itself from its inception an overly formalistic potential, even if this took some time to become fully realized and dominant. Gradually, less and less reliance has been placed on the empirical or other grounding of basic assumptions, and more on the process of deduction from premises that are there simply because they are assumed.

Nevertheless, characteristics (1) to (3) above have remained prominent in mainstream economics from the 1870s to the 1980s. They define an approach that still remains ubiquitous in the economics textbooks and is taught to economics undergraduates throughout the world." -- Geoffrey M. Hodgson (1999). "False Antagonisms and Doomed Reconcilations", Chapter 2 in Evolution and Institutions: On Evolutionary Economics and the Evolution of Economics, Edward Elgar

Journalistic Comments On Economics

• David Warsh has a piece on János Kornai's challenges in pursuing a career in economics in communist Hungary. (I don't know if David Warsh reads me. If I interested him, he later did more research for his piece, from which I am grateful to learn.)
• Chris Hayes has a piece in the Nation on the last American Economic Association meeting. He writes about the unwillingness of mainstream economists to acknowledge heterodox economic ideas. Other bloggers and journalists have already commented on this article. I have yet to see anybody else in these and other discussions reference Fred Lee
• Many other bloggers have already commented on a Robert Solow review, in The New Republic, of a recent biography of Joseph Schumpeter. I might as well acknowledge I wrote the first draft of the Wikipedia entry on Schumpeter.

Update: Added some links, including reference to Fred Lee.

Greg Mankiw: Incompetent or Dishonest?

Some have assured me that mainstream economics is valid because this is not valid neoclassical economics (and mainstream economists know the invalidity of these claims):

"The neoclassical theory of distribution teaches us that a person's earnings depend on his or her productivity." -- Greg Mankiw, "How to Become Rich"

Of course, I am aware of mainstream economists who don't believe what Mankiw says:

"All optima imply marginal conditions in some form. These conditions are part of an overall solution. Neither they nor the quantities involved in them are prior to the overall solution. It reflects badly on economists and their keenness of intellect that this was not always obvious to everyone." -- Christopher Bliss, "Introduction, The Theory of Capital: A Personal Overview", in Capital Theory (edited by C. Bliss, A. Cohen, and G. C. Harcourt), Edward Elgar

"Why Do People Hate Economists?"

Ezra Klein has a series of posts on the topic. Some of the commentators seem to me to know what they are talking about. The discussion gets into the question of whether issues of efficiency can be separated from issues of equity, of whether efficiency can be discussed in a value-neutral way. (Short answer: No.)

Klein also talks about how "econ-speak" privileges attempts to raise Gross Domestic Product over attempts to pursue other goals. He illustrates this claim by discussion of vacation time. (I realize that, at the level of high theory, Klein's claim is false. I think that this objection elides questions of how economists participate in public discourse.)

I think people "hate" economists, like Democrats "hate" President Bush, or the French "hate" Americans. That is, it is just something some people disconnected from reality tell themselves to discredit other points of view.

The Meaning(lessness) Of Rationality

After many analyses, some mainstream economists acknowledge that they may not have a coherent understanding for what it means for a person to be rational:

"When these assumptions [of equilibrium, competition, and the completeness of markets] fail, the very concept of rationality becomes threatened, because perceptions of others and, in particular, of their rationality become part of one’s own rationality. Even if there is a consistent meaning, it will involve computational and informational demands totally at variance with the traditional economic theorist’s view of the decentralized economy." -- Kenneth J. Arrow (1986). "Economic Theory and the Hypothesis of Rationality" Journal of Business, V. 59, N4, Pt. 2 (reprinted in The New Palgrave)

A lot of this attempt to conceptually clarify the meaning of "rationality" uses game theory. In parallel with this theoretical work, economists and others have performed a body of experiments. These experiments found many cases in which the predictions of neoclassical theory were falsified. Daniel Hausman, in a chapter in his The Inexact and Separate Science of Economics, treats the resulting work as a case study. He tries to understand why mainstream economists retain a theory with such a poor track record in controlled experimental settings.

I have blogged on experimental economics before. (A Mark Thoma post post inspired me to put this post up.)

Daniel Hausman On One Aspect Of The CCC

"Demand theorists know there are few Giffen goods. They know why there are Giffen goods. They can successfully predict that certain goods in certain economies (potatoes in Ireland, rice in China, or yams in New Guinea) are likely to be Giffen goods. Capital theorists, on the other hand, do not know whether capital reversing is common or rare. Until recently they possessed no theory which made sense of the phenomenon. The status of that fundamental theory remains, moreover, questionable. From the perspective of the Austrian theory or of Clark's theory, capital reversing is nothing but a disconfirmation. Capital theorists are also unable to predict when capital reversing will occur. They cannot point to some feature of an economy and say, 'Ah, we can see that this is one of the exceptional cases in which we should not expect our simpler capital theories to work.' There is no justification for the claim that capital reversing demands only minor qualifications in simplified capital theories." -- Daniel M. Hausman (1981). Capital, Profits, and Prices: An Essay in the Philosophy of Economics, Columbia University Press

Hausman makes a distinction in this book between Models and Theories. Those interested in how Hausman's draws his lines are probably better advised, though, to read his later The Inexact and Separate Science of Economics.

Surowiecki Popularizes My View

Like Dean Baker, I have said before that important issues in "free" trade agreements are matters of governance, not trade. James Surowiecki makes fairly closely the same point in his weekly New Yorker column, in the 14 May 2007 edition. I read this in the dead trees version before reading comments on this column from various bloggers.

Zizek and Others

Like D-Squared, I'm dubious about some responses to continential philosophy, cultural criticism as put forth by the Frankfort school, post-structuralism, deconstruction, and other doctrines to which Alan Sokal might object. I feel that there are many blog posts and blogs that show more understanding of this stuff than I can.

I generally get whatever understanding I have of anti-foundationalism from Wittgenstein, analytical philosophers like Goodman, Putnam, American pragmatism, and even Rorty. I am not at all sure that these views are needed to effect social change. Nor do I take them as tied in necessarily with any very radical views. This may because in my random reading, I have read a limited amount of Rorty.

I am amused that this latest go around concentrates on Zizek. I have quoted bits from Zizek here before. My general impression of Zizek is that he is amusing. I feel that I am following along when I read him, but I distrust my ability to summarize what he is saying. Except, strangely enough, I think I can give some impression of his views on Lenin, if I felt like it.

I realize that not all these "post-modern" writers are doing the same thing. I think I'd get more out of my copy of one of Baudrillard's books if I hollowed it out and used it to store valuables.

I don't think I got much out of the extremely limited amount of Derrida that I have read. (I also like some of the Austin and Searle I have read - in the case of Searle, I also attended a guest lecture where he expounded his well-practiced views on strong AI.) I think I'd like to understand Foucault better, even though he can write a long time on sex without it coming close to being a turn-on.

I am interested in the history of ideas. I see the point of telling a history forward. In this case, the participants in the story may both point at measures of what they take to be the outside world as an argument for contending views. I can see the point of bracketing out how we have come to understand the world in trying to understand what participants in the story found convincing. I take this to be the strong program.

And I also understand that divisions between academic subjects, genres, etc. are not given. How some of us might group texts today may be very different from how others elsewhere and elsewhen grouped the same texts. Furthermore, on what time-scale continuity and discontinuity occurs may vary with how you look at texts. I take this to be part of Foucault's point in talking about "discursive formations."

Selected References

• Jean Baudrillard (1994). Simulacra and Simulation (Trans. by Sheila Faria Glaser), University of Michigan Press
• Fernand Braudel (1967). Capitalism and Material Life: 1400-1800 (Trans. by Miriam Kochan), Harper Colophon
• Jacques Derrida (1988). Limited, Inc. (Trans. by Samuel Weber), Northwestern University Press
• Michel Foucault (1972). The Archaeology of Knowledge (Trans. by A. M. Sheridan Smith), New York: Pantheon Books
• Richard Rorty (1991). Objectivism, Relativism, and Truth: Philosophical Papers, Volume 1, Cambridge University Press
• Ricard Rorty (1998). Achieving Our Country: Leftist Thought in Twentieth-Century America, Harvard University Press
• Slavoj Zizek (2001). On Belief, Routledge

Increasing Technorati Ratings

Whether it is realistic or not, I assume most readers of this blog probably have noticed Radek has been writing about me, sort of, lately.

Levy and Temin Should Reference Galbraith

From Dani Rodrik, I learn that Frank Levy and Peter Temin have out a new working paper, “Inequality and Institutions in 20th Century America” (1 May 2007). I haven't finished reading their paper, but I do not believe they reference James K. Galbraith’s Created Unequal: The Crisis in American Pay (Free Press, 1998) or Galbraith's later work. If not, they should.

János Kornai

Harvard has an economist on their faculty who understands how the hardness or softness of budget constraints varies among institutional structures.

János Kornai is a Hungarian who, as I understand it, published his first article on economics in 1956. During the 1960s, he researched a planning methodology in parallel with the official Hungarian planning; the official planning was based on Leontief input-output analysis. Kornai's methodology consisted of sectorial planning, addressed by Linear Programming, and a "central problem" of allocating resources, based on a game-theoretical formulation (Kornai and Liptak 1965).

Among the Post Keynesian economists I read, though, I think some of Kornai's later work is more frequently cited. In this work (Kornai (1971 and 1970), Kornai and Martos (1973)), he compares and contrasts certain institutional characteristics of actually existing capitalism and socialism. If I understand correctly, Kornai found that he had to create a lot of terminology because his observations did not fit into economic theory as he found it. In particular, neoclassical price theory ignores the institutional detail and non-price signals Kornai thinks important. Frank Hahn thought well enough of this work to engage it.

Lately Kornai (1990 and 2000) has been writing about post-communist transition economies.

I would like to be more familar with Kornai's work than I am. I would have trouble sumarizing his major points more than above.

References

• F. H. Hahn (1973). "The Winter of Our Discontent", Economica, New Series, V. 40, N. 159 (Aug.): 322-330
• J. Kornai and T. Liptak (1965). "Two-Level Planning", Econometrica, V. 33, N. 1 (Jan.): 141-169
• J. Kornai (1971). Anti-Equilibrium, Amsterdam: North Holland
• J. Kornai and B. Martos (1973). "Autonomous Control of the Economic System", Econometrica, V. 41, N. 3 (May): 509-528
• J. Kornai (1979). "Resource-Constrained versus Demand-Constrained Systems", Econometrica, V. 47, N. 4 (Jul.): 801-820
• J. Kornai (1990). The Road to a Free Economy: Shifting from a Socialist System: The Example of Hungary, New York: W. W. Norton
• J. Kornai (2000). "What the Change of System from Socialism to Capitalism Does and Does Not Mean", Journal of Economic Perspectives, V. 14, N. 1 (Winter): 27-42

Blinder, Once Again, On "Free" Trade

Alan Blinder has an op-ed in the Washington Post, and a lot of blogs are commenting. Brad DeLong merely echoes out Blinder's essay. Mark Thoma echoes some questions knzn has for Blinder. I've already pointed out an earlier Blinder comment on Globalization.

In related news, Max Sawicky doesn't appreciate Lou Dobb's support. Dani Rodrik has also been asking some questions about globalization in a dialog with, for example, Tyler Cowen. Ezra Klein has figured out that many economists ostracise those who deviate on free trade, whether they have anything serious to say or not.

Let me consider a couple of paragraphs in Blinder's essay:

"We economists assure folks that things will be all right in the end. Both Americans and Indians will be better off. I think that's right. The basic principles of free trade that Adam Smith and David Ricardo taught us two centuries ago remain valid today: Just like people, nations benefit by specializing in the tasks they do best and trading with other nations for the rest. There's nothing new here theoretically.

But I would argue that there's something new about the coming transition to service offshoring. Those two powerful forces mentioned earlier - technological advancement and the rise of China and India - suggest that this particular transition will be large, lengthy and painful." -- Alan Blinder

Notice the lengthly (dis-equilibrium) transition between two end states. Blinder's analysis is not set in an Arrow-Debreu model of intertemporal equilibrium, which some assure us is not vulnerable to a Cambridge capital critique. Rather, it seems to be set in the exploded Heckscher-Ohlin-Samuelson model, which is logically invalid if production uses capital goods [and the rate of interest is positive - I added this clause in an update]. Where else can you find an acknowlegement that, where Blinder accepts the orthodoxy, he gets his sums wrong?

Rymes Measures Productivity

I have previously referenced some papers providing empirical evidence that capital-reversing and other Sraffa effects can be seen in practice.

The Cambridge Capital Controversy has other implications for applications. In particular, one should be sceptical about the Solovian framework for measuring Total Factor Productivity (TFP). One might ask how one should analyze national accounts at an aggregate level instead. I have read very little of his work, but Thomas K. Rymes has pursued a research program directed at that question. He is also apparently interested in the Post Keynesian theory of endogenous money. I provide a list of some of his papers, most of which I recently downloaded. I don't have access to the book listed below.

References

• Thomas K. Rymes (2006). "On National Income", Carleton University Working Paper (9 October)
• T. K. Rymes (2004). "Modern Central Banks Only Have Real Effects", Carleton University Working Paper
• René Durand and Thomas K. Rymes (2000). "On Capital and Productivity: Harrodian and Keynesian Measures", 26th General Conference of the International Association for Research in Income and Wealth, Cracow, Poland
• T. K. Rymes (2000). "On the Cambridge Correction to the Measurement of Productivity in Manufacturing" CSLS Conference on the Canada-U.S. Manufacturing Productivity Gap (21-22 January)
• Colin Rogers and T. K. Rymes (1998). "On 'Money' in ISLM and AD/AS Models", Carleton University Working Paper (February)
• Alexandra Cas and Thomas K. Rymes (1991). On Concepts and Measures of Multifactor Productivity in Canada, 1961-1980, Cambridge University Press

Aristotle Manuscript Found

Exciting, for those interested in old writings. I haven't read the book this quotation is from:

"Of everything which we possess there are two uses: both belong to the thing as such, but not in the same manner, for one is the proper and the other the improper or secondary use of it. For example, a shoe is used for wear, and is used for exchange; both are uses of the shoe." -- Aristotle, Politics

That sounds like Smith's distinction, for example, between use value and exchange value.

Böhm-Bawerk on Surplus Value

It's easy enough to find on the Internet simple people (e.g., commentators here on the side of their host) ignorant of clarifications over a century old:

"The first question is, 'What is meant by saying, "Capital is productive"?'

In its commonest and weakest sense, the expression may be taken to mean merely that capital serves for the production of goods, as distinguished from serving for the immediate satisfaction of wants. In that event we are conferring upon capital the rank of a 'productive' entity only in one particular sense. I mean the same sense which appears in our general division of all goods into 'producers' and consumers' goods.' And even if that degree of productive effect were so slight that the value produced failed to equal the value of the capital expended in the producing, yet even that slight degree would justify us in conferring the title of 'productive.' But it is clear from the first, that a power which has productivity in this sense alone is completely incapable of accounting for the rise of originary interest.

The adherents of the productivity theories do, as a matter of fact, invest the term with a stronger meaning. Expressly or tacitly they understand it as meaning that, by the aid of capital, more is produced, that is to say, that capital is the cause of a special productive surplus result.

But this meaning is further subdivided. The words 'to produce more' or 'a productive surplus result' may mean one of two things. They may mean either that capital produces more goods or that it produces more value, and these are by no means identical. To keep the two as distinct in name as they are in fact, I shall designate the capacity of capital to produce more goods as its physical or technical productivity, and its capacity to produce more value as its productivity of value. It is perhaps not unnecessary to say that, at the present stage, I am leaving the question entirely open, as to whether capital actually possesses such capacities or not. I am merely recording the different meanings which may be given, and have been given, to the statement that 'capital is productive.'

Physical productivity manifests itself in an increased quantity or, possibly, in an improved quality of the product. I might illustrate it by the well-known example given by Roscher: 'Let us imagine a nation of fisher-folk without private ownership or capital, dwelling naked in caves, and living on fish caught by hand in pools left by the ebbing tide. All the workers here may be considered equal, and each man is presumed to catch and eat 3 fish per day. But now one prudent man limits his consumption to 2 fish per day for 100 days, lays up in this way a stock of 100 fish, and makes use of this stock to enable him to apply his whole labor-power for 50 days to the making of a boat and a net. With the aid of this capital he catches 30 fish a day from that time on.'

In this instance the physical productivity of capital manifests itself in the fact that the fisher, with the aid of capital, catches more fish than he would otherwise have caught, namely, 30 instead of 3. Or, to put it more correctly, he catches somewhat fewer than 30 instead of 3. For the 30 fish which are now caught in a day are the result of more than one day's work. To calculate properly, we must add to the labor of catching fish a quota of the labor that went into the making of boat and net. If, for instance, 50 days of labor were required to make the boat and the net, and if the boat and the net last for 100 days, then the 3,000 fish which are caught in the 100 days, appear as the result of 150 days labor. The surplus production then, due to the employment of capital, is represented for the whole period by 3,000 - 450 = 2,550 fish, or for each single day by 20 - 3 = 17 fish. This surplus production is a manifestation of the physical productivity of capital.

Now how would the production by capital of 'more value' be manifested? The expression 'to produce more value' is, in its turn, ambiguous because the 'more' may be measured by various standards. It may mean that, by the aid of capital, a value is produced which is greater than the value which could be produced without the aid of capital. In the foregoing illustration it may mean that the 20 fish caught in a day's labor with the aid of capital are of more value than the 3 fish which were got when no capital was employed. But the expression may also mean that, with the aid of capital, a value is produced which is greater than the value of the capital itself. In other words, it may mean that the capital gives a productive return greater than its own value, so that there remains a surplus value over and above the value of the capital consumed in the production. To put it in terms of our illustration, the fisher equipped with boat and net catches 2,700 more fish in 100 days than he would have caught without boat and net. These 2,700 fish are to be termed the (gross) return of the employment of capital and, according to this alternative interpretation of the expression, these 2,700 fish are of more value than the boat and net themselves, so that after boat and net are worn out, there still remains a surplus of value.

Of these two possible meanings those writers who ascribe to capital a productivity of value usually have the latter in mind. When, therefore, I use the expression 'productivity of value' without qualification, I shall mean the capacity of capital to produce value exceeding its own value.

Thus we have for the apparently simple proposition that 'capital is productive,' no fewer than four interpretations which are clearly distinguishable from each other. In order to place them in proper perspective, I should like to array them side by side. The proposition may signify any of the following:

1. Capital has the capacity of serving to produce goods.
2. Capital has the power of serving to produce more goods than could be produced without it.
3. Capital has the power of serving to produce greater value than could be produced without it.
4. Capital has the power to produce value greater than that which it possesses itself.

It should be self-evident that such widely differing ideas, even if they can, perchance be designated by identical terms to summarize them, must not be considered identical. Even less permissible would it be to consider them interchangeable in one or more given syllogisms. For instance, it should be self-evident that even though I may have demonstrated a capacity on the part of capital to produce goods at all, or to produce a greater quantity of goods, I am still not entitled to consider that I have established its power to produce more value than could have been produced without its assistance, or to produce a value in excess of that which the capital itself possesses. To substitute the latter two concepts in a demonstration which may have established the correctness of a syllogism involving the former two would obviously be tantamount to proffering a sophism, where a logically sound proof cannot be found..." -- Eugen von Böhm-Bawerk, Capital and Interest, V. I: "History and Critique of Interest Theories"; Chapter VII: The Productivity Theories, Section A. Preliminary Survey, Part 1. Ambiguity of the Term, 'Productivity of Capital'

Of course, Sraffa showed Böhm-Bawerk's answers to his questions to be logically invalid.

Irrelevant Aside On Friedman's Methodology

You may sometimes read (neoclassical) "Economic theory shows" p. Often these claims are untrue. One can prove this falsity by constructing examples in which the assumptions of (neoclassical) economic theory hold, but not p results. So the statement you have read is logically flawed.

I sometimes encounter people who respond with the non sequitur, "Assumptions do not need to be realistic." If this response made sense, those who propound it would be able to specify which assumption is claimed to be unrealistic in these examples. Good neoclassical economists understand this logic.

Anyways, those economists that insist that assumptions do not need to be realistic - that, in fact, unrealistic assumptions are actually desirable - probably take their position from Milton Friedman. From Steve Keen's Debunking Economics, I found a response by Alan Musgrave to this idea. Musgrave, perhaps when combined with a later Uskali Mäki comment, seems to me perceptive. From these two authors, one can get a taxonomy of assumptions. Here's Musgrave's, albeit with the first reworded following Mäki's suggestion:

• Negligibility: "The hypothesis that some factor", or combination of factors "has an effect upon" "the phenomenon under investigation" "small enough to be neglected relative to a given purpose".
• Domain: A specification of the domain of applicability of a theory.
• Heuristic: An assumption for developing a theory in a simple form that can be removed in later approximations.

The same wording might be used to express an assumption in all categories. For example, a model assumption might be "The government has a balanced budget". This might mean that the effects of budget imbalances have a negligible effect on the results of the model, that the model only applies when the budget is balanced, or that the model can be developed in a more complicated fashion with no assumption on the balance of the budget. Pace Friedman, assumptions, properly paraphrased, better be true ("realistic") in applications.

Update: Radek doubts some economists write "Economic theory shows..." As far as I am concerned, this is close enough:

"These observations should not be puzzling, for they are what standard economic theory predicts." -- Edward C. Prescott (1986). "Theory Ahead of Business Cycle Measurement", Quarterly Review, Federal Reserve Bank of Minneapolis (Fall): 9-22

References

• Milton Friedman (1953). "The Methodology of Positive Economics", in Essays in Positive Economics, University of Chicago Press
• Uskali Mäki (2000). "Kinds of Assumptions and Their Truth: Shaking an Untwisted F-Twist", Kyklos, V. 53, Fasc. 3: 317-336
• Alan Musgrave (1981). "'Unreal Assumptions' in Economic Theory: The F-Twist Untwisted", Kyklos, V. 34, Fasc 3: 377-387