Saturday, November 23, 2013

On "Neoclassical Economics"

I just want to document here some usages of the phrase, "Neoclassical economics". I restrict myself to literature in which the use is in the nature of aside, including within critiques of mainstream and neoclassical economics. Such documentation can be multiplied indefinitely. I do not quote from literature (e.g., Colander, Holt, and Rosser 2004; Davis 2008; Lawson 2013; Lee and Lavoie 2012; Varoufakis 2012) which focuses on the meaning of the word and on the sociology of economics. I find it quite silly to attempt to refute a critique of mainstream economics by complaining, without any other argument, that the word 'neoclassical' appears in that critique.

"In the last dozen years what before was simply known as economics in the nonsocialist world has come to be called neo-classical economics. Sometimes, in tribute to John Maynard Keynes's design for government intervention to sustain purchasing power and employment, the reference is to Keynesian or neo-Keynesian economics. From being a general and accepted theory of economic behavior, this has become a special and debatable inter-pretation of such behavior. For a new and notably articulate generation of economists a reference to neoclassical economics has become markedly pejorative. In the world at large the reputation of economists of more mature years is in decline." -- John Kenneth Galbraith (1973).
"One further matter merits consideration before we get down to business. I often refer to neoclassical theory and I had better make clear what I do and do not mean by this designation. For present purposes I shall call a theory neoclassical if (a) an economy is fully described by the preferences and endowments of agents and by the production sets of firms; (b) all agents treat prices parametrically (perfect competition); and (c) all agents are rational and given prices will take that action (or set of actions) from amongst those available to them which is best for them given their preferences. (Firms prefer more profit to less.)" -- Frank Hahn (1984).

"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 (1988).

"The creators of the neoclassical model, the reigning economic paradigm of the twentieth century, ignored the warnings of nineteenth-century and still earlier masters about how information concerns might alter their analyses- perhaps because they could not see how to embrace them in their seemingly precise models, perhaps because doing so would have led to uncomfortable conclusions about the efficiency of markets. For instance, Smith, in anticipating later discussions of adverse selection, wrote that as firms raise interest rates, the best borrowers drop out of the market. If lenders knew perfectly the risks associated with each borrower, this would matter little; each borrower would be charged an appropriate risk premium. It is because lenders do not know the default probabilities of borrowers perfectly that this process of adverse selection has such important consequences." -- Joseph E. Stiglitz (2002).
  • David Colander, Richard P. F. Holt, and J. Barkley Rosser, Jr. (2004). The changing face of mainstream economics, Review of Political Economy, V. 16, No. 4: pp. 485-499.
  • John B. Davis (2008). The turn in recent economics and return of orthodoxy, Cambridge Journal of Economics, V. 32: pp. 349-366.
  • John Kenneth Galbraith (1973). Power and the Useful Economist, American Economic Review, Presidential address at the 85th annual meeting of the American Economic Association in Toronto, Canada in December 1972.
  • Frank Hahn (1982). The neo-Ricardians, Cambridge Journal of Economics, V. 6: pp. 353-374.
  • Tony Lawson (2013). What is this 'school' called neoclassical economics?, Cambridge Journal of Economics, 2013.
  • Fred Lee and Marc Lavoie (editors) (2012). In Defense of Post-Keynesian and Heterodox Economics: Responses to their Critics, Routledge. [I've not read the book, but have read some chapters published seperately.]
  • 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.
  • Joseph E. Stiglitz (2002). Information and the Change in the Paradigm in Economics, American Economic Review, V. 92, N. 3 (June): pp. 460-501.
  • Yanis Varoufakis (2012). A Most Peculiar Failure: On the dynamic mechanism by which the inescapable theoretical failures of neoclassical economics reinforce its dominance.

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