DISCLAIMER: I actually dislike disclaimers, but this is apparently a sensitive topic. So there you have it: what I write here is my opinion and classification, and others may (or rather will) disagree. Being a good scientist I will build my argument on sources, but writing on this topic inherently involves judgement calls and opinions.

This post was sparked by a recent discussion I’ve had on LinkedIn. The author of the post proclaimed the obsoleteness of “the current neoclassical economic system” and then summed up neoclassical economics as “Our economy needs commodities. There is money in scarcities. Scarcity is good. Greed is good. Need is good….”

Independent of whether I agree with his analysis of our current economic system being obsolete, I took issue with the summing up of neoclassical economics as he did. A going back and forth between us ensued, and I figured I’d collect my thoughts in this post. I’ve done some reading since so my view on this has slightly changed (hence the title of this post).

What is neoclassical economics?

The way I saw this, was that neoclassical economics is current economic theory as we teach it. But rather than writing that straight down I figured I’d better go and check. So I did a quick search in the literature. One of the first articles that turned up was: The death of neoclassical economics, by David Colander. He describes that the term is used differently by different people, and this causes confusion. This is the main reason why he calls for putting an end-point to neoclassical economics. Colander writes:

The problem is its use by heterodox economists, by many non-specialists and by historians of thought at unguarded moments, as a classifier for the approach that the majority of economists take today.

Colander, The death of neoclassical economics, p 130

And:

The worst use, and the place one hears neoclassical most often, is in discussions by lay people who object to some portion of economic thought. To them bad economics and neoclassical economics are synonymous terms.

Colander, The death of neoclassical economics, p 130

He then goes on to explore what the term should mean and how it has evolved over the years, based on historical context. The term classical was coined by Marx and has evolved to refer to work by e.g. Adam Smith, David Ricardo, Jeremy Bentham and John Stuart Mill.

Neoclassical builds on this work; originally it referred mainly to the work of Alfred Marshall, but over time evolved to include the work of Carl Menger, Léon Walras, and William Stanley Jevons. It then evolved further in use by lay people and what Colander calls “heterodox economists” to also mean its current use of “bad” mainstream economics. But we cannot have both. Therefore Colander proposes to say that neoclassical economics died a slow death between 1935 and 2000. Neoclassical economics then focuses around six main attributes:

  1. Allocation of resources at a given moment in time
  2. Central role for utilitarianism (ordinal or cardinal)
  3. Focus on marginal trade-offs
  4. Assume far-sighted rationality
  5. Methodological individualism (start from the individual and reason towards the market)
  6. General equilibrium theory

Although some of these attributes still feature in modern economics, its views are far broader than this. For example, allocation across time is an important topic these days, especially considering sustainability and economic growth (e.g. this post by @villysgaard), going beyond marginal trade-offs is often called for (e.g. this post by @brookskaiser) and many models these days are built on game theory, set theory and topology, assuming far-sighted rationality has given way to behavioral economics, and whether or not the sum of individual preferences can always be translated into social preferences is also shown to be doubtful (e.g. this post). Modern mainstream economics has moved on.

What is neoclassical economics NOT?

Let me also write what neoclassical economics and modern economics are not, combined with an analysis of how some people came to see it as such.

Neither neoclassical economics nor mainstream economics claims that scarcity is good. Scarcity is, that’s all. There is scarcity because humans are assumed to have unlimited wants. Note that unlimited wants do NOT mean that we want unlimited money, or infinite amounts of goods. We can be quite satisfied with having enough of one thing or good, but then we’ll want something else. Time is the ultimate scarce resource. I would like to write this blog post and drink a cup of coffee, but I cannot do both at the same time.

In how far people actually can say enough is enough is a point one can debate of course, but that scarcity is widespread is something few people would doubt.

It is true that economists recognize that if something is (very) scarce that its price will rise, provided the good is traded and that therefore the people who own the good can make a lot of money. But we would not make a judgement about that being good or bad. We only say that if everything works out as in our models, those who value the good the most will be the ones paying this price. The market makes sure that goods are allocated to those who value them the most, provided a number of assumptions are met. In that way we maximize the economic pie, without having to worry too much about the distribution of costs and benefits (see also here on these pesky little details).

Neither neoclassical economics nor mainstream economics claims something ridiculous as “greed is good”. Yes, there is the invisble hand, and self-interested individuals can produce the greatest good, and many economic models are still populated with maximizing agents. BUT economists also realize that these outcomes only come true, as I said, if certain assumptions are met. These assumptions are, among others (from Perman et al.):

  1. Markets exist for all goods and services produced and consumed
  2. All markets are perfectly competitive.
  3. All transactors have perfect information
  4. Private property rights are fully assigned in all resources and commodities.
  5. No externalities exist.
  6. All goods and services are private goods. That is, there are no public goods.
  7. All utility and production functions are ‘well behaved’.
  8. All agents are maximisers

When one claims on this basis economists think that greed is good, we are brushing over a lot. As Colin W. Clark wrote about the topic on which he is often misquoted:

It is foolish to asset that “Clark (or someone else) has shown that it is optimal to harvest a biological resource to extinction if the discount rate is high enough,” for example. A certain bioeconomic model studied by Clark (or whoever) may produce this result, but there are inevitably underlying assumptions that may affect the prediction. Unless Clark (for example) is a phony, he will have carefully specified these assumptions, and attempted to indicate what happens to the prediction when the assumptions are changed.

C.W. Clark, Mathematical Bioeconomics, The economics of conservation (3rd ed.), p.125

Without going into the meaning of all of the above assumptions required for perfect competition, a quick glance suffices to say how none of these are actually met simultaneously in the real world. Perfect competition and its associated assumptions teach us how markets can work and distribute resources efficiently, without further government intervention. Markets that come close to this may need little further guidance or regulations. How close some markets come is a subject of debate. Some economists have more faith in markets than I do.

However, when any of these assumptions are not met, we are in the complex world of 2nd best, and things become a lot more difficult to analyze.

Where do these misunderstandings come from, and why are they used in our current economic system?

Where does the notion that economics is solely interested in maximizing net benefits and that we assume “greed is good” come from? I suspect in part economists have themselves to blame. Sometimes we are just too eager to point out how the world works using (too) simple economic models, ignoring the caveats that come with these models. In addition, what people remember from their introductory economics classes is typically the blackboard versions of these models, with demand curves sloping downwards at 45° and supply sloping upwards at 45° (they can also be (nearly) flat you know), partial equilibrium, no externalities, and yes, utility and profit maximizing agents (see also here).

Now if all that you remember from economics is just that, and you combine it with a solid dose of libertarianism, you get the system that we are currently engaged in, with some policy makers making ridiculous claims that we should just leave things to the market and all will be well, or that making water a traded commodity will solve all water scarcity problems.

Image Credits:

Mistake picture © stevepb (pixabay.com) https://www.needpix.com/photo/download/423477/mistake-spill-slip-up-accident-error-careless-failure-business-unexpected

Greed is bad: © thetortmaster  https://www.flickr.com/photos/23876049@N06/9445807005