TPM Cafe Book Club: Neoclassical Economics: Threat or Menace?

My comment on the Christopher Hayes discussion over at TPM Cafe:

It's Different for Lefties and Righties | TPMCafe: My view is that the neoclassical economics toolkit can be very, very useful--no, stronger than that, is very useful and necessary--for everybody from the center on left. The methodological individualism of the toolkit forces you to look at real people and how situations help or hurt them. The competitive market benchmark assumed by the toolkit requires you to think carefully and specifically about just where the externalities are that keep you from relying on markets alone to solve whatever problem you are looking at. The equilibrium conditions established by the toolkit force you to check for unanticipated consequences, for blowback due to changes in incentives and so forth.

The result is that the neoclassical economics toolkit makes you a smarter, stronger, more powerful, more effective, more reality-based leftie.

By contrast, the neoclassical toolkit can be absolute poison for people right on center. It functions like a kind of crack, reducing their arguments to empty slogans: "the market takes care of that"; "acts of capitalism between consenting adults"; "they hired the money, didn't they?"; "it's not the government's, it's theirs."

People right-of-center should be exposed to the neoclassical economics toolkit only after posting a $1M bond to cover collateral damage, and only under the supervision of trained professionals.

Comments

[Miracle Max]

This is persuasive; I mostly agree with it, as far as it goes. It is also amusing. But it fails to engage the issues under discussion.

[anne]

http://www.calvorn.com/gallery/photo.php?photo=7325&u=254856,17

Bobolink
Shawangunk Grasslands National Wildlife Refuge.

Perfect.

[anne]

http://www.tpmcafe.com/blog/bookclub/2007/may/30/heterodox_errors

May 30, 2007

Heterodox Errors
By Paul Krugman

I don't have time to weigh in on all the issues here, but I'd like to warn against an error I think both sides tend to fall into: assuming that you have to use heterodox economics to reach conclusions critical of free markets. As I said, both sides tend to fall into that error: the heterodoxishly-minded bash neoclassical economics because they claim that it automatically makes you a defender of capitalism red in tooth and claw, and the free-marketeers reject warnings about markets gone wrong as somehow necessarily reflecting ignorance of economic theory. It just ain't so.

Let me give two cases in point. One is the California electricity crisis of 2000-2001. Those of us who saw it as a crisis produced by market manipulation did so on the basis of pretty standard economics, maximization, equilibrium, and all. I know a lot of people ridiculed the market manipulation story, eventually confirmed by the Enron tapes, with statements that began "Economics 101 says ..." - but that just showed that they didn't know much about economics, and were confusing a set of analytical tools with an ideological mindset those tools often don't support.

The other is the effects of trade on income distribution. Anyone who thinks that neoclassical economics says that everyone gains from free trade, and that you have to reject the assumptions of the field to raise concerns, obviously doesn't know anything about the subject: ever since Stolper-Samuelson 1941 we've known that trade can easily hurt large numbers of people, so the question is always an empirical one. A dozen years ago I thought the effects were small, but that was based on the numbers, not a judgement in principle. Now I've revised my views up, because the numbers are bigger.

My point isn't that neoclassical theory can do anything. But it's perfectly possible to believe in extensive market failure, demand a lot more government intervention in the economy, while still believing that maximization-plus-equilibrium is a nifty way to think about lots of problems.

[andres]

Both Brother Brad and Brother Paul are spot on in their comments. But there are more wonders in social science than are dreamt of in their philosophy.

The real problem with right-of-center cheerleading is that it is based on 19th century thinking--it ignores all of the advances that have been made in neoclassical economics in the 20th century with regards to asymmetric information, uncertainty, economies of scale and externalities. Once all of those advances are factored in, you can no longer view neoclassical economics as a blanket endorsement of laissez-faire anti-governmentalism.

However, neoclassical economics is necessary but not sufficient. A good knowledge of neoclassical economics can make one a good liberal economist as a opposed to a bad right-wing or (more rarely) a bad left-wing economist. But in order to understand political processes, ie the reasons why optimal economic policies are rarely adopted, one needs to go further into the realms of class, culture, and even (yuck) gender.

The advent of the Bush Administration as a social and historical phenomenon _cannot_ be explained by neoclassical economics, and this makes the shrill ravings of Brad and Paul Krugman all the more poignant.

[ay]

1) I think the toolkit provides a basic framework and establishes a common language (for the lack of a better term) with which people can have meaningful debate instead of shouting past each other all the time.
2) It is a forcing mechanism to make one's thought process more disciplined and arguments more structured so that one does not come off as "sloppy or wishy washy" when discussing these often subtle points.

[Julian Elson]

I think the biggest risk in neoclassical economics is when people start treating it as a kind of Swiss army social science, which transcends and renders all other forms of social scientific inquiry obsolete. For instance, when people think that they can determine how to deal with crime just by modelling incentives, risks, deterrents, and margins, and that they don't need to actually talk to any criminologists about it, they find themselves doing bad economics as a substitute for good criminology.

Of course, just as economics produces junk science along with good science, criminology also produces junk science along with good science, so just because a criminologist said it about crime doesn't meant that it's certainly right. Also, economics *does* have a lot to contribute to other social sciences, even if it can't replace them (well). (I know Brad is something of a Posner fan, but I'd nonetheless cite him as something of an example of this.)

[John Emerson]

I find the whole debate depressing. I personally have no dog in the theoretical fight between Marxists, Keynesians, Austrians, et al, except that I've liked some of the institutionalist things I've read. (Feminist and evolutionary economics, so called, don't seem especially heterodox in the theoretical sense). However, except for the Austrians and perhaps the Marxists, all of the heterodox schools seem less toxic and more humane than the orthodox.

I mostly think about the toxic effects noted by Brad in his final paragraph. To me, this is what economics is and has been during my adult life (since 1967 or so.) The fact that there exist quiet little scientists in the schools doing stuff that isn't really awful hasn't been vividly present in my life experience.

When I try to say things, invariably economists will say, "Oh, that's just the sociology of economics", "That's just politics", "Oh, yes, we could present ourselves better", "We're really scientists and not responsible for the opinions of other economists or the use that is made of our work." Utter, self-serving crap, but they're institutionally secure (a sociological aspect of their profession that they're untroubled by) and do not have to understand or pay attention to what I say. (I can't understand the math, you see.)

Anyway, what should be an honest discussion of the way economics works always gets turned into a theoretical debate in which the orthodox try to destroy all of the heterodox forever while evading criticism to the maximum extent possible.

A recent survey showed that economists are more optimistic about the future than anyone else, and that economists have the same opinions regardless of their income. Both these facts can be explained by the fact that the low end of the wage scale for fully-employed econ PhDs without crippling disabilities must be around $80,000 a year.

The major weakness of economics may have nothing special to do with the theoretical battles (though my opinion is that the orthodox are the worst). Economics is a partial description of reality, and it's worst where it hooks in to non-market reality -- community, the physical environment, the family, the cultural and none-economic intellectual world. Economists are not always even discreet in expressing their contempt for social scientists or anyone else using any methods other than economic methods, or studying topics not easily describable in economic terms.

And they will use all sorts of evasions to obscure the harmful effect the inevitable limits of their science have on its usability as a source of policy wisdom or understanding of human life in general. There's quibbly fake modesty, or opportunistic ventures into philosophy of science, but at crunch time economists are unabashed about telling people how it is.

[jamie_2002]

Basic economics (as taught to me in the 1980's) is based on a specific model--
a market with many competing buyers and sellers; each actioning rationally (evaluating costs and benefits of different options) to maximize utility; none with power to influence the market.

Such a market provides efficient price signals to allocate scare resources. The result is that the costs of production are met by the returns to production at the margin, and no profit beyond marginal costs accrues.

The only profitable option for any rational agent in this situation is to evade the market-- to develop monoply/ monopsony power, to create barriers to competition, to foist externalities on others, to evade agreements and reneg on contracts.

Every agent that captures returns above costs is a success from the standpoint of rationality, yet economists refer to these as market "failures". How valuable is a model that treats the logical consequences of its premises as "failures"?

[Joe S.]

Is our host a closet Straussian? He seems to be arguing that neoclassical economics is only safe in the hands of well-trained lefties. Poorly-trained lefties cannot use it, and wingnuts are incapable of doing anything productive with it. Cute.

I like the implications of this argument even more than the argument itself. If we removed economics from the American undergrad curriculum, the nation would be better off. Ignorant wingnuts and beefy bidnessmen could not enlist Mr. Science (as Econ 101) to justify their respective hatred and greed. And there is no downside from dropping undergrad economics. Physics is much better undergrad training for Ph.D. economists than an undergrad economics degree. A large dose of physics would cure economists of physics envy and inappropriate mathematicization, at very least. ("Mathematical physicist" is one of the worst insults you can give to a theoretical physicist.)

Come to think of it, physics is better undergrad training for almost anything analytic, with philosophy perhaps #2.

[ogmb]

"Every agent that captures returns above costs is a success from the standpoint of rationality, yet economists refer to these as market "failures". How valuable is a model that treats the logical consequences of its premises as "failures"?"

Simply put because the social cost are higher than the individual gain from the anti-market activity.

[John Tiemstra]

Let me register a few specific objections:

"forces you to look at real people." But the people in the theory aren't real. They only care about money. No real people are like that.

"competitive market benchmark" This encourages thinking that whatever is, is right. It also leads most people to ignore externalities, monopolies, etc., not focus on them.

"equilibrium" In the most competitive markets, equilibrium changes every ten seconds. (That's why they have the ticker on CNBC.) So how does that matter? In most important markets (consumer goods, cars, labor) prices are negotiated or administered. In both cases, power matters, and NC economics has no "tools" for dealing with power.