Angel Versetti

Neo-classical economics cannot provide solutions to the problems we face today. Discuss.
Neo-classical economic thought, along with Neo-Keynesianism, are the dominating theories of modern economicsI. Most countries, which have economies tending towards free market systems, are found to possess features, similar to those, favoured by Neo-classic thoughtII. Once again, have we witnessed that vital questions have not been answered properly and neoclassical economists have failed to provide solutions to the problems we are facing todayIII. Neo-classical economics is largely dealing with short-term economic events and the process of allocating resources within an economy, which is in contrast with other significant economic thoughts, namely classical, Marxian and KeynesianIV. Austrian school of thought, though widely considered to be a variation of neo-classic economicsV, also offered some theories, contradicting the general neo-classical trendVI. In Neo-Classical economics, longterm effects are not given much attention and markets are analysed within limited time-span, which can be seen in works of such Neo-classicists, as Alfred MarshallVII, Leon WalrasVIII, John Bates ClarkIX and other distinguished representatives of the thought. Theory of price forming eclipsed questions of distribution and progressX, as immediate processes in the market and allocation of resources became the topic of discussions and debatesXI. Neo-classicists looked at an economy as a perfectly isolated entity, as if it were not affected by history or law or any other external factorsXII. They used pure and empiric cases to build theories and argued that investigations into markets' behaviour should only take markets themselves and disregard other factorsXIII. Abstract and simplified cases had grown very popular and were used to explain situations and solve problems using and applying mathematical formulae and logicXIV. Thus Neo-classicists tried to universalise and simplify difficult matters and they did manage to do that to some extent. The only problem was, and is, that the real world is not perfect, which seems to be the case in their theoriesXV and economics cannot be independent of and perfectly parallel to politics, law, sociology and other humanitarian subjects and social sciencesXVI XVII. Isolating markets does not give a full picture of the economy and its development. Unlike classical economists, who were interested in historical change, development over time had little importance in the work of neo-classical theorists. Most assumptions were based on logical reasoning disregarding timeXVIII. There was clear transition of focus from macro- to micro-economics. *** Alfred Marshall was the major pioneer of neo-classic thought, having introduced his "Principles of economics". Whilst analysing prices, he assumed that people behaved rationally, pursuing maximal utility, whereas businesses - profitsXIX. This point was to be criticised [in Thorstein Veblens works in particular], as people did not behave rationally every time, when engaging in an economic activity, or simply did not suspect about underlying costs or externalities due to information failure, or any other reason. Sometimes people simply relied upon luckXX. Veblen, whose vision of markets and especially of consumption, differed considerably from that of most Neo-Classicists, argued that economic rationality and pursuit of utility are not the dominating features of consumers.

On the contrary, he argued that various sociological reasons lay beneath people's decisions to engage in economic activities, and the chase after social status and emulation often resulted in irrationalityXXI. Overall, Veblen claimed that people were instinctive rather than reflectiveXXII. Veblen's theory of conspicuous consumption contests the rationality assumptions of Alfred Marshall's work as well as his exploration of demand. In the analysis of price, Marshall considered the demand curve to be staticXXIII, i.e. causes for it to be shifted, such as fashion, regulation, level of income, expectations or any other cause none of these were taken into account, which gives an incomplete understanding of functioning of markets, so rapidly fluctuating nowadays due to these factorsXXIV XXV XXVI. For the first time, production of intangible objects was deemed important, as from the point of view of Marshall, economy produced not just commodities, but utilities: Man ... only produces utilities... ... it would be best to regard all labour as productive, except that, which failed to promote the aim, towards which it was directed, and so produced no utility"XXVII

Marshall's point of view on costs was completely different from that of his predecessors. The labour theory of value was set aside. Instead, the questions of sacrifices and opportunity costs took its place. His conclusions on price formation have been recognised as self-evident axiomsXXVIII. Utility-based demand and production costs-based supply curves offered simple, yet precise answers. Incomes, which had previously been regarded as profits, became responsible for managers wages and interest rates. Businesses, in pursuit for profits, would strive to diminish the production costs, as there was assumed to be perfect competition and companies were unable to influence prices. Marshalls predictions of life cycles and limits of expanding of businesses have been refutedXXIX XXX, as division of management and ownership provided necessary conditions for long, potentially infinite, sustainability of companies. Additionally, studies of special markets do not provide solutions to problems, arising in mass markets, or answers to questions dealing with aggregate demand and supply, especially long-term aggregate supply. Therefore, conclusions drawn by Marshall may not be applicable effectively to modern economies problems. Lastly, in his opus magnum, Alfred Marshall inferred that the economy would be able to stabilise itself automatically and such problems as unemployment and economic inefficiency would be mended by the very markets after a brief period of timeXXXI. Marshall assumed that the economy would adjust itself so that it is functioning very close to, or indeed upon, the Production Possibility Frontier. Any efforts of the government to rectify the situation or intervene would result in [economically] pernicious consequencesXXXII. The author admitted, however, that free markets may not achieve socially desirable goals or ideal allocation of resourcesXXXIII, but still did not opt for government regulation of markets, having suggested instead that people be more educated and enlightened [economically] in order to prevent various risky and unfavourable speculations on marketsXXXIV. In later editions of his work, however, Marshall admitted that certain policies or actions of the government, resulting in improved allocation of resources, could in some cases increase utility and therefore, be justified. He also pointed out that in practise it would be difficult to apply thisXXXV. Marshalls postulates and conclusions were not altogether wrong on self-stabilising markets and tendency of liberal economies to grow, as on the whole GDPs of all countries in the

world grew in the last centuryXXXVI and the world has become wealthier, with higher living standards for most countries as a resultXXXVII. Nevertheless, many arguments, which Marshall used, and answers he gave, cannot be applied to modern post-industrial economies, and consequently cannot provide solutions to the problems that we face today. As a national policy, Alfred Marshalls postulates have limitations, and therefore objectives of the governments - keeping unemployment low and ensuring stable growth of the economy in particular - cannot be accomplished using Marshalls methods alone. *** There were other distinguished neo-classic economists in late XIX early XX century, who contributed immeasurably to the formation of economic thought. Leon Walras, from Switzerland, studied markets and introduced the theory of general equilibrium. Similarly to Marshall, he claimed that, when studying markets, determination of price and other activities in economics, one should only consider pure hypothetical situations and disregard practical featuresXXXVIII. His theory of perfect competition, where all buyers and sellers are in one immeasurable auction, has been somewhat realised in modern stock exchanges, but is still considered to be unachievableXXXIX. In his analysis of markets, Walrus always assumed maximal efficiency of resources and employment of labour possibleXL. Recent statistics show, however, that unemployment levels in most developed countries are above averageXLI and expected to grow (see graph below). Rising unemployment leads to idleness of the capital the economy functions well within the Production Possibility Frontier.

*** John Bates Clark, a contributor to the neo-classical thought from the USA considered monopoly impossible in free, uncontrolled markets, due to perfect competitionXLII; even if significantly large companies emerged, they would not be able to influence pricesXLIII. According to multiple researches, modern markets of a vast majority of developed economies are dominated by a very small number of corporationsXLIV XLV . Oligopoly is present in such vital markets as groceryXLVI, telecommunicationsXLVII and InternetXLVIII, mediaXLIX, book publishingL, airplane industryLI and many othersLII. Competitiveness in such markets deteriorates and an opportunity for collusions or cartels opens and, in essence, monopoly prevails with the conspirators not influencing, but setting and fixing prices, which leads to much worse consequences for competitiveness and price-forming than Clark could have allowed for.

Grocery Market of the UK

Concentration Ratio of four largest firms in the UK grocery industry is estimated at 76%, which is considered to be very high concentration with multiple elements of monopoly.

*** Knut Wicksell, a Swedish economist and anti-monarchist, discussed different aspects of neoclassical theory: he allowed for the fact that free markets would not always lead to socially desirable results and contemplated on impossibility of perfect competition between people and various socio-economic implications of the factLIII. According to Wicksell, people are not born with equal abilities, do not have same skills, power, education, health and economic assets, which therefore diminishes the probability of perfect competition to zero. Market participants and investors are not free equal agents: the society is not classlessLIV. Wicksell expressed some socialist views on the economic question of resources allocation, having considered them more acceptable than those of free markets.

*** Austrian school of thought, with Carl Menger and Eugen von Bhm-Bawerk in particular, criticised the Neo-classical methods of constructing artificial empirical scenarios and suggested that a complex net of human actions and their consequences be regarded more carefully to explain the functioning of marketsLV. They saw economics as one of the humanities and deemed mathematical equations and formulae inappropriate for explanation of sophisticated processes in economies, opting for deduction and logic. Theory of methodological individualism was proposed to support the critique of neo-classical aspectsLVI. Some late Neo-classicists were to concur with this theory, so eventually it somewhat merged Austrian school of thought with Neo-classical economics, although the two differ in opinions and methods applied significantly.

*** Overall, neo-classical theory is based on sound logic and offers laconic explanations to many hypothesised problems; nevertheless it cannot provide answers to the problems we face today, due to multiple differences between the economic world of neo-classicists and the real modern world: * Neo-classic economics does not provide answers to many macro-economic problems and give too narrow a picture of markets. *Full efficiency and employment are considered to be unchallengeable inherent features of economies, which clearly does not apply to the current situation in most countries. *Assumption of perfect competition and inability of businesses to influence prices and demand. Studies have indicated that most markets have imperfect competition, where suppliers influence and effectively form pricesLVII. *According to neo-classical economics, markets will mend all inefficiencies. Government intervention is damaging the economy and cannot bring desired results. The history has proven these assumptions wrongLVIII LIX. *Only single changes were considered, whilst other conditions were assumed to have stayed constant. Recent studies have shown that in the markets, various chains of events occur, and all factors of production and conditions of demand are constantly changing and influencing markets and price formationLX LXI LXII. Studies of single changes effects upon the market would only be applicable to primitive hypothesised problems, whereas the complex and sophisticated system of modern economics would be left unexplained. *Assuming consumers to be perfectly rational and seeking utility contradicts with ideas, put forward by Veblen and other sociologistsLXIII. *Equilibrium, as it is defined by neo-classic economists, has been criticised for being subjective and prescriptiveLXIV. Ethical conclusions were often drawn from the scientific data, which moved the works further away from pure scienceLXV. *Distribution of wealth and long term economic effects are not explained in much detail. *** In response to failure of neo-classical economists to provide answers to a range of vital questions, multiple economic works emerged to fulfill the task. Of these works, which formed an opposition to the neo-classical ideology, the most significant was General theory of Employment, Interest and Money by John Maynard Keynes. This work emerged during the Great Depression an event that brought down the ideals of neo-classical economistsLXVI LXVII and thus became a timely sensation, analysing conditions, which neo-classists considered unreal; multiple flows in neo-classical reasoning were exposed and criticised. Keynes was interested in the forces, which governed the total output of economics. He reversed the course of economic thought back to macroeconomics. Microeconomic problems, on which the neo-classicists had concentrated, were moved to the background. Unregulated markets would fail, Keynes asserted, and inevitably result in unemployment and inefficiencyLXVIII.

Keynes did not argue with neo-classical economists analyses of microeconomics, but he was sure that they were insufficient for effective national policy and achieving various socioeconomic goals. He refuted one of the key postulates of neo-classical thought that interest rates determined equilibrium between savings and investmentsLXIX. Neo-classical economists had only looked at money that was spent, whereas Keynes enquired into the reasons for holding and hoarding itLXX. Neo-classicists only considered money as a medium of exchange; Keynes proved that it was also a store of valueLXXI. Self-stabilising properties of economy had been disprovedLXXII. There was a risk of reaching general equilibrium with persisting mass unemployment.

Later in his work, Keynes went on to challenge the neo-classical theory of determination of interest rates, having proved that they were not established through supply and demand for money. Interest rates, which neo-classicists considered the chief determiner of the amount of savings, made little difference to common people, according to him. Savings were interestinelasticLXXIII. Keynesian Economics emerged at challenging times; gave a valuable insight into imperfect functioning of economies and essentially became a successor and an opponent to Neoclassical thought. *** Economic theories are ever-developing and progressing. There have been critiques of Keynesian economicsLXXIV, because government intervention might affect markets negativelyLXXV; as well as revisions and extensionsLXXVI. New theories are being elaborated every day in search of perfection. One theory cannot provide answers to all questions, be it Marshallian, Keynesian, Marxian or any other. How tight should market forces be constrained? Could economies benefit from market and economic cycles? Is Pareto efficiency truly desirable? Reasoning and experience as well as rationality and moderation could become the keys to answers and success. All of the theories are not flawless; none of them appear to be a panacea; yet, each has contributed to the formation of modern economic thought. Neoclassical thought is not an exclusion. Alone, it cannot solve the problems the society is facing today; however, it would be unwise to reject it altogether and not to learn from its past trials. By making errors and analysing them, mankind is nearing the truth. Neoclassical economics has doubtlessly done that.

Angel Versetti
This essay contains 2499 words.

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