Neoclassical economics II: pseudo-scholarship

[Published at Pearls & Irritations, 22 Sept.]

Neoclassical economics is without scholarly integrity. It does not belong in universities. It certainly should not be the dominant source of policy advice to governments.

Most scholarly disciplines, be they history, physics or ecology, have a conception of appropriate standards by which the evidential basis of an argument is presented and the reasoning leading to conclusions is explained. The goal is to shed light on the workings of the world, and a criterion for a successful study is that observations or records are consistent with the study’s conclusions.

Neoclassical economics, the strand of economics that has dominated world policies for several decades, fails these criteria. Its conclusions are regularly contradicted by developments in the real world. A dominant criterion for a successful study is that its logic is internally consistent; it thus confuses mathematics with the science it claims to be. It is variously claimed that assumptions on which a theory is based don’t matter, or that the better the theory the more unrealistic the assumptions, or that all theories are wrong. It imagines its theories are useful approximations to reality, and fails to appreciate that more reasonable assumptions can lead to radically different conclusions, so its theories may be deeply misleading.

Neoclassical economics originated late in the nineteenth century and claimed to build on the ‘classical’ economics of Adam Smith, David Ricardo and others. Whereas Smith thought markets could in some circumstances result in satisfactory outcomes for all participants, he also required that markets are embedded in and restrained by society and morality. He was really railing against the corrupt alliance of merchants and the government in setting up colonial trading monopolies. He warned that wherever merchants might congregate one should suspect a conspiracy to defraud customers.

Neoclassical economists created a mathematical theory that purported to show that ‘free’ markets will always bring an economy to a general equilibrium in which all supplies balance all demands. Furthermore, this general equilibrium was shown to be an optimum, in the sense that outputs would be maximised for given inputs of land, labour and capital.

When rich people heard about this theory they started paying neoclassical economists lots of money to keep saying that free markets are best. It means rich people should keep making money as fast as they can. It means government is bad, because it gets in the way of rich people. Adam rolled over.

However certain assumptions were required to get the mathematics to yield this brave new world vision. There can be no economies of scale (beyond a point of diminishing returns), there should be no social interactions, and everyone should be rational calculators. People are reduced to transacting atoms, to rational economic man, to what I call calculating reptiles.

The flow of time has to be suspended. It was regarded as a triumph when it was shown that if we can all assign probabilities to all future contingencies then the general equilibrium is still possible. So it is assumed we each have this power, and a computer the size of the universe to implement it. Physicists and applied mathematicians might recognise that this amounts to telescoping the unknown future into the known present; it is analogous to transforming your system of equations from hyperbolic to elliptic. It gets rid of the path-dependence of solutions. History doesn’t matter and the future is assured.

If any of these stringent assumptions is changed to something more reasonable, equilibrium is no longer possible. Not just hard to find, impossible. For example, Henry Ford and Jeff Bezos have understood that economies of scale can allow you to undercut your rivals, gain more market share, increase your economies of scale and further undercut your rivals in a runaway, unstable process until you gain near-monopoly in your market segment. The technological homogeneity of the internet puts this tendency on steroids. If a potent new software or strategy comes along, you empire is at risk of being overthrown. There is no equilibrium.

If there is no general equilibrium, then nothing can be said about optimality, because optimality emerges from the general equilibrium. It means there is no basis for claiming free markets are efficient.

The accumulation of absurd assumptions in neoclassical economics can be recognised as a desperate attempt to exclude instability and thus to preserve the old conclusion. Neoclassical economists became infatuated with equilibrium, contorted their theories to maintain it, and lost all connection with reality.

A regular defence, offered for example by another faux-Nobelist, Paul Krugman, is that their theories are helpful to maintaining systematic thinking. That requires the theory to bear some useful approximation to reality. In a widely-cited paper, Milton Friedman in 1953 apparently tried to argue that no theory can fully represent reality (correct), so all theories are approximate (correct) and that the biggest pay-offs of insight come from rough, general approximations (sometimes correct). His statements are so garbled and contradictory, however, it is hard to tell if that is really what he was trying to say. So some people take him to have said assumptions don’t matter, etc. Unfortunately, as their own theories demonstrate, hopelessly unrealistic assumptions will get you a hopelessly unrealistic theory.

Why were neoclassical economists taken by surprise by the Global Financial Crisis of 2008? They said it was a black swan event, something no-one could have anticipated. Except that some well-known people did anticipate it, on the basis that there was far more debt than people were likely to be able to repay. People did fail to repay, there was a cascade of defaults and the global financial system seized up.

The problem, you see, is that neoclassical economists exclude money and debt from their theories. Why? Well, aside from the ill-informed excuses they advance, if you allow for debt then the present becomes linked to the future (when the debt is supposed to be repaid), and the future involves risk, such as the possibility of cascading defaults. Our modern token money is itself a form of debt. So arguably the most potent forces in a modern economy, money and debt, are left out of their theories. So they did not see the GFC coming, and their predictions of prosperity just around the corner regularly fail.

Another bit of inconvenient reality: cascading defaults can trigger a financial market crash, and a market crash is an obvious manifestation of instability. There was no equilibrium. There are many sources of instability in an economy when you look: technological innovation, economies of scale, money and debt, social interactions, ‘irrational’ herd behaviour among others. Economies are always far from equilibrium, which makes them complex self-organising systems, like organic systems, with radically different behaviours: as different as wild horses from a rocking horse.

As I noted in Part I, the illusion of an agile, self-correcting economy, and society, allows economists to expect, and then to conclude, that the gross global disruption of serious global warming will merely shave a few percent off the global GDP.

There is a fringe of dissenting economists, and the odd scientist like me, who have been pointing out for many years that neoclassical economics is misleading nonsense. The dissident economists are excluded from the best jobs, the best journals and positions of influence by what James Galbraith calls a ‘Politburo for correct economic thinking’.

Scholars in other disciplines need to be alerted to the presence of this imposter in their midst. Neoclassical economics is pseudo-science, assertions dressed up in mathematics to look like science. It fails basic scholarly criteria, like changing your theory when it completely fails to accord with reality. It is profoundly confused about what good scholarship and good science involve. Its professional criterion for a successful career is conformity to its groupthink.

3 thoughts on “Neoclassical economics II: pseudo-scholarship

  1. Yoshinori Shiozawa

    Geoff Davies,

    I do not doubt your goodwill and sincerity, but is it time to endlessly repeat criticizing neoclassical economics? As a heterodox economist, I clearly admit that “Neoclassical economics is pseudo-science, assertions dressed up in mathematics to look like science.” But, I have a different opinion concerning the strategy of economics to take as an economist. (Even if you are not an economist, you have some responsibility to consider how to reconstruct economics as long as you say something about economics.) 

    N.B. Here, I confine myself to neoclassical economics as an entity separated from policy and policy implications. It is possible to think that they are inseparable, but it is more confusing to talk them together than to clarify the problem.

    You have noted that”Neoclassical economists created a mathematical theory that purported to show that ‘free’ markets will always bring an economy to a general equilibrium in which all supplies balance all demands. Furthermore, this general equilibrium was shown to be an optimum, in the sense that outputs would be maximised for given inputs of land, labour and capital.”

    The first part is clearly an ideological aspect of using mathematics in economics. I want to question the second part after “Furthermore”. You are right to point that equilibrium and optimality contain policy implications at the ideological level. You can denounce them but I want to ask you. How can we abandon them?

    You have written in your article Economics as Science, and the Role of Maths on posted on July 3, 2012 that
    “Many heterodox economists also seem to have an aversion to the use of mathematics.  This is understandable given that neoclassical economists have for more than a century confused their mathematical modelling with science. Again, the lesson is to know the limitations of your mathematical models and to be open to revising or abandoning them.”

    I think the most important word in the above citation is “revising”. In order to rebuild more scientific economics, we cannot abandon mathematics. Mathematics is much more varied than those used in neoclassical economics and than those most economists imagine. Economics is possible without (or better refusing consciously) equilibrium and optimum, but mathematics is necessary and very helpful. Please see our book with Morioka and Taniguchi: Microfoundations of Evolutionary Economics: https://www.springer.com/gp/book/9784431552666

    See also book reviews on our book by
    Marc Lavie https://link.springer.com/article/10.1007/s43253-020-00004-5
    and by
    Yoshio Inoue http://www.shiozawa.net/chosho/Inoue2020AReviewOnShiozawaMorioka&Taniguchi2019.pdf

    The new theory developed in our book is still a small core of economics. It lacks many fields to be filled, but it offers at least a first step of economic theory that can replace neoclassical economics at the very core of economics (price theory and theory of demand and supply adjustment). It rejects equilibrium framework and is not based on optimal behavior of economic agents. As we refuse the concept of “equilibrium” itself, strictly speaking, we cannot not say that the economy is far from equilibrium but our theory stands on the recognition that it is a dissipative structure “far from equilibrium” rather than an equilibrium described in Arrow and Debreu theorem. See also my old presentation paper:Economy as a dissipative structure http://www.shiozawa.net/english/EconomyAsADissipativeStructure1996.pdf

    Please send me your e-mail. I want to send you in return the PDF of our book. You can verify yourself whether I am saying something reasonable or not.

    What I want to say is: (1) it is now time to build a new theory that can supersede and replace neoclassical economics, and (2) it is now no time to continue neoclassical economics at the theoretical level. (This does not imply that we should continue ideological aspects of neoclassical economics.)

    Reply
    1. Geoff Post author

      Thanks for your comment Yoshinori. However you misinterpret my intentions. This article was for an Australian audience of people mostly following the neoliberal prescriptions. They have not yet realised the fundamental flaws in equilibrium economic theory, so we still have to keep repeating the message, as tiresome as that is.

      On the other hand my comment on RWER blog is to get people to move on from complaining about neoclassical economics and to take a useful approach to economics, which you and I would agree has to be non-equilibrium.

      Thank you for offering your book manuscript. In fact we corresponded once before by email and you sent me a copy. I have not read it in any detail, but only because my interest is more at the macro, emergent level of phenomena rather than a micro basis. I’m sure your work is valuable. I presume you would know about work coming out of the Santa Fe Institute among others, summarised in The Origin of Wealth by Eric Beinhocker, on agent-based models.

      Finally, my book Economy, Society, Nature is entirely about establishing a new and productive approach to understanding economies: my approach is to infer the far-from-equilibrium framework and to explore its implications, but only briefly.

      Oh and I certainly do not suggest abandoning mathematics. On the other hand, we should use a level of mathematics appropriate to the context: sometimes that will require an elaborate theory, and sometimes a simple rough estimate may suffice.

      Reply
      1. Yoshinori Shiozawa

        If your comment on RWER Blog “is to get people to move on from complaining about neoclassical economics and to take a useful approach to economics, which you and I would agree has to be non-equilibrium,” it’s fine. I hope it works as such, although Lars Syll and his followers are almost always “complaining about neoclassical economics” and do not seem to move on. As you have many readers who are happy to listen to your advice, I hope you will help them get to move on. Lars Syll will not change but you can change many of his followers.

        As for my book with Morioka and Taniquchi, I have indeed sent a PDF. I was forgetting it. By the title of the book, you may have understood that it concerns only “micro” economics, but it is foundations of, for example, Post Keynesian economics. You will know it if you read Marc Lavoie’s book review.

        As for Santa Fe and Beinhocker, I have just posted a comment on Asad Zaman’s RWER bolg article. Please read
        https://rwer.wordpress.com/2020/12/04/complexity-economics/#comment-175551
        I am not thinking that Beinhocker’s book is simply a summary of Santa Fe. It contains a very important theme, i.e. social technology.

        It is true that economics needs many more varied approaches but rejecting mathematics from economics research is to reduce substantially its possibility and works effectively reactionary to the development of economics.

        Reply

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