Defining Neoclassical Economics: Stripping the Invisible Cloak Off the Naked Emperor (Part 1)

By Akmal Zulkarnain

In recent years, there are these ever-growing calls from numerous parties – individuals, organizations, academic circles and the like – for an alternative towards the mainstream thinking in economics. With the emergence of popular websites like Evonomics.com, writings and criticism against the prevailing methods, analysis and practices of mainstream economists and financiers are gaining even more popularity among the masses. Some, like Professor Steve Keen of Kingston University, criticizes the mainstream economics consistently on a regular basis, and even produced probably one of the most profound modern critique of the mainstream economics in his book entitled Debunking Economics (Keen, 2011)[1]. Others, like the ever-growing group of economists (often associating themselves with various alternative school of thoughts) has attempted to produce some sets of economic theories and analyses, often (declaring their schools to be) distinct from the mainstream economics; notably the ecological economists, Islamic economists, Marxian economists etc.

These calls for an escape from the mainstream ‘thought-prison’ are often motivated by various causes. Some, like the ecological economists, are motivated by the severe deterioration of nature and the environment due to unrestrained and unsustainable economic activities, that are often not treated as an important subject in mainstream economics’ body of thought. Hence, this problem arouses the need for an alternative school of thought in economics that provides economic theories and analyses that treat the economy as a subsystem of Earth’s larger ecosystem, and emphasizes the preservation of natural capital, and outlines economic practices that are not hostile towards the preservation of the natural environment and resources.  Others, like the Islamic economists, are moved by the spirit to devise a school of thought in economics that is grounded in the correct Islamic worldview and not in contradiction with the essential Islamic tenets and beliefs, hence, resulting in economic practices that are both just and ethical.

Whatever the reason may be, it is obvious that a lot of (if not all) economic problems and crises that we experience today may be in one way or another attributable to the deficiencies in the mainstream economic thinking, which gave rise to these numerous mixed responses towards it. Failure of mainstream economic thinking to correctly depict the reality, as well as the shortage of theories that are able to predict the advent of economic and financial crises of the late 20th and early 21st century are but some of the criticism loathed upon this school by keen observers.

One may naturally spot the common enemy of all these movements and groups, that is, the mainstream economic thinking and theorizing. Consequently, one must necessarily posit the central question; what is meant by ‘mainstream economics’? Since the label ‘mainstream’ is a socially constructed and imposed label; -that is, it is a label for the most dominant school of thought in a plethora of school of thoughts of economics that are in existence – there must be a unique name for this ‘mainstream’ school of thought, that makes it necessarily distinct from others. One should therefore ask; what would be the appropriate name for this school of thought? What is this ‘mainstream’ school of thought that we are talking about? What would be the main defining features of this school of thought, that are unique to it so that we may make a proper distinction of it from others?

As in any superhero movies, the villain – the antagonistic force – must possess a name. While this seems obvious, the name we give to super-villains serve a very practical and far-reaching purpose; one of proper identification. In our case, ‘villain’ we concern ourselves with is the neo-classical economics school of thought (for a quick survey of how the term neo-classical came about, see Aspormorgous, 1986)[2]. This essay attempts to give a proper definition of this school, by laying out the defining features of it, ones that are necessary for a theory to be defined as neoclassical. Those defining features are: 1) methodological individualism 2) methodological instrumentalism 3) methodological equilibration. Which means to say that all neoclassical theories must be built upon, or rest upon these pillars. Or, in other words, all economic theories that are built upon these foundations are necessarily neo-classical. It is well recognized by the writer that the terms employed here seems to be a bit of a technical nature, hence, the proceeding parts of this two-part essays is an attempt to properly expound these three defining features of neoclassical economics (or three meta-axioms of neoclassical economics, which would be explained later, no worries) in a manner that is more understandable and comprehensible to the general reader with proper recourse to examples from neoclassical body of theories for enhanced understanding.

On the Need for A Proper Definition of Neoclassical Economics

Before we may proceed to the three defining features of neoclassical economics, one must bear in mind the importance and significance of giving a proper definition of this school of thought. Why is this important? Why should we get ourselves involved in this lengthy (and perhaps, to some – worthless and impractical) endeavor? It might seem strange that a lot of time and effort is spent on something so basic as a “definition,” nonetheless, at times it is the most basic of concepts that are the most problematic.

One of the things that would always frustrate critics of neo-classical economics is the argument set forth by some that there is simply no neo-classical school of thought. To them (mostly advocators of neo-classicism), there exist only two kinds of economic analysis; one that is ‘scientific’, which employs sophisticated mathematical models, often considered as ‘robust’, and the other which consists of ‘unscientific’ guess games, absent from the sort of mathematical models present in the latter. Guess what, you got it right. The ‘scientific’ economics as mentioned above refers to the neo-classical economics’ school of thought, the one that is taught in virtually most of the economics department in universities around the world (if not all). Majority of students (and lecturers) in these departments do not even have an idea of the existence of this school of thought, what more of the critics laid out against it. What they are spoon-fed since the first day of enrolling in their respective faculties is that they are learning some kind of ‘science’ that deals with the problem of maximizing individual satisfaction subject to certain constraints, and that this ‘science’ that they are learning is somewhat absolute, and regarded as ‘the one and only way to correctly analyze economic phenomenon occurring in the world’.

The question of whether economics may be regarded as ‘a science’ or not is a subject of a long debate by itself, and will not be expounded here. The abovementioned challenge (that economists tend to deny the existence of the neo-classical school of thought – whether intentionally, or out of sheer ignorance) is one of the more practical reason for us to properly define what neo-classical economics is. If you are somehow exposed to the various critics of neo-classicism out there, you may find several attempts by different personnel in defining this school of thought. Some of them try to equate neo-classicism with the notion of hyper-rationality. That is, the neo-classical school of thought pays a hefty attention towards the assumption that individuals are rational (rationality here defined as possessing full knowledge of the choices that they are making, often involving the benefits and costs of such decisions, and would always maximize their utility subject to a certain budget constraint. Not that this notion of ‘rationality’ is a narrow conception of rationality as understood by many neo-classicists). A rational economic man, or Homo Economicus, would be hyper-sensitive towards small changes in expected utility from the different choices that they make, and employs a somehow rigid mathematical reasoning in determining the utility maximizing decisions they are about to make.

However, in the advent of theories like the evolutionary game theory, this notion of rationality has been modified, and Homo Economicus, instead of being a hyper-rational individual, now makes decisions based on a bounded-rationality or even irrationality (for a review of this theory, see Hargreaves-Heap and Varoufakis, 2004)[3]. Neo-classical school of thought has evolved constantly in the past few decades, that many of the theories that we learn in class no longer employ this notion of hyper-rationality, hence rendering the definition by some scholars that say neo-classicism may be defined as the body of theories that submit to the notion of hyper-rationality to no longer take hold. The same goes for some definitions by critics that focused on selfish individualism, the notion of market-clearing or Pareto optimality. Although these features are usually present in many neo-classical economics theories, they are not its necessary features. Critics must develop a sound definition of this school of thought, in order to dodge the arguments by many advocators that this school of thought is simply non-existent.

We seek to employ a quite different approach of defining this school of thought. Instead of giving a simple one-sentence definition of it (which would, most of the time be less than sufficient to properly define the school), we resort to present our definition by giving three meta-axioms – defined as the axioms of axioms – of neoclassicism. What is an axiom? It is a statement or proposition that is regarded as being established, accepted, or self-evidently true. It serves as the most basic proposition or statement, in which all arguments set forth. Like the brick of a building, it serves as the building block in which a whole structure would later be constructed on its foundation. Axioms are often employed in logic and mathematics, in which it consists of the most basic statement that is regarded as self-evidently true, like the statement ‘all mortals die’, or in mathematics the axiom of extension that says; ‘if two sets have the same elements, then they are equal’. In neo-classical economics, we may observe a lot of axioms being employed in its formulation of theories and analyses. Like the axiom that says individuals are defined as Homo Economicus. Meta-axioms, on the other hand, are the axioms of these axioms. By virtue of them being meta-axioms, they are present in ALL neoclassical body of theories, and therefore become a defining feature of this school of thought. This, according to Yanis Varoufakis and Christian Arnsperger (2006)[4], is the most apt approach in defining neo-classical economics, that is by resorting to its meta-axioms. Which means to say that, each and every theory that stands upon these three meta-axioms, may be well defined and classified as belonging to the neoclassical school of thought.

The first axiom: Methodological Individualism

Now let us move into the first meta-axiom of neoclassical economics; methodological individualism. Methodological individualism was a term first coined by the German sociologist, Max Weber in his work, Economy and Society (Weber, 1922). This technical term was first used by Weber to explain a method used in social studies, in which, all social phenomena should be explained by showing how they result from individual actions which, in turn, should be explained through reference to the intentional states that motivate the individual actors. In the case of neoclassical economics, all economic phenomena should be explained by first focusing on the individuals whose actions brought it about, understanding fully the ‘workings’ at the individual level, and, finally, synthesizing the knowledge derived at the individual level in order to understand the complex economic phenomena at hand. That may sound a bit too abstract and complex, but worry not, let us look at a few examples from the economic theories we learn in class to help illuminate this point.

In simple terms, each and every single economic analysis done by an economist who submit to the neo-classical school of thought, would always start with the analysis of the individual actions and behavior. Imagine, you are a neo-classicist faced with the problem of understanding why people buy more, whenever the prices of goods drop. This is the most basic economic theory among the plethora of theories belonging to the neo-classical school; The Law of Demand (which, to some, is no longer considered as a theory but an absolute law, in which every single economic phenomenon will be in co-tango with this law, with a few exceptions). Remember, the problem at hand is something that happens at the market level, an interaction that involves the participation of many individuals, not just a single one.

Recall, how we are taught to ‘construct’, or ‘derive’ the demand curve. We would first take a look into why individuals behave so. What would be the motive for individuals to buy or not to buy a single goods in the market. To understand this, we carry out the ‘indifference curve analysis’, to comprehend how an individual’s satisfaction is maximized by virtue of him or her consuming a particular goods or services. Look closely at this excerpt from Pyndick and Rubinfeld (2012) Microeconomics;

pyndick.png

Source: Pindyck and Rubinfeld (2012)[5]

The above illustration depicts the standard economic analysis done at the individual level in a market. Any students of economics would have been familiar with these two graphs. An individual makes decision(s) that maximizes his/her individual satisfaction, denoted by the level of utility, U, associated with the utility maximizing point (the intersection point between the indifference curve and the budget line in graph (a)). Then, by manipulating the changes in prices of goods, we determine the different quantity of goods consumed by the same individual, to derive an individual demand curve. To arrive at the market level demand curve, one must then ‘add up’ all the individual demand curves of different persons in the market, by a process known as ‘horizontal summation’. Henceforth, the analysis of economic phenomenon is observed at the market level.

Notice how this method to derive the market demand curve to analyze socio-economic phenomena at the market level is a stark illustration of methodological individualism.  Initial analysis is done at the individual level (the indifference curve analysis) and this analysis in inflated by a series of adding up individual demand curves (which results from different individual analysis of different persons) to arrive at the market level demand curve. This, in turn, is used to explain the socio-economic phenomenon at large.

Notice, how other neoclassical theories employ the same methodological anchorage. In numerous fields, ranging from finance to development to labor economics, one may observe the pervasive influence of neoclassicism, especially on the utilization of methodological individualism in economic analyses. In the field of development studies, for example, one may observe the same trend in the attempts made by neo-classicists to explain the concept of fertility. If one were to study the subject on population growth and economic development, one must inevitably comes across this theory that goes under the name ‘the microeconomic household theory of fertility’. This theory is an attempt by economists to understand what would be the determinant(s) of fertility. Or in other words, what is the cost and benefit analysis employed by families, in deciding how big would their family size be. How do mothers decide whether to conceive a child or not? In an attempt to make the analysis as ‘scientific’ and ‘robust’ as possible, economists adapted the traditional indifference curve analysis as shown in this excerpt from Todaro and Smith (2014):

todaro.png

Source: Todaro and Smith (2014)[6]

Notice how similar the above model with the basic derivation of individual demand curve model. Instead of starting the analyses of the actions of individuals in this society by looking at social practices, religious beliefs and norms (things that would usually be understood at the generally more societal level), neo-classicist choose to start-off from an analysis of the individuals’ decision-making processes. The mechanics of the above theory will not be discussed here, but what is important is the method employed in this analysis of fertility, which is a direct replication of the traditional indifference curve analysis, and has its roots grounded in methodological individualism. Also note that this was never the method used by classical economists such as Adam Smith, Keynes, Ricardo, not even Hayek (to see a clearer explanation on non-neoclassicists’ methodological anchorage other than methodological individualism, see Keen, 2011). This is also the indication that neo-classical school of thought is embedded within the 19th century anglo-celtic liberal individualism tradition, something which many other non-neoclassical economists do not identify themselves with.

Continues in Part 2…

[1] Steve Keen (2011) Debunking Economics – Revised and Expanded Edition – The Naked Emperor Dethroned, Zed Books, London

[2] Aspromourgos, T. (1986) On the origins of the term ‘neoclassical’. Cambridge Journal of Economics 10(3): 265–270

[3] Hargreaves-Heap, S. and Y. Varoufakis (2004) Game Theory: A Critical Text, Psychology Press

[4] Arsnperger,C. and Y. Varoufakis (2006) What is Neoclassical Economics, Post-Autistic Economics Review, issue no.38, 1 July 2006 article 1

[5] Pindyck, R. and Rubinfeld, D. (2012) Microeconomics (8th Edition), The Pearson Series in Economics, Pearson

[6] Michael P. Todaro & Stephen C. Smith (2015) Economic Development (12th Edition), Pearson

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