Defining Neoclassical Economics: Stripping the Invisible Cloak off the Naked Emperor (Part 2)

By Akmal Zulkarnain

The Second Meta-Axiom: Methodological Instrumentalism

Before going deep into the discussion on this second meta-axiom, and before looking at the examples of theories from neoclassical body of thought that encapsulate this meta-axiom, we shall – to avoid confusion –  venture into its proper conceptualization. As Yanis Varoufakis and Christian Arnsperger (2006) put it, ‘methodological instrumentalism’ refers to one of the most fundamental assumptions underlying all neoclassical economics theories and hypotheses that is, all behaviors of each and every individual is preference-driven or, to be more precise, all behaviors of economic agents are to be understood as means for maximizing their preference-satisfaction. Okay, that sounds all complex and jargon-loaded, but here is a simple explanation of it. According to neoclassicals, all individuals have an ultimate aim with regards to the economic decisions they make; that is to maximize their individual satisfaction (or, as the jargon in economics goes, utility). Each and every action and behavior of these individuals are seen, by neoclassical theories as mere means towards achieving this somehow ‘sacred’ end. If a buyer decides to spend his money to buy a loaf of bread in the market, this is viewed in the light of neoclassicism as simply an act to bring about maximum satisfaction attainable through the act of buying a loaf of bread by the individual.

The preference[1] of the individuals, on the other hand, is given, and fully determining. In other words of saying it, we are taught, within any neoclassical economic theories that all actions and behaviors of any economic agents are motivated by their preference-satisfaction, and only this criterion matters. Nothing else. This second meta-axiom leaves no such rooms for philosophical questioning of whether individuals would ultimately act according to their preferences. It is one of the dogmas of neoclassicism, individuals have preferences, and it is exactly these preferences that they are trying to maximize by making economic decisions, and all the actions and behaviors taken by the individuals are mere instruments to achieve this goal.

According to Varoufakis and Arnsperger (2006), this second meta-axiom – methodological instrumentalism – has its roots in the writings of the 18th century Scottish philosopher, David Hume (1711 – 1776). In his work, Treatise of Human Nature (Hume, 1738)[2],  Hume divided the human decision-making processes into three modules[3]; Passion, Belief and Reason. Whenever a person decides, his Passion provides the ends, the destination that the person would want to arrive at. Reason, on the other hand, provides a course (or a map) that would steer the person to get to the predetermined destination as provided by Passion. Belief functions as the external constraints upon the working of Reason, by providing the likely consequences of different alternatives that the person may undertake. This bears a striking resemblance to neoclassical economic theories. An individual, in his decision-making process is defined as a bundle of different preferences (the person possesses different preferences), his beliefs are regarded as a bunch of subjective probability density functions, which in turn would determine the level of expected utilities for his different preferences, and the person’s Reason is the optimizer that functions by maximizing these utilities. As how the preceding section suggest, we would now take a peek into an example of one neoclassical microeconomic theory that serves as the embodiment of this meta-axiom to help us understand the seemingly complex explanation above. Scrutinize the following excerpt from Pyndick and Rubinfeld (2012) in detail: Untitled.png

Graph 1. Source: Pindyck and Rubinfeld (2012)[4]

This illustration is a part of the neoclassical analysis of ‘different individual behaviors towards risk’, with the behavior of a risk-averse person[5] being depicted in the graph above. Again, any students of economics would certainly have the sufficient familiarity with the above illustration. The horizontal axis represents different incomes a person will get, given a set of jobs the person is able to undertake. Suppose, hypothetically, that this person chooses to work as a government officer, and gains $20,000 salary per month. This would yield an expected utility of 16, much higher than the expected utility of the person working as a salesman, that yields an income of $10,000 with the probability of 0.5 and an income of $30,000 with the probability of 0.5 (so that the expected income is also $20,000), that corresponds to an expected utility of only 14. As the preceding section suggests, the mechanics of this theory is not of interest to us, but what is more important is how the second meta-axiom, methodological instrumentalism, is portrayed within this theory.

Notice how the interplay between the three modules; Passion, Belief and Reason within the above theory. The person is said to have an end, that is fueled by his Passion, to maximize the level of his expected utility as a result of making an economic decision whether to choose the job with a stable income of $20,000 or the one with uncertain (or, risky) income of either $10,000 or $30,000 with a 50-50 probability of each of them occurring. The person’s Belief – in this sense being defined as his aversion towards risk – provides the likely consequences of the two alternatives; a job with stable income is viewed to be more desirable than the other, therefore yielding a higher expected utility than the latter. Notice, how this person’s Belief has been reduced to a function, that would ultimately influence the level of expected utility associated with each alternative the person is facing. Reason, would then work in a cold-blooded manner by maximizing the person’s expected utility. This person’s behavior and action, is viewed, by the neoclassical treatment of behavior towards risk, as merely an instrument that is meant to achieve a transcendental aim; maximizing preference-satisfaction. All neoclassical analysis, would ultimately start on the bedground that people would always aim to maximize their subjective preference-satisfaction, and their actions and behaviors are the vehicles to achieve that end. There exist no philosophical room whatsoever to argue whether the individual would ultimately act towards maximizing his preference-satisfaction as predetermined by his Passion.

Observe, how neoclassicists analyze the behavior of a person that is risk-loving. A risk-loving person has a slightly different set of Beliefs than a risk-averse one, with respect to the consequences of different alternatives the individual is facing. The following excerpt fairly illustrates this point:

Untitled2.png

Graph 2. Source: Pindyck and Rubinfeld (2012)[6]

A risk-loving person prefers risky outcomes over the less risky ones. Notice how this different ‘Belief’ possessed by a risk-loving person is reduced to just a subjective probability density function depicted as the red curves in the above diagrams. In Graph 2, the risk-loving person’s ‘Belief’ is depicted as the convex red curve (an exponential function) as opposed to a concave red curve (logarithmic function) representing a risk-averse person’s ‘Belief’ in Graph 1. This, is a clear portrayal of methodological instrumentalism at play.

Here is a further note; this account of methodological instrumentalism is not the direct product of Hume’s ideas on the three modules involved in human’s decision making. Throughout history, it took the contributions of the English philosopher and founder of modern utilitarianism, Jeremy Bentham (1748 – 1832) and 19th century neoclassicists to make a synthesis out of their own ideas and Hume’s to finally arrive at this second meta-axiom of neoclassicism. As a side note, a keen reader of the history of economic thought might also have a slightly different (but not totally distinct) idea whenever the word ‘methodological instrumentalism’ came about. Though widely accepted as being one of the methodological anchorage of neoclassicism, methodological instrumentalism is often associated with the American economist and monetarist, Milton Friedman (1912 – 2006). In 1953, Friedman wrote a widely read treatise under the title The Methodology of Positive Economics (Friedman, 1966)[7]. This treatise was meant to lay down the methodological foundation of a positive economics (Friedman adopted this distinction of a positive science of economics from the late John Neville Keynes (1852 – 1949)[8] in Keynes’ work; The Scope and Method of Political Economy[9] (Keynes, 1890)), and has received tons of critics ever since its publication. Though Friedman has never properly addressed his critics, this paper has been cited by countless unsuspecting neoclassicists whenever they talk about the proper methodology of the science of economics that they employ.

Friedman has never employed the term ‘methodological instrumentalism’, nonetheless writers often refer to it to describe Friedman’s stance on the methodology of positive economics. A proper assessment of Friedman’s methodology is a lengthy subject in and of itself, and should be treated justly and critically in some other write-ups[10] (inshaAllah!). A keen reader of the subject of the philosophy of science, might, in one way or another, be familiar with instrumentalism as being one of the methodological view in the field of epistemology and philosophy of science, advanced by the American philosopher John Dewey (1859 – 1952). Later, Dewey’s formulation of instrumentalism may have influenced Friedman when he was writing The Methodology of Positive Economics in one way or another, as some writers have proposed, but that would also be a subject of inquiry in later writings, if God wills.

At this point, after properly conceptualizing the second meta-axiom of neoclassicism with a recourse to a few examples taken from a standard neoclassical textbook, it is safe to assert that all neoclassical theories are formulated upon this meta-axiom; methodological instrumentalism. Though there would exist variations in neoclassical theories that treat the preferences of an individual to be not strictly exogenous (meaning that the preferences of an individual are not externally given, and may be influenced by some other endogenous factors; like what people in his society expects him to have preference on, etc), an individual’s preferences remain fully determining. People, according to neoclassicists, are irreversibly ends-driven.

The third meta-axiom: Methodological Equilibration

For the last and final meta-axiom of neoclassical economics, we shall now explore the notion of methodological equilibration. In a nutshell, this meta-axiom may be summarized within the following phrase; the axiomatic imposition of equilibrium. This, among the other two meta-axioms, may be the least complicated to point out, the least complex to be understood and the most obvious in terms of its apparentness in many mainstream economic theories. Advocators of neoclassicism have this tendency to claim that the neoclassical body of thought has the superiority over other ‘non-scientific’ economic analyses in the sense that it possesses the predictive power that is able to make accurate descriptions of and predictions on any economic phenomena be it at the micro or macro level. To achieve this, neoclassical theories require that individuals’ instrumental behavior (driven by the desire to achieve maximum preference-satisfaction[11]) is coordinated is such a manner that all aggregate[12] behaviors become regular to produce solid predictions.

How do neoclassicists go about doing this? Neoclassical theories often start with the exercise of defining the individual’s utility functions and specifying their constraints according to the individual’s set of beliefs. This has been discussed under the previous two sections on the first and second meta-axioms. Then, here comes the standard practice by neoclassicists that is; they pose the question; What behavior should we expect in equilibrium? The question of whether the equilibrium may be achieved, and if yes, how does it materializes, or the question of whether it is actually possible to achieve an equilibrium in the first place, are the sort of questions that would be treated as having a secondary importance to the axiomatic and dogmatic imposition of equilibrium.

Why do neoclassicists impose this axiomatic equilibrium into literally each and every economic model they construct? Well, the reason is fairly simple and straightforward; the natural emergence of equilibrium as a consequence of individual’s utility maximizing behavior and rational choices simply cannot be demonstrated! Mainstream economists fail to demonstrate that at any particular point in time, equilibrium is the natural anchor that the market would rest upon, and this poses some great difficulties in terms of maintaining the behavior of the market in a relatively more predictive manner.

Therefore, instead of tackling the question; ‘How does the equilibrium came about?’(which, in many instances are impossible to be answered), neoclassical economists often beat around the bush by using the following cunning method; ‘Let us first assume that we are in equilibrium. Then we study what are the forces that would ‘deviate’ us from this dogmatically imposed equilibrium.’. Problem solved. What is astonishing is that this method has been employed by economists from the very beginning of the ‘modern’ development of this ‘science’. Observe how the French philosopher and mathematician A. A. Cournot (1801 – 1877) employed this method in his ground-breaking discovery of the theory of oligopolistic competition in his work; Recherches sur les principes mathématiques de la théorie des richesses (Cournot, 1838)[13]. As early as 1838, when A. A. Cournot was facing a difficulty in proving the emergence of an equilibrium in his model on oligopoly, Cournot choose not to discuss on this difficulty. Instead, his strategy was to study what happens when we begin from that equilibrium he just axiomatically imposed. Then, he continues to study what would be the tendency for this system to move away from this equilibrium. In the absence of that tendency, the system is considered to be stable (or the forces capable of dislodging the equilibrium thus imposed are present, but minimal, not enough to permanently oust the equilibrium out of place, then the system would still be considered ‘stable’).

Cournot’s work, according to Varoufakis and Arsnperger (2006) helped established this peculiar practice among economists ever since[14]; First, one discovers an equilibrium. Second, one assumes (axiomatically) that agents (or their behavior) will find themselves at that equilibrium. Lastly, once arrived at the equilibrium, one demonstrates that any small disruption would be inadequate to oust the economic agents out of the axiomatically predetermined equilibrium. These three steps, we believe, cannot be less than familiar to any students of economics. These three-steps are what we refer to as ‘methodological equilibration’.

Stripping the invisible cloth off the naked emperor

In 1837, the prolific Danish author and poet, Hans Christian Andersen (1805 – 1875) wrote a legendary fairy tale that has been translated worldwide into more than 100 languages under the title; keiserens nye klæder (English: The Emperor’s New Clothes)[15]. This fairy tale revolves around an emperor, who has a very peculiar liking towards fancy clothes. One day, two swindlers came to the kingdom where the emperor rules. These two swindlers claimed that they could weave the most magnificent dress imaginable for the emperor, but, the characteristics of this ‘dress’ is rather strange. They claimed that the dress will be made from the finest materials and host some rather magnificent colors and patterns, uncommon to any other dresses one has ever wear during the time. Apart from that, this dress has this wonderful way of becoming invisible to anyone who are stupid, and not worthy for his office.

Well, if somebody claim to you that they have a dress that will make itself invisible to anyone dumb enough not to see it clearly, would you admit that you not see the dress? No, no you don’t. That was exactly what the emperor, and everybody else in the castle did. From the ministers and treasurers to the caretakers and the gardeners, out of fear that they be called fools, all pretended that they indeed saw the dress, some even purportedly admired the ‘beauty’ of this invisible dress, even though in actuality, there weren’t any! The two ‘weavers’ happened to be darn phonies, who wanted to make handsome fortunes out of the stupidity of the whole kingdom. The ‘invisible’ dress was in fact, a no-dress! It was made out of nothing. The weavers ‘worked’ day in day out on an empty loom; a loom without any thread. And nobody dared raise a notch against them, for the fear of being called a dimwit.

The dress was prepared for a huge public procession, one meant specifically to display the newly weaved dress, the one like no other. Farmers, laymen and peasants, all lined up, eyes fixed towards the emperor, whom, at first glance, appeared to be naked! Surely them laymen all suspected something! Nonetheless, the experts from castle has all worked to spread the word that people whose sight cannot catch the grandiose of the emperor’s dress, are morons. Nobody muttered a word, for they all loathe the thought of being called a jerk.

All it takes for the scandal to unearth was one young boy. One boy, who happened to be clueless of the rumors surrounding the magical dress. He was bewildered to find his King, walking in front of a crowd, without a single piece of garments on. What was even more astonishing, was the deafening applause the King receive, from pretentious farmers and peasants, all appeared to be in a state of inexplicable euphoria. He then innocently shouted: ‘But he hasn’t got anything on!’ And the crowd turned to him in astonishment, almost disbelief. ‘He hasn’t got anything on!’ the boy roared. It was at this moment that the emperor knew, that the whole kingdom has been duped.

The Perfect Parable

‘The Emperor’s New Clothes’ is the perfect allegory that illuminates the nature of today’s mainstream economics. Though having the characteristics of being ‘un-scientific’, incoherent, and empirically unsupported, – basically is of little to no value at all – neoclassicism continues to predominate many strategic decision making positions in society, and has lingered long enough to reign almost all economics departments of higher educational institutions throughout the globe. Any act of resistance, be it by professional economists, students of economics, policy makers, or anyone among the public will be met with extreme hostility. Positions in academic departments, as well as publications in many high impact economic journals are less than friendly towards any non-neoclassical approach towards economic analysis. Promotions, for those working in strategic decision making bodies in a society – especially the central banks, has more often than not come to those who have held this economic ‘faith’ in neoclassicism.

What can possibly bear a more striking resemblance to the emperor and his ‘invisible’ cloth? At first glance, the bizarre senselessness of mainstream economics seems to many, be very apparent, – especially to students of economics, who has not yet been purged by the neoclassical orthodoxy. Many whom studied the standard microeconomics syllabus would be exasperated at the inherent contradictions of the theories they encounter, which lies at the very heart of mainstream economics. Many find it strange that the discussions they undertake in economic theorizing often lacks any relation whatsoever to what is happening in the real world, and the alienation they experienced are often suffocating. Nevertheless, out of fear of being called a dimwit, or being dismissed out of college, their questioning voices has repeatedly been silenced. Some – out of disappointment with pure economic theorizing – seek refuge in other related fields. Some find solace in history of economic thought, philosophy, developmental studies and political studies, which would be more than helpful to enrich the realm of economic theorizing. Some others, for negative or positive reasons, turn their back towards economics, and dived deep into self-centered counter-productive avenues in finance, often deluded by the promised fortunes stock trading and derivatives trading were to offer, and how it would increase their personal wealth and financial worth.

It is about time that somebody raise a finger, to point out that the emperor is really in the buff. That what seems to many to be possessing a grandiose appearance is, in reality, inherently inconsistent and incoherent. Three meta-axioms, one neoclassical economics. It is hard to imagine how any standardly trained economists would deny that his theoretical practices digress from these three methodological anchorage thus discussed. The bottom line, is then, despite all denials by advocators of this strain of thought, there is such a thing as a body of social theory that subscribes to the three meta-axioms above, and which we may legitimately and distinctively call, neoclassical. And despite all the attention it gets, this school of thought is fundamentally flawed, and needs a reconsideration on its theoretical and philosophical foundation. Maybe, what it takes is for us to muster enough strength, and to raise our voices amid the deafening applause for the emperor, and roar;

“But he hasn’t got anything on!”    

Akmal Zulkarnain
29th July 2017    

[1] Preference here, is defined as ‘the act, fact, or principle of giving advantages to some over others’.

[2] Hume, D. (2009) A Treatise of Human Nature, Being an Attempt to introduce the experimental Method of Reasoning into Moral Subjects, The Floating Press. (Original work first published in 1738

[3] Modules here is being defined as ‘each of a set of standardized parts or independent units that can be used to construct a more complex structure’

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

[5] Generally, a person who is risk-averse would prefer a less risky outcome than the riskier one. In this example, the risk averse person prefers a certain given income to a risky income with the same expected value of income ($20,000).

[6] See 4.

[7] Milton Friedman (1953) The Methodology of Positive Economics, Essays in Positive Economics (1966), Chicago, Univ. of Chicago Press, pp. 3-16, 30-43.

[8] Not to be confused with the late John Maynard Keynes. These two are closely related. John Neville Keynes was the father of the great economist John Maynard Keynes. J. N. Keynes outlived J. M. Keynes by several years.

[9] J. N. Keynes (1999) The Method and Scope of Political Economy, Original work published 1890, Batoche Books, Kitchener.

[10] For a thorough appraisal of Friedman’s methodological instrumentalism, see Steven Rappaport (1986) What is Really Wrong with Milton Friedman’s Methodology of Economics, Reason Papers No. 11 (Spring 1986) 33 – 62, Reason Foundation, and Bruce J. Caldwell (1980) A Critique of Friedman’s Methodological Instrumentalism, Southern Economic Journal, Vol. 47, No. 2 (October 1980), 366 – 374

[11] Refer to the previous discussion on the second meta-axiom; methodological instrumentalism

[12] Aggregate here is defined as ‘formed or calculated by the combination of many separate units or items; total’. Aggregate behavior here refers to economy-wide sums of individual behavior.

[13] A. A. Cournot (1938) Researches into the Mathematical Principles of the Theory of Wealth (Nathaniel T. Bacon, Trans.). New York, The Macmillan Company (Original work published 1938)

[14] To be exact, Cournot and many ‘mathematical economists’ was not highly celebrated when their works first circulated among the academia of their time. Nonetheless, according to Irving Fischer in his paper, Cournot and Mathematical Economics (Fischer, 1898), it was not until 60 years after the publication of Cournot’s work on oligopolistic competition in 1838 that the mathematical approach of economic analysis took a firm root among economists and was highly celebrated. Source; Fischer, I. (1898) Cournot and Mathematical Economics, The Quarterly Journal of Economics, Vol. 12, No. 2 (Jan 1898) pp. 119-138.   

[15] Pretty much one of the most widely read fairy tale ever, written by one of the most widely read author the world has ever witnessed. Among his other popular works on fairy tales are; The Little Mermaid (1837), The Ugly Duckling (1843), The Princess and The Pea (1835), Thumbelina (1835)

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