Monday, 17 October 2016

The Use and Abuse of 'Neoclassical Economics'

This is a post about words and wording rather than content. But since words and language matter for how we understand the object in consideration, the distinction doesn't really hold. But I believe it conveys the intention; I wanna talk about the misuse of the word 'Neoclassical'  not primarily the contents or methods or elements that characterises it.

Nothing drives me more insane than the awkward and mistaken use of 'Neoclassical' to capture the mainstream practice of contemporary economics. Critics of its contents loudly and indignantly call for change, but stubbornly and mistakenly brand this mainstream economics 'Neoclassical'. In the midst of their intellectual confusion, they add insult to injury by loosely treating it as a catch-all for whatever bad idea they happen to disagree with.

For anyone who ever opened a book on the History of Economic thinking, it is quite clear that 'Neoclassical economics' refers to the combination of ideas and methods developing in and after the Marginal Revolution in 1871. When Menger, Walras and Jevons in very different ways proposed to think about individual economic decisions on the margin rather than the classical economists' emphasis on entire categories of goods, a new era of economic thinking had begun. Within a few decades, it was unquestionably the method most used by every economist, despite their otherwise very different opinions; a new framework had been created. Well-known economists like Edgeworth, Marshall and Pareto lived and worked in this tradition, properly referred to as Neoclassical economics (1871-1936).  

When most economist in the 1930s aftermath of the Great Depression couldn't convincingly explain its occurrence, the ruling neoclassical tradition was challenged, and its dominance gradually transferred to what would henceforth be the start of Keynesian macroeconomics; Keynes's 1936 book gave a framework to a profession grasping for an analytical lens to explain what they were witnessing. Fuelled by their newly-discovered use as policy advocates and their experiences shortly thereafter running a World War II economy, barely anybody questioned the Keynesian dominance in the 1950s and 1960s; a large government could stabilise fickle and unstable markets, it could prime the pump and achieve growth and low unemployment. This was the highpoint of thinking about the economy in aggregate terms and spending-is-mending doctrines. Neoclassical economics was dead, Keynesian economics had taken its place.

Over the course of the next four-decades, the Keynesian macro ideas merged with aspects of its Neoclassical predecessor, to form the Neoclassical Synthesis. This is how Oliver Blanchard in MITs econ dictionary describes it:
Unlike the old neoclassical economics, the new synthesis did not expect full employment to occur under laissez-faire; it believed, however, that, by proper use of monetary and fiscal policy, the old classical truths would come back into relevance.
This epoche of economics, with economists such as Hicks, Samuelson and Modigliani, is also referred to as New Synthesis – or 'Neo-Keynesians'  by diverging post-Keynesians who claim that this approach represented a "bastardisation" of Keynes's writings. In short, this first Neo-Keynesian-Neoclassical Synthesis held that in the short run, Keynesian income determination ruled; in the long run, prices and wages would adjust and the old classical and Neoclassical truths would appear. 

The 1970s oil crisis spelled doom for this new framework. All of a sudden unemployment increased at the same time as price inflation – termed Stagflation  an outcome as impossible in the Keynesian framework as was a Great Depression for the early 20th century Neoclassicals. The Synthesis wasn't undermined only by the onset of hitherto-unobserved events such as stagflation, but also from deeper failings: Blachiard explains the essence of Lucas and Sargent's influential 1978 article:
The ‘fundamental flaw’ was the asymmetric treatment of agents as being highly rational and of markets as being inefficient in adjusting wages and prices to their appropriate level.
Lucas and Sargent suggested treating macro relations as if markets cleared, and so rooted their theories appropriately in micro relations of rational and optimising individuals. It became known as New Classical partly because it drew on Smith-Ricardo ideas that markets equilibrate by adjusting prices. It is sometimes called Monetarism Mark II  or equivalently, treated Milton Friedman-style Monetarism as the first wave of New Classicals, for which Lucas and Sargent and Barro were the second wave.  

The response by their critics involved deriving microfoundations to the Keynesian framework to rationally account for the stickiness of wages and prices: menu costs and imperfect information was born. Prominent economists include Mankiw, Romer etc., and were called New Keynesians in response to the New Classicals they were staving off. This is how Mankiw describes this second Synthesis following the battles between New Classicals and New Keynesians:
During the 1990s, the debate between new classical and new Keynesian economists led to the emergence of a new synthesis among macroeconomists about the best way to explain short-run economic fluctuations and the role of monetary and fiscal policies. The new synthesis attempts to merge the strengths of the competing approaches that preceded it. From the new classical models it takes a variety of modeling tools that shed light on how households and firms make decisions over time. From the new Keynesian models it takes price rigidities and uses them to explain why monetary policy affects employment and production in the short run.
A useful ways of picturing the development is given in Samuelson & Nordhaus' 1985 textbook, where the term 'Neoclassical' finally was properly assigned to Walras & Marshall:


The blogger Lord Keynes has a more extensive family tree, that would have been perfect had he not messed up the title of the main box ("Neoclassical Economics – Mainstream Economics"). My only problem, of course, lies in his incorrect use of the word:


What this short adventure into the history of economic thought has taught us is that 'Neoclassical Economics', properly understood, ended back in the 1930s. What has passed as economics since has been various intellectual battles between schools of thought which could by no strech of the imagination be labelled 'Neoclassical'. Colander's insightful article in 2000 explains it well:
We all, me included, fall into the habit of calling modern economics neoclassical when we want to contrast modern mainstream economics with heterodox economics. When we like the alternative, the neoclassical term is often used as a slur, with our readers or listeners knowing what we mean. Of course, historians of thought are far better at avoiding this “slur” use than are others. The worst use, and the place one hears the term neoclassical most often, is in the discussions by lay people who object to some portion of modern economic thought. To them bad economics and neoclassical economics are synonymous terms.
Since new approaches always develop in response to earlier approaches, they always carry with them some parts of that approach. Same goes for economics, which explains why we in contemporary mainstream economics find elements such as marginal productivity and focus on relative prices, given to us in the language of calculus. Although those aspects were critical for Neoclassical economics in the early 1900s, their use doesn't render modern economics 'Neoclassical'.

Colander (2000) again delivers the death blow:
There is much not to like in current economics; but slurring it, by calling it neoclassical economics, does not add to students’ understanding of the current failings of economics. Economists today are not neoclassical according to any reasonable definition of the term. They are far more eclectic, and concerned with different issues than were the economists of the early 1900s, whom the term was originally designed to describe.
In other words: enough already. 'Neoclassical Economics' is not a catch-all for economic thinking one disproves of. It is not an accurate description of dominant contemporary economic thinking. Use the term for what it means – and stop using it for what it doesn't mean.

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