Can “It” Happen Again? Defining the Battlefield for a Theoretical Revolution in Economics

The political earthquake represented by the election of President Donald Trump and the UK’s Brexit vote has fueled a belief that political and intellectual elites have lost sight of where society is going, and that the relationship between them and the rest of society is gripped by a crisis of representation. Signs of distress and impatience are multiplying amid fears that the French and German elections will produce further shocks.

Politicians, quite obviously, are the first culprits. They are perceived as both incapable of realizing how deeply the economic transformations of recent decades have affected everyday life of the majority of people, and as utterly indifferent to the losses they have suffered. But economists, also, are regarded with increasing skepticism, given that much of the profession has been more interested in celebrating the gains from globalization than in analyzing with open mind the complex transformations it implied – and their consequences.

The role of experts

Signs of such distrust may be read not only in the vote for Brexit (despite the majority of economists warning that this would bring dire consequences), but also, for example, in the rebellion against the euro, spreading in growing parts of the continent’s electorate.

European public opinion represents however an interesting case. The prevalent public attitude towards economists has until very recently, in fact, been basically one of trust and respect, contrasted with the universal disdain for politicians. It may even be said that part of the European intellectual elite (using the media) have actually contributed, in recent decades, to fueling the distrust in politics and politicians, especially in Southern European countries. One recent example would be mainstream economists (and journalists in their wake) explaining the sudden rise in interest rates on government bonds in Italy and other European countries in 2010-11 as caused by the sheer size of public debt. This debt load was blamed on corrupt politicians failing to heed the analyses and policy prescriptions of economists (calling instead for austerity). In this narrative, the politicians were not only corrupt and self-serving, but also irresponsible and prone to populism. Politicians were the villains, while economists tended to portray themselves as the true defenders of general interest.[1]

The view of the economist as a politically impartial arbiter of the general interest remains prevalent among European elites (particularly in Germany), and is deeply ingrained in the so-called ‘Brussels Consensus’. It pervades the very design of many European institutions that limit discretionary power and subordinate political stances to the decisions of technical bodies (such as the European Central Bank) or to standing rules, both of which are shaped by the economists’ supposedly superior knowledge.

If the popular consensus over the wisdom of economists is now wavering, this is due to the growing social distress brought about by austerity policies, and by the growing inequality of incomes and opportunities that characterized these decades of globalization – with the great numbers of losers it produces.

Distrust in the experts’ authority has been building slowly. Already a few years ago, the outbreak of the great financial crisis in the USA and its worldwide consequences began challenging the reputation of economists. The fact that the size and depth of the crisis took the great majority of economists by surprise, and that many of them were completely at loss on how to manage it, were regarded as a sort of intellectual scandal. In the academy, unease has even taken the form of open protest, as testified by a number of students’ initiatives[2] and on-going discussions about alternative curricula also involving academics of critical orientation.[3] At the same time, for the most active and informed parts of the public it is clear that the desire for a change in politics also implies deep rethinking of economic relations and rebalancing of economic powers (these themes have been central, for example, in the ‘Occupy’ and ‘Indignados’ movements).

Both conscious criticism and less conscious unease are directed towards the corpus of economic doctrines that support the ideology of neoliberalism. Deregulation of markets, reduction in labor protection, abolition of trade barriers, retrenchment of welfare state and reduction of public expenditure, are all policy prescriptions that derive from the theoretical premise that free markets possess self-adjusting properties which ensure automatically optimal results, while regulation and state intervention are ineffective, distortionary, or worse. The economic profession has played a non-secondary role in fostering the general adoption of such policies, whose effects are increasingly perceived as ruinous and divisive. At the same time, quite puzzlingly, such straightforward policy implications are generally derived from very abstract models. An accusation often leveled at economics is that it deals with an imaginary world, instead of studying and explaining the real economic processes that affect people’s lives.

If so many economists in the last four decades have embraced this attitude and this point of view, however, it would certainly be unfair to assume that this can be entirely explained in terms of either intellectual conformism or complacency toward the interests of the powerful. The neoliberal faith in the self-adjusting properties of the market finds indeed profound theoretical justifications at the theoretical core of the economic discipline – it is what students are taught in virtually all introductory economic classes.

Neoliberalism and economic theory

Despite the unease it produced within and outside of the economics profession, the shock of the 2007-9 crisis has not caused any radical change of theoretical paradigm in mainstream economics research and teaching. True, there has been some pragmatic re-discovery of Keynesian policies (in the USA more than in Europe), and some attention, for a limited period of time, to economists who had doubted the solidity of financial markets and predicted that some big trouble was likely. But the core of mainstream theory has not changed much. Now, as in recent decades, it is dominated by a unique framework of thought, which is recognizable despite the great plurality of theories, models and specific fields of application that characterize the discipline. According to this framework, economic problems are to be analyzed in terms of the maximizing choices of rational individuals, who act based on their preferences and resources, and interact in the market with other individuals who, on the basis of different preferences and resources, make different choices. Such interaction establishes the equilibrium prices, understood as those prices that equate demand and supply of each good and each factor of production. This structure of thought is so basic that it is usually not recognized as the expression of a particular theoretical point of view, but as the language of economics itself. Even macroeconomic modeling is currently based on such framework, which extracts aggregate economic laws and policy prescriptions from hypotheses on and analysis of the individual behavior.[4]

This framework is supposedly sufficiently general and flexible to allow for different results and different policy implications, which can be derived through suitable hypotheses, such as, for example, imperfect or incomplete markets, liquidity constraints, and rigidities of any sort. [5] As a consequence of the crisis, in fact, an increasing number of models have taken into account various kinds of financial and real shocks, and non-optimal outcomes. In addition, some themes, like inequality, have received more attention than before.[6] However, the basic theoretical framework has not changed.

In actuality, this basic theoretical structure is less flexible and general than is usually depicted. One relevant consequence of assuming that economic behavior is the product of maximizing choices of rational (and free) individuals is that the market solution envisaged by the theory is naturally endowed with optimal properties. Rational agents are assumed to choose the best possible allocation of their resources; if market forces are free to operate through flexibility of prices and rates of remuneration, the system tends spontaneously to reach an overall efficient solution, which also implies no waste of resources. As a consequence, any sub-optimal result, as for example the presence of involuntary unemployment, has necessarily to be explained in terms of some obstacles (like the above-named imperfections and rigidities) that hinder or halt the equilibrating mechanisms. Ultimately, the purpose of economic policy, according to this view, should be simply that of removing those obstacles.

Thus the faith in the self-adjusting properties of the market is very basic to economics – or, at least, to the approach that currently dominates it.

Change in Economics

The conceptual framework described above is proper to neoclassical theory, the approach that has dominated economics from the last decades of the 19th century until today. As is well-known, in the 1930s Keynes attempted (and in part managed) to challenge this approach, by showing the chronic tendency of aggregate demand to be insufficient to absorb full-employment production, and thus the need for public investments to correct the sub-optimal results of the market.

The impact of Keynesianism on the economic profession and on economic policy was so great that it became the consensus view in the following decades, but the neoclassical habits of thought did not disappear. They continued to dominate microeconomics, while Keynes had focused attention on macroeconomic relations, with the consequence that the two branches of economics often offered divergent (and even contradictory) results. Besides, Keynes’ theory was very soon re-interpreted in an imperfectionist fashion, so that, although his contention about the systematic appearance of unemployment and waste of resources was basically accepted, such outcomes were seen as the product of rigidities, especially that of money wages. Thus, Keynes’ theoretical revolution was partly defused, while hybrid models increasingly tried to couple Keynesian analysis of macro-aggregates with neoclassical foundations, often reaching the conclusion that the self-adjusting mechanisms of the system would be restored in the long run.

In the 1960s and 1970s, monetarism successfully challenged such theoretical compromise and re-established the supremacy of the neoclassical view, not only in the most abstract part of the theory but also in macroeconomic modeling and policy, thus founding the modern consensus.

The historical development of economic thought shows not only a succession of different dominant theoretical paradigms each superseding the previous one (as happens in all fields of human knowledge), but also, in such a succession, the temporary disappearance and subsequent resurgence of previously abandoned modes of thought. It may in fact happen, in social sciences, that a particular theoretical approach is abandoned not because the accumulation of knowledge has rendered it obsolete, but for other reasons such as its policy implications or the vision of society it entails. The same approach may thus be rediscovered in a different historical moment, when its potential for analysis is once again appreciated.

At the same time, given the well-known impossibility to prove or disprove a theory by means of controlled experiments, the emergence of new empirical evidence is never sufficient, alone, to induce a change in the dominant intellectual paradigm.

Even when facts are very difficult to reconcile with theory and seem to pose ineludible theoretical questions, a good theorist may invoke the category of exception, or may identify the intromission of additional factors that altered the conditions observed in reality with respect to the hypotheses of the theory, thus explaining away the lack of consistency between facts and theoretical predictions.

On the other hand, a widespread unease towards the current state of economics, even when it takes the form of conscious and organized protest, may well feed heterodox strands of thought, but it is usually considered too ideological to seriously question the mainstream ‘scientific’ view.

Changes of theoretical paradigm happen, and have happened, at times when the perceived incapability of mainstream theory to address what are felt as the most urgent economic problems by society at large coincides with a theoretical challenge that rises within economics itself — as was the case with both the Keynesian and the monetarist revolutions.

A first implication of the above, is that the critical economist cannot count on the sheer force of facts to make her/his point of view prevail; s/he will have to fight the theoretical battle. A second implication is that, when looking for new theoretical paradigms that may shatter the prevailing consensus in economics, one may well look to the past.

In search of alternatives

A deep change in economic theory requires turning to a completely different structure of thought.

The emphasis on individual preferences and choices at the center of the neoclassical paradigm reflects the ambition of what, in the late 19th century, was a new framework of thought: to base the explanation of economic phenomena entirely on the psychic forces of the human mind, thus interpreting them as natural rather than social phenomena. Together with the use of mathematical language (differential calculus), this implied that political economy – which just at that time changed its name to economics – could claim a theoretical status analogous to that of the natural sciences. The object of this science was the behavior of the abstract and undifferentiated individual who interacts with other individuals in the market, also conceived abstractly. This implies an ahistorical conception of the economic process, which is seen as linear, i.e. proceeding from the endowments of original factors to production to exchange and consumption, with the latter regarded as the ultimate purpose of economic activity.[7] Equilibrium prices automatically ensure market clearing and ultimately reflect the relative scarcity of resources; the distribution of income between wages and profits is also governed by the market mechanism and reflects the natural equilibrium of the system. 

This theoretical conception of the economic process is, however, by no means the only possible one. Actually, it historically superseded a completely different approach, the classical political economy of Adam Smith and David Ricardo, which had flourished until the first decades of the 19th century. At the core of the classical system of thought there was the notion of surplus, which is the part of the economy’s product that can be freely devoted to any use (consumption, accumulation or mere waste) without prejudicing the possibility of reproduction of the economy.[8] The classical theory of distribution analyzes the way such surplus is divided among the participants in production: it is based on the idea that one distributive variable is determined, independently of the other, by social rules, while the other emerges as a residual. Classical economists regarded real wage as the independent distributive variable, and generally conceived it as determined at the subsistence level. Such determination was the product of social conflict and reflected the imbalance of power between classes that allowed profit (and rent) to appropriate the whole surplus.[9]

Classical theory thus highlights the social (that is to say, arbitrary) character of distribution and its conflictual nature. Historically, such theory of distribution was based on a theory of value that conceived the value (relative price) of the commodity as independent of distribution itself, and as determined by the technical conditions of production. Thus, in contrast to neoclassical theory, classical political economy sees relative prices not as indexes of scarcity, determined by the equality of demand and supply. Instead, prices represent the cost at which a commodity may be produced.

Classical theory sees the economic process as circular rather than linear; the emphasis is on production (and thus accumulation and development) rather than on exchange. The center of analysis is not the behavior of the undifferentiated abstract individual, but the interaction between individuals, groups, social classes, who act in a specific historical context.

The implications of all this are less abstract than might appear at first sight, if — following the suggestion of one of the greatest economists of the past century, Piero Sraffa — the analytical core of classical political economy is taken as a basis on which to found a modern theoretical view of the working of the economic system. The system of relative prices identified in the classical approach depends on the technical conditions and the socially determined rule of distribution; it ensures compatibility and reproducibility of the system, but has no properties of optimality. [10] That is to say, public intervention does not necessarily have to be seen as distorting an otherwise ‘natural’ equilibrium.

At the same time, the independence of the factors that determine prices and those that determine quantities in the classical approach constitutes an ideal framework to re-propose Keynes’ fundamental insight about the potential plurality of levels of output that an economic system is able to attain on the basis of given resources, and to found an analysis of accumulation and growth that does not assume the tendency to full employment. The relevance of social and historical factors, which according to the classical approach are prime determinants of economic magnitudes, also implies that economics, if re-founded on classical bases, would no longer make such a massive use of the kind of abstract and ahistorical models that currently dominate the discipline.

New theoretical foundations for economic policy

If it is agreed that a deep and radical change of paradigm in economic theory is desirable, what the discussion above shows is that such a change is also possible. The idea that the root of economic phenomena is to be found in the free choices of independent individuals, and that economic magnitudes are determined by the interplay between demand and supply, may be deeply entrenched in our habits of thought, but this is by no means the only way to analyze the inner working of the economic system. Different approaches have existed and do exist, and altogether new ones may be conceived, without assuming that the only ‘scientific’ conception of economics is the dominant one.

Obviously, such a theoretical revolution is not easy to accomplish. Apart from the difficulties of winning over the profession to the new modes of thought (and the new language they entail), there is the question of what capacity any alternative body of critical economic thought in economic theory has to provide government bodies and policy-makers with a fully developed and comprehensive package of policy prescriptions, apt to address the various problems and circumstances.

As regards the general principles, the alternative paradigm has a great potential to provide solid theoretical foundations for an active economic policy. If no optimal result is automatically attained by market forces, and there is no spontaneous tendency to full employment, public intervention is both possible and desirable. The state may either provide the demand necessary for ensuring full employment of the labor force; or drive the innovation process; or foster specific sectors and products; or disincentivize through taxation and regulation the production of particular goods; all without violating any supposedly ‘natural’ economic principle.

Another question, however, is whether such an alternative approach is able to provide clear policy prescriptions to address the different possible problems. The question has both a qualitative and a quantitative dimension. From the first point of view, the conception of the economic process as deeply influenced by social and historical conditions and the conflict view of distribution imply the awareness that policy decisions generally favor some groups while damaging others, and so the virtual impossibility of objectively defining any sort of ‘collective’ interest. Thus, contrary to the ‘technocratic’ view, no policy decision may be taken in the name of abstract economic principles without making a clear choice about which social groups to favor. From the second point of view, the conception of the economic process as affected by a complex set of forces, including social and historical factors, implies the difficulty, if not impossibility, of assessing precisely the quantitative effect of any policy measure (although not, generally, its sign).

Thus, something is lost with respect to the view of economic policy that derives from current mainstream theory in terms of clear-cut prescriptions and simple recipes. At the same time, however, the critical approach allows due consideration of the complex interrelations that form the economic system. It requires an unpretentious conception of economic policy – made of a continuous attempt to obtain the socially chosen result, with the possible need for corrections and adjustment of the chosen measures. What is relevant is that such an approach opens up the possibility of regarding the economic performance of a country and the inequalities it may produce as strongly influenced by deliberate social choices.

Coming back to the current political situation, and the possible role of critical economic thinking in influencing the changes that are taking place, it is quite clear that the difficulties facing neoliberal elites do not necessarily amount to a definitive decline of the neoliberal ideology, nor that societies are necessarily choosing progressive ways out of such crisis. Critical economic thinking may, however, play an important role — both in exposing the unwarranted conclusions and false truths of mainstream thought, and in providing the progressive parts of society with analytical tools necessary to understand the complexities of reality and to try to govern them.

Footnotes

Aspromourgos, T. (2014), Thomas Piketty, the Future of Capitalism and the theory of Distribution: a Review Essay, Centro Sraffa Working Paper 7.

Garegnani, P. (1987), Surplus Approach to Value and Distribution, in The New Palgrave: A Dictionary of Economics, (eds J. Eatwell, M. Milgate and P. Newman), Palgrave Macmillan.

Kurz, H.D. (1987), Capital Theory: Debates, in The New Palgrave: A Dictionary of Economics, (eds J. Eatwell, M. Milgate and P. Newman), Palgrave Macmillan.

Piketty, T. (2014), Capital in the Twenty-First Century, Harvard University Press.

Romer, P. (2016), The Trouble With Macroeconomics, available at https://paulromer.net/wp-conte…

Serrano, F. and Melin, L.E. (2015), Political Aspects of Unemployment: Brazil’s Neoliberal U-Turn, available at http://www.excedente.org/artig…

Sraffa, P. (1960), Production of Commodities by Means of Commodities, Cambridge University Press.

Stirati, A. (2016), Piketty and the increasing concentration of wealth: some implications of alternative theories of distribution and growth, Centro Sraffa Working Paper 18.

[1] I am not maintaining, of course, that politicians are generally innocent of self-interest and corruption. The systematic media campaign against the political class as a whole, however, often takes the form of an indiscriminate attack against public intervention in the economy (and especially public expenditure) as such. See the illuminating analysis in Serrano and Melin (2015), discussing the case of Brazil.

[2] Such as, for example, the International Student Initiative for Pluralist Economics and Rethinking Economics, involving economics students from various countries (see https://www.theguardian.com/education/2014/may/04/economics-students-overhaul-subject-teaching).

[3] Such as the CORE project (see http://www.core-econ.org/).

[4] Although there are strands of thought that try to challenge the traditional notion of rationality and propose a more complex view of human behavior, the theoretical mainstream is entirely dominated by methodological individualism.

[5] Macroeconomic modeling is currently dominated by the so-called ‘dynamic stochastic general equilibrium models’, which model individual choices in conditions of uncertainty. Given the obvious difficulty of modeling the behavior of a multitude of different agents, macroeconomic results are usually obtained in these models on the basis of very heroic simplifying assumptions, such as the existence of a single immortal agent (see the critical discussion in Romer, 2016). In the supposedly ‘Keynesian’ variety of such models, some kind of rigidities or particular values of some parameters imply the result that the system undergoes non-optimal fluctuations.

[6] It may perhaps be maintained that the widespread interest aroused by Piketty’s book is one of the effects of the crisis. Apart from the novelty of the theme, however, Piketty’s discourse is entirely cast in terms of standard economic theory (see for example Aspromourgos, 2014, Stirati, 2016).

[7] Precisely this linear conception of the economic process, it is worth noting, is at the basis of the analytical difficulties than undermine the validity of neoclassical theory from a logical point of view. As is known, these are connected to the impossibility of a consistent analytical treatment of capital, which neoclassical theory tends to consider as equivalent to the original factors of production, while it is made of produced means of production (the theme has been treated extensively in the capital controversies of the 1960s; see Kurz, 1987, for a brief account).

[8] A very synthetic exposition of the classical approach is to be found in Garegnani (1987).

[9] Subsistence itself had in the analysis of classical economists a historic determination, its measure being influenced by the social norms and institutions that concurred to define a basic standard of living in any specific historical context. It is worth noting that not only the product of the social conflict may be a higher-than-subsistence real wage, but also that, analytically, it is possible to regard the rate of profit as independently determined and the real wage as the residual, as for example in the system of Sraffa (1960).

[10] Sraffa’s solution to the problem of value actually implies, differently from classical authors, a simultaneous determination of relative prices and the residual distributive variable. This solution, which gives analytical consistency to the classical system, preserves however its basic feature of a determination of relative prices entirely on the basis of the technical conditions of production and the social rule of distribution, with no reference to the demand-and-supply apparatus.