Criticisms of neoclassical economics
Encyclopedia
Neo-classical economics has come under critique on the basis of its core ideologies, assumptions and other matters.
bias. In this view, it does not focus on explaining actual economies but instead on describing a "utopia" in which Pareto optimality
applies. In the opinion of some developers of an alternative approach, the purpose of neoclassical economics is "to demonstrate the social optimality if the real world were to resemble the model", not "to explain the real world as observed empirically".
" as being quite different from real people. Many economists, even contemporaries, have criticized this model of economic man. Thorstein Veblen
put it most sardonically. Neoclassical economics assumes a person to be,
Large corporations might perhaps come closer to the neoclassical ideal of profit maximization, but this is not necessarily viewed as desirable if this comes at the expense of neglect of wider social issues. The response to this is that neoclassical economics is descriptive and not normative. It addresses such problems with concepts of private versus social utility.
"—about the validity of neoclassical economics, with an emphasis on the economic growth
, capital
, aggregate theory, and the marginal productivity theory of distribution. There were also internal attempts by neoclassical economists to extend the Arrow-Debreu model to disequilibrium investigations of stability and uniqueness. However a result known as the Sonnenschein-Mantel-Debreu theorem suggests that the assumptions that must be made to ensure that the equilibrium is stable and unique are quite restrictive.
Neoclassical economics is also often seen as relying too heavily on complex mathematical models, such as those used in general equilibrium
theory, without enough regard to whether these actually describe the real economy. Many see an attempt to model a system as complex as a modern economy by a mathematical model as unrealistic and doomed to failure. Famous answer to this criticism is Milton Friedman
's claim that theories should be judged by their ability to predict events rather than by the realism of their assumptions. Mathematical models also include those in game theory
, linear programming
, and econometrics
.
For a detailed critique of mathematical modeling, as used in the
academic and political practice of neoclassical economics, see
Pitfalls of Economic Models.
In the "Concluding Remarks" (p. 524) of his 2001 Nobel Prize lecture,
Joseph Stiglitz examined why the neoclassical paradigm—and models
based on it—persists, despite his publication,
over a decade earlier, of some of his seminal results showing that
Information Asymmetries
invalidated
core Assumptions of that paradigm and its models:
In the aftermath of the 2007-2009 global economic meltdown,
the profession's attachment to unrealistic models is increasingly
being questioned and criticized. After a weeklong workshop,
one group of economists released a paper highly critical of
their own profession's unethical use of unrealistic models.
Their Abstract offers an indictment of fundamental practices:
The assumption of rational expectations
which has been introduced in some more modern neoclassical models (sometimes also called new classical) can also be criticized on the grounds of realism.
In general, allegedly overly unrealistic assumptions are one of the most common criticisms towards neoclassical economics. It is fair to say that many (but not all) of these criticisms can only be directed towards a subset of the neoclassical models (for example, there are many neoclassical models where unregulated markets fail to achieve Pareto-optimality and there has recently been an increased interest in modeling non-rational decision making).
Economists tend to focus on markets or aggregate outcomes instead of observing individual behavior. Neoclassical economists have argued that evolutionary or "market forces" tend to select naturally the most “fit“ actors. Hence, neoclassical economic theories are based on assumptions that (competitive) markets provide an environment that involves incentives for economic actors to learn optimal behavior, on average, in the long run. In this line markets are thought to “heal“ the cognitive imperfections of actors through evolutionary forces, compelling most of them to behave "as if" they were rational . According to Joseph Stiglitz, “(Economics as taught) in America’s graduate schools .... bears testimony to a triumph of ideology over science.” Recently more and more critics have raised their voices against the way Economics
is being taught. On the subject Mark Blaug
says: "Economics has increasingly become an intellectual game played for its own sake and not for its practical consequences for understanding the economic world. Economists have converted the subject into a sort of social mathematics in which analytical rigour is everything and practical relevance is nothing.”
on his article A contribution on the state of economics in France and the world asks himself: "Is there anything missing even from the hotly contested domains of modern mainstream economics?" On his opinion, three large areas have disappeared from the teaching of Economics
, "at very considerable intellectual and social cost": the history of economics itself, the proper study of macroeconomic and monetary economics - which have been submerged by the neoclassical emphasis on market transactions between firms and households - and the lack of instruction in differing institutional contexts (political, national and international structures, policy histories) .
Recently empirical evidence has indicated that markets produce the types of learning assumed in the traditional neoclassical Economics
only under very limited ideal conditions - which are rarely met in real-life - namely perfect competition and free information (see SUNDER, 1995) .
It may take an extended period of time for markets to eventually converge to an equilibrium, if at all. Even under ideal conditions especially if the economic actors' initial beliefs are not coordinated .
Normative bias
Neoclassical economics is sometimes criticized for having a normativeNormative economics
Normative economics is that part of economics that expresses value judgments about economic fairness or what the economy ought to be like or what goals of public policy ought to be....
bias. In this view, it does not focus on explaining actual economies but instead on describing a "utopia" in which Pareto optimality
Pareto efficiency
Pareto efficiency, or Pareto optimality, is a concept in economics with applications in engineering and social sciences. The term is named after Vilfredo Pareto, an Italian economist who used the concept in his studies of economic efficiency and income distribution.Given an initial allocation of...
applies. In the opinion of some developers of an alternative approach, the purpose of neoclassical economics is "to demonstrate the social optimality if the real world were to resemble the model", not "to explain the real world as observed empirically".
Assumptions of rationality
The assumption that individuals act rationally may be viewed as ignoring important aspects of human behavior. Many see the "economic manHomo economicus
Homo economicus, or Economic human, is the concept in some economic theories of humans as rational and narrowly self-interested actors who have the ability to make judgments toward their subjectively defined ends...
" as being quite different from real people. Many economists, even contemporaries, have criticized this model of economic man. Thorstein Veblen
Thorstein Veblen
Thorstein Bunde Veblen, born Torsten Bunde Veblen was an American economist and sociologist, and a leader of the so-called institutional economics movement...
put it most sardonically. Neoclassical economics assumes a person to be,
"a lightning calculator of pleasures and pains, who oscillates like a homogeneous globule of desire of happiness under the impulse of stimuli that shift about the area, but leave him intact."
Large corporations might perhaps come closer to the neoclassical ideal of profit maximization, but this is not necessarily viewed as desirable if this comes at the expense of neglect of wider social issues. The response to this is that neoclassical economics is descriptive and not normative. It addresses such problems with concepts of private versus social utility.
Equilibrium theory
Problems exist with making the neoclassical general equilibrium theory compatible with an economy that develops over time and includes capital goods. This was explored in a major debate in the 1960s—the "Cambridge capital controversyCambridge capital controversy
The Cambridge capital controversy – sometimes simply called "the capital controversy" – refers to a theoretical and mathematical debate during the 1960s among economists concerning the nature and role of capital goods and the critique of the dominant neoclassical vision of aggregate...
"—about the validity of neoclassical economics, with an emphasis on the economic growth
Economic growth
In economics, economic growth is defined as the increasing capacity of the economy to satisfy the wants of goods and services of the members of society. Economic growth is enabled by increases in productivity, which lowers the inputs for a given amount of output. Lowered costs increase demand...
, capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
, aggregate theory, and the marginal productivity theory of distribution. There were also internal attempts by neoclassical economists to extend the Arrow-Debreu model to disequilibrium investigations of stability and uniqueness. However a result known as the Sonnenschein-Mantel-Debreu theorem suggests that the assumptions that must be made to ensure that the equilibrium is stable and unique are quite restrictive.
Neoclassical economics is also often seen as relying too heavily on complex mathematical models, such as those used in general equilibrium
General equilibrium
General equilibrium theory is a branch of theoretical economics. It seeks to explain the behavior of supply, demand and prices in a whole economy with several or many interacting markets, by seeking to prove that a set of prices exists that will result in an overall equilibrium, hence general...
theory, without enough regard to whether these actually describe the real economy. Many see an attempt to model a system as complex as a modern economy by a mathematical model as unrealistic and doomed to failure. Famous answer to this criticism is Milton Friedman
Milton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...
's claim that theories should be judged by their ability to predict events rather than by the realism of their assumptions. Mathematical models also include those in game theory
Game theory
Game theory is a mathematical method for analyzing calculated circumstances, such as in games, where a person’s success is based upon the choices of others...
, linear programming
Linear programming
Linear programming is a mathematical method for determining a way to achieve the best outcome in a given mathematical model for some list of requirements represented as linear relationships...
, and econometrics
Econometrics
Econometrics has been defined as "the application of mathematics and statistical methods to economic data" and described as the branch of economics "that aims to give empirical content to economic relations." More precisely, it is "the quantitative analysis of actual economic phenomena based on...
.
For a detailed critique of mathematical modeling, as used in the
academic and political practice of neoclassical economics, see
Pitfalls of Economic Models.
In the "Concluding Remarks" (p. 524) of his 2001 Nobel Prize lecture,
Joseph Stiglitz examined why the neoclassical paradigm—and models
based on it—persists, despite his publication,
over a decade earlier, of some of his seminal results showing that
Information Asymmetries
Information asymmetry
In economics and contract theory, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other. This creates an imbalance of power in transactions which can sometimes cause the transactions to go awry, a kind of market failure...
invalidated
core Assumptions of that paradigm and its models:
"One might ask, how can we explain the persistence of the paradigm for
so long? Partly, it must be because, in spite of its deficiencies, it
did provide insights into many economic phenomena. ...
But one cannot ignore the possibility that the survival of the [neoclassical]
paradigm was partly because the belief in that paradigm,
and the policy prescriptions, has served certain interests."
In the aftermath of the 2007-2009 global economic meltdown,
the profession's attachment to unrealistic models is increasingly
being questioned and criticized. After a weeklong workshop,
one group of economists released a paper highly critical of
their own profession's unethical use of unrealistic models.
Their Abstract offers an indictment of fundamental practices:
"The economics profession appears to have been unaware
of the long build-up to the current worldwide financial crisis
and to have significantly underestimated its dimensions
once it started to unfold. In our view, this lack of understanding
is due to a misallocation of research efforts in economics.
We trace the deeper roots of this failure to the profession's
focus on models that, by design, disregard key elements
driving outcomes in real-world markets.
The economics profession has failed in communicating the limitations,
weaknesses, and even dangers of its preferred models to the public.
This state of affairs makes clear the need for a major reorientation
of focus in the research economists undertake, as well as
for the establishment of an ethical code that would
ask economists to understand and communicate
the limitations and potential misuses of their models."
The assumption of rational expectations
Rational expectations
Rational expectations is a hypothesis in economics which states that agents' predictions of the future value of economically relevant variables are not systematically wrong in that all errors are random. An alternative formulation is that rational expectations are model-consistent expectations, in...
which has been introduced in some more modern neoclassical models (sometimes also called new classical) can also be criticized on the grounds of realism.
In general, allegedly overly unrealistic assumptions are one of the most common criticisms towards neoclassical economics. It is fair to say that many (but not all) of these criticisms can only be directed towards a subset of the neoclassical models (for example, there are many neoclassical models where unregulated markets fail to achieve Pareto-optimality and there has recently been an increased interest in modeling non-rational decision making).
Economists tend to focus on markets or aggregate outcomes instead of observing individual behavior. Neoclassical economists have argued that evolutionary or "market forces" tend to select naturally the most “fit“ actors. Hence, neoclassical economic theories are based on assumptions that (competitive) markets provide an environment that involves incentives for economic actors to learn optimal behavior, on average, in the long run. In this line markets are thought to “heal“ the cognitive imperfections of actors through evolutionary forces, compelling most of them to behave "as if" they were rational . According to Joseph Stiglitz, “(Economics as taught) in America’s graduate schools .... bears testimony to a triumph of ideology over science.” Recently more and more critics have raised their voices against the way Economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
is being taught. On the subject Mark Blaug
Mark Blaug
Mark Blaug , was a British economist , who has covered a broad range of topics over his long career. In 1955 he received his PhD from Columbia University in New York under the supervision of George Stigler...
says: "Economics has increasingly become an intellectual game played for its own sake and not for its practical consequences for understanding the economic world. Economists have converted the subject into a sort of social mathematics in which analytical rigour is everything and practical relevance is nothing.”
Incomplete
James K. GalbraithJames K. Galbraith
James Kenneth Galbraith is an American economist who writes frequently for mainstream and liberal publications on economic topics. He is currently a professor at the Lyndon B. Johnson School of Public Affairs and at the Department of Government, University of Texas at Austin. He is also a Senior...
on his article A contribution on the state of economics in France and the world asks himself: "Is there anything missing even from the hotly contested domains of modern mainstream economics?" On his opinion, three large areas have disappeared from the teaching of Economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, "at very considerable intellectual and social cost": the history of economics itself, the proper study of macroeconomic and monetary economics - which have been submerged by the neoclassical emphasis on market transactions between firms and households - and the lack of instruction in differing institutional contexts (political, national and international structures, policy histories) .
Learning in Economics: Do Markets Heal?
However recent studies have shown that empirical evidence on this subject is mixed. There is plenty of empirical evidence that "anomalous" behavior can survive for a long time in real markets such as in market "bubbles" and market "herding" (see AVERY & ZEMSKY, 1998). Evidence from the laboratory shows that some anomalies are overcome by learning in real life market environments, while others are not: “The data suggest the market glass is both half-full of deviations and half-empty because some deviations were drained away by learning“ (CAMERER, 1995, 675) .Recently empirical evidence has indicated that markets produce the types of learning assumed in the traditional neoclassical Economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
only under very limited ideal conditions - which are rarely met in real-life - namely perfect competition and free information (see SUNDER, 1995) .
It may take an extended period of time for markets to eventually converge to an equilibrium, if at all. Even under ideal conditions especially if the economic actors' initial beliefs are not coordinated .