Criticisms of neoclassical economics

Neo-classical economics has come under critique on the basis of its core ideologies, assumptions and other matters.

Normative bias

Neoclassical economics is sometimes criticized for having a normative 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".^[1]

Assumptions of rationality

The assumption that individuals act rationally may be viewed as ignoring important aspects of human behavior. Many see the "economic man" 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,

"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."^[2]

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 controversy"—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, ^[3] 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:

"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." ^[3]

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." ^[4]

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 ^[5]. 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.”

Incomplete

James K. Galbraith 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) ^[6].

Learning in Economics: Do Markets Heal?

The assumption that conduct is prompt and rational is in all cases a fiction. But it proves to be sufficiently near to reality, if things have had time to hammer logic into men. Where this has happened, and within the limits in which it has happened, one may rest content with this fiction and build theories upon it.

—Joseph Schumpeter (1934, 80; first published 1911)

However recent studies have shown that empirical evidence on this subject is mixed.^{[citation needed]} 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) ^[5].

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) ^[5].

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 ^[5].

See also

• Post-autistic economics
• Real-world economics review

References

1. ^ Alfred S. Eichner and J. A. Kregel (1975) "An Essay on Post-Keynesian Theory: A New Paradigm in Economics", Journal of Economic Literature, V. 13, N. 4 (Dec.): pp. 1293-1314.
2. ^ Thorstein Veblen (1898) Why Is Economics Not an Evolutionary Science?, reprinted in The Place of Science in Modern Civilization (New York, 1919), p. 73.
3. ^ ^{a b} Joseph E. Stiglitz. 2001 Nobel Prize lecture: "INFORMATION AND THE CHANGE IN THE PARADIGM IN ECONOMICS". http://nobelprize.org/nobel_prizes/economics/laureates/2001/stiglitz-lecture.pdf. 
4. ^ Colander, David; Follmer, Hans; Haas, Armin; Goldberg, Michael D.; Juselius, Katarina; Kirman, Alan; Lux, Thomas; and Sloth, Birgitte: "The Financial Crisis and the Systemic Failure of Academic Economics". http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1355882.  (March 9, 2009). Univ. of Copenhagen Dept. of Economics Discussion Paper No. 09-03
5. ^ ^{a b c d} Tilman Slembeck. Learning in Economics: Where Do We Stand? A Behavioral View on Learning in Theory, Practice and Experiments, St. Gallen (Switzerland): Department of Economics, University of St. Gallen, Discussion paper no. 9907, August 1999 pp 10-12
6. ^ James K. Galbraith (2001) A contribution on the state of economics in France and the world. post-autistic economics newsletter : issue no. 4, January, article 1

Bibliography

• Avery, C. & Zemsky, P. (1998): Multidimensional Uncertainty and Herd Behavior in Financial Markets, American Economic Review, 88(4), 724–748.
• Camerer, C. (1995): Individual Decision Making, in: Kagel, J.H. & Roth, A.E. (Eds.): Handbook of Experimental Economics, Princeton, Princeton University Press, 587-703. ISBN 9780691058979
• Joseph A. Schumpeter (1911) The Theory of Economic Development: An inquiry into profits, capital, credit, interest and the business cycle, 1983 edition ISBN 0878556982
• Sunder, S. (1995): Experimental Asset Markets: A Survey, in: Kagel, J.H. & Roth, A.E. (Eds.): Handbook of Experimental Economics, Princeton, Princeton University Press, 445-500. ISBN 9780691058979