What is neoclassical economics – a rejoinder to Noahpinion

14 Jun, 2013 at 11:07 | Posted in Economics | 22 Comments

neoclassical-economics-with-related-tags-and-termsNoah Smith – on his blog Noahpinion – writes that when yours truly and other heterodox economists criticize neoclassical economics

the term “neoclassical” gets slung around quite a lot, usually as a perjorative (sic!) … The idea is that “neoclassical” econ is the dominant paradigm, and that the “heterodox” schools are competing paradigms that lost out, and were, to use Kuhn’s terminology, “simply read out of the profession…and subsequently ignored.”

He then goes on to define neoclassical economics with the help of Wikipedia:

“Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits by cost-constrained firms employing available information and factors of production, in accordance with rational choice theory.”

OK, makes sense. Assumption of individual rationality, utility maximization, and supply/demand. One or more of things terms probably describes most of mainstream economics theory.

The basic problem with this definition of neoclassical economics – basically arguing that  the differentia specifica of neoclassical economics is its use of demand and supply, utility maximization and rational choice – is that it doesn’t get things quite right. As we all know, there is an endless list of mainstream models that more or less distance themselves from one or the other of these characteristics. So the heart of neoclassical economic theory lies elsewhere.

The essence of neoclassical economic theory is its exclusive use of a deductivist Euclidean methodology. A methodology  that is more or less imposed as constituting economics, and, usually, without a smack of argument.

The theories and models that neoclassical economists construct describe imaginary worlds using a combination of formal sign systems such as mathematics and ordinary language. The descriptions made are extremely thin and to a large degree disconnected to the specific contexts of the targeted system than one (usually) wants to (partially) represent. This is not by chance. These closed formalistic-mathematical theories and models are constructed for the purpose of being able to deliver purportedly rigorous deductions that may somehow by be exportable to the target system. By analyzing a few causal factors in their “laboratories” they hope they can perform “thought experiments” and observe how these factors operate on their own and without impediments or confounders.

Unfortunately, this is not so. The reason for this is that economic causes never act in a socio-economic vacuum. Causes have to be set in a contextual structure to be able to operate. This structure has to take some form or other, but instead of incorporating structures that are true to the target system, the settings made in economic models are rather based on formalistic mathematical tractability. In the models they appear as unrealistic assumptions, usually playing a decisive role in getting the deductive machinery deliver “precise” and “rigorous” results. This, of course, makes exporting to real world target systems problematic, since these models – as part of a deductivist covering-law tradition in economics – are thought to deliver general and far-reaching conclusions that are externally valid. But how can we be sure the lessons learned in these theories and models have external validity, when based on highly specific unrealistic assumptions? As a rule, the more specific and concrete the structures, the less generalizable the results. Admitting that we in principle can move from (partial) falsehoods in theories and models to truth in real world target systems does not take us very far, unless a thorough explication of the relation between theory, model and the real world target system is made. If models assume representative actors, rational expectations, market clearing and equilibrium, and we know that real people and markets cannot be expected to obey these assumptions, the warrants for supposing that conclusions or hypothesis of causally relevant mechanisms or regularities can be bridged, are obviously non-justifiable. To have a deductive warrant for things happening in a closed model is no guarantee for them being preserved when applied to an open real world target system.

Henry Louis Mencken once wrote that “there is always an easy solution to every human problem – neat, plausible and wrong.” And neoclassical economics has indeed been wrong. Its main result, so far, has been to demonstrate the futility of trying to build a satisfactory bridge between formalistic-axiomatic deductivist models and real world target systems. Assuming, for example, perfect knowledge, instant market clearing and approximating aggregate behaviour with unrealistically heroic assumptions of representative actors, just will not do. The assumptions made, surreptitiously eliminate the very phenomena we want to study: uncertainty, disequilibrium, structural instability and problems of aggregation and coordination between different individuals and groups.

The punch line is that most of the problems that neoclassical economics is wrestling with, issues from its attempts at formalistic modeling per se of social phenomena. Reducing microeconomics to refinements of hyper-rational Bayesian deductivist models is not a viable way forward. It will only sentence to irrelevance the most interesting real world economic problems. And as someone has so wisely remarked, murder is unfortunately the only way to reduce biology to chemistry – reducing macroeconomics to Walrasian general equilibrium microeconomics basically means committing the same crime.

If scientific progress in economics – as Robert Lucas and other latter days neoclassical economists seem to think – lies in our ability to tell “better and better stories” without considering the realm of imagination and ideas a retreat from real world target systems reality, one would of course think our economics journal being filled with articles supporting the stories with empirical evidence. However, contrary to Noah Smith, I would argue that the journals still show a striking and embarrassing paucity of empirical studies that (try to) substantiate these theoretical claims. Equally amazing is how little one has to say about the relationship between the model and real world target systems. It is as though thinking explicit discussion, argumentation and justification on the subject not required. Neoclassical economic theory is obviously navigating in dire straits.

The latest financial-economic crisis has definitely shown the shortcomings of neoclassical economic theory. What went wrong, according to Paul Krugman, was basically that economists “mistook beauty, clad in impressive-looking mathematics, for truth.” This is certainly true as far as it goes. But it doesn’t go deep enough. Mathematics is just a means towards the goal – modeling the economy as a closed deductivist system.

If the ultimate criteria of success of a deductivist system is to what extent it predicts and coheres with (parts of) reality, modern neoclassical economics seems to be a hopeless misallocation of scientific resources. To focus scientific endeavours on proving things in models, is a gross misapprehension of what an economic theory ought to be about. Deductivist models and methods disconnected from reality are not relevant to predict, explain or understand real world economic target systems. These systems do not conform to the restricted closed-system structure the neoclassical modeling strategy presupposes.

Neoclassical economic theory still today consists mainly in investigating economic models. It has since long given up on the real world and contents itself with proving things about thought up worlds. Empirical evidence only plays a minor role in neoclassical economic theory, where models largely function as substitutes for empirical evidence.

What is wrong with neoclassical economics is not that it employs models per se, but that it employs poor models. They are poor because they do not bridge to the real world target system in which we live. But “facts kick”, and hopefully humbled by the manifest failure of its theoretical pretences, the one-sided, almost religious, insistence on mathematical deductivist modeling as the only scientific activity worthy of pursuing in economics will give way to methodological pluralism based on ontological considerations rather than formalistic tractability.


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  6. This is a great piece, but still IMO the difference is much simpler. I don’t know what “heterodox” actually means, but if we compare to classical economists, they separated price and value. All income is not earned. Neoclassical instead treats all incomes as “earned” (“microfoundation?”). To Adam Smith all monoply prices were unearned, but this is the structure of reality. To neoclassicals monopoly prices are “market imperfections” not reality (and caused somehow by the government).

  7. Hey Lars!

    I really pretty strongly take issue with the idea that anything in the mainstream is neoclassical by definition, and that if the mainstream’s ideas change, then the meaning of “neoclassical” should also change. I think that is a counterproductive way to think about the world.

    However, I really like the rest of this post, and in fact I was about to write a post about this. Pure theorizing, unsupported by empirics, has always really annoyed me. And doing empirics only to test existing theories, not to identify or explore or characterize unexplained phenomena, annoys as well. So I think that was very well said.

    An increasing amount of the research in mainstream economics departments and journals is inductive and empirical, not deductive or theoretical. This is a good thing.

  8. Superb analysis!

  9. For what it´s worth or matter ,it was at least with no doubt ,Thorstein Veblen who coined the term Neoclassical in his “Preconceptions of Economic Science”, The Quarterly Journal of Economics,Part III. Vol. 14 No. 2. (Feb., 1900), check on pg. 261 here: http://www.geocities.ws/veblenite/txt/precon.txt

    And there he refer to Neoclassicals specifically
    as the the marginalists in the tradition of Alfred Marshall, not including Menger and others in the Austrian School although he wrote “the so-called Austrian school is scarcely distinguishable from the neo-classical, unless it be in the different distribution of emphasis”.He pointed out that the great divergence was “between the modernized classical views, on the one hand, and the historical and Marxist schools” on the other.

  10. “She [i.e. Prof. McCloskey] argued that modern economics reflects different branches that stem from classical economics, with neoclassical being one”.

    With all due respect to Prof. McCloskey and to Dwayne Woods, who originally posted the quote above, I have a really hard time seeing in what possible sense neoclassical economics can be seen as a branch stemming from classical political economy.

    Prof. Vernengo pointed to a reason why neoclassicism cannot be considered a stem from classical economics (distribution theory).

    But there is more to it than that: the classicals’ emphasis was on production, growth, distribution, that of marginalists/neoclassicals is on demand and prices; marginalists/neoclassicals are subjectivists, classicals were objectivists; marginalists/neoclassicals are methodological individualists, classicals were not.

    In fact, other than the shared “classical” adjective, I see very little in common between neoclassical economics and classical political economy.

    That’s an odd “branch”, to say the least.

  11. Careful Lars, the pythagoreans killed people for less.

  12. Dears,

    What we mostly call “neoclassical” economics is better called “Samuelsonian,” since it dates from P. S. Samuelson and his brother-in-law Kenneth Arrow. Historically the neoclassicals are those of the 1870s, including Walras (beloved of the Samuelsonians), Jevons, Marshall (thence Keynes and the Second Chicago School of Friedman et al.), and Menger, the Austrian, thence Hayek and Kirzner and the like, who detest Samuelsonianism.


    Deirdre McCloskey

    • Hi Deirdre:
      I think that would be a very narrow definition of neoclassical economics, one that leaves not just Hayek, but also Friedman out. I think it was well established that the Marginalist Revolution core was about the fact that the remuneration of ‘factors of production’ was determined by supply and demand, and hence conflict, which was central for the old classical authors (Smith, Ricardo and Marx), was not what determined income distribution. My post on this is here http://nakedkeynesianism.blogspot.com.ar/2013/06/what-is-really-neoclassical-economics.html, since Noah also cites me on the use of the term neoclassical economics.

      • haha Dr. Vernengo, I swear I made my post below before I read your recent blog post…

      • “Neoclassical theory is based on the assumptions that are a combination of mechanistic analogies of positivism, behaviorism, utilitarianism, and reductionalistic methodologic individualism, each one is contentious issues in the philosophy of science. Their combination is probably unmatched in terms of logical inconsistencies and unrealistic starting point in today’s social sciences.” Professor Joachim Israel
        in Klappjakten på välfärden,1993,

        • Nicely put by my old sociology professor 🙂

    • Ms. McCloskey, perhaps it would be better to call them the marginalists? Regardless, the critique above applies directly to all of marginalism. Krishna Bharadwaj’s history of classical theory vs. “neoclassical” or marginalism (book called Themes in Value and Distribution), among other analyses, shows this very clearly. Your attempts at substituting neoclassical for samuelsonian is inappropriate considering the word was first used by Thorstein Veblen, far before Samuelson’s time.

  13. In any case, Varoufakis et al’s book, Modern Political Economics does a wonderful job in brining the “core” neoclassical assumptions together. In this respect, they are in agreement with you, “that for the most part their methodological/theoretical stances they are predominantly neoclassical at heart.” I don’t disagree necessarily but I think that the variation “within” is a lot more interesting than a reductive ad neoclassicism might imply!

  14. On this issue, I am closer to McCloskey and Noah than you. As I read the economic literature, there is much more variety than your portrayal allows for. Granted that the Samuelson model formalism probably predominates, but even within this frame there has been some creative things that have emerged. In fact, I would argue that precisely because abstract formal models have to ultimately confront the real world clever economists are always trying to calibrate their models in such a way that their abstractions capture some dimension of what’s outside their models. Roger Farmer’s work is a good illustration of this endeavor. This process is probably doomed to fail but a “thousand” flowers do bloom because of it! Varoufakis sees it as an “iron cage” in which all attempts to escape are doomed as long as the “basic premises” are accepted – Maybe!?

  15. Long before Noah, Deirdre McCloskey wrote something on the use and abuse of the label Neo-Classical economists. I think here argument is spot on. She argued that modern economics reflects different branches that stem from classical economics, with neoclassical being one. She demarcates the type of economics that prevail to day with Paul Samuelson and the Euclian deductivist approach you talk about sits closer to him than pre-WWII neoclassicists.

    • Or maybe the difference has to do with theory vs. empirical work. There are certain branches of mainstream economics today that are more empirically oriented and that don’t have to – explicitly at least – rely on the core neoclassical axioms/methods. I would notwithstanding that, still argue that when challenged on the foundations for most of their methodological/theoretical stances, they are predominantly neoclassical at heart.

    • I think the definition of NCE given here is too restrictive, NCE is constrained to a very peculiar world view (market equilibria). However your definition applies quite well to economics as a whole.

      Alan MacFarlane posted a must watch interview with Wynne Godley on youtube : http://www.youtube.com/watch?v=FphsWVy7aOI

      In Part 2, Wynne more or less trashes post-Keynesian economics. [ Joan Robinson, Richard Kahn, etc. ] He says they were unfriendly, vain, quarrelsome, never helped other people, left no coherent body of work, produced no “post-Keynesian synthesis”. They all wanted to be number one.

      The problem with economics it the top-down approach. Physics is science because Kepler modelled the planetary system using Tycho Bahre’s data. Modern physics began bottom-up and has always been about better models.

      Economics has generally been about explaining why “I’m right and everyone else is wrong”. Hence Wynne’s comments on the Cambridge post-Keynesians.

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