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1/8/10

Is this the death of the neoclassical paradigm? Part I

I am currently reading Hyman Minsky’s most important work, Stabilizing an Unstable Economy. With the current backlash against the once hegemonic Chicago-School of economics that solely emphasized the microeconomic aspects of economics—the pro-capitalist, uncritical apology for Adam Smith’s notion of the ‘invisible hand’ of the free market. They totally reject the macroeconomic/structural—Keynesian/Marxist—legacy of economic analysis and Paul Samuelson’s so-called “neoclassical synthesis”. Largely informed by the liberal-fundamentalism of Hayek, Friedman--both of whom taught at Chicago--and Mises, they believe that any government intervention that does not apply to all equally leads to totalitarianism and sub-optimal economic outcomes, viz., ‘The Road to Serfdom’; however, it is a thesis that runs contrary to historical evidence (read: http://perspectivos.blogspot.com/2009/12/on-hayek-part-i.html).

They also argue that capitalism is the only true system of freedom where individuals are free to choose to do what they want. However, C.B. Machperson’s critique of Friedman points out that capitalism is built and depends on a inherent inability of persons to be free--the proletariat--and a duality of power between those who lack capital and those who have capital, which relegates those without capital without a choice when it comes to work--exploitation--caused by dispossession and coercion from the state and its ‘structural reforms’; thus, as Machperson states, “Professor Friedman's demonstration that the capitalist market economy can co-ordinate economic activities without coercion rests on an elementary conceptual error”. I will quote Macpherson here at length:

The proviso that is required to make every transaction strictly voluntary is not freedom not to enter into any particular exchange, but freedom not to enter into any exchange at all...What distinguishes the capitalist economy from the simple exchange economy is the separation of labour and capital, that is, the existence of a labour force without its own sufficient capital and therefore without a choice as to whether to put its labour in the market or not. Professor Friedman would agree that where there is no choice there is coercion. His attempted demonstration that capitalism co-ordinates without coercion therefore fails.

This also disproves Hayek’s rather eclectic notion that capitalism and liberalism basically evolved peacefully from the immutable forces of idealism and was not implemented as a conscious, material, program by capital and the liberal-state; however, as Polanyi states that “[the] lassiez-faire economy was the product of deliberate State action” (147).

However, the aforementioned critiques undermine the premises of the their theory, but it is the theory itself that is now under attack. Paul Krugman’s latest blog post entitled “This is the way the Chicago School ends” (http://krugman.blogs.nytimes.com/2010/01/07/this-is-the-way-the-chicago-school-ends/) suggests that we have a Kuhnian ‘paradigm shift’ happening. The Chicago School, as Krguman, et al., suggest cannot explain away the inability of the theory to explain the causes of the financial crisis. This inability is suggestive of ‘anomalies’, which Kuhn describes occurs when “normal science leads only to the recognition of anomalies and to crises. And these are terminated, not by deliberation and interpretation, but by a relatively sudden and unstructured event like the gesalt [sic] shift” (122). This is now happening, running on all cylinders, as the attacks are coming from all sides: the neo-keynesians, institutionalists and marxists and this is starting relentless attack is bearing fruit. The attack, spearheaded by Paul Krugman and Joseph Stiglitz is reversing the neoliberal ‘counter-revolution’ of the 1980s. So wide-ranging is the assault on the traditional neoclassical ideology that Joseph Stiglitz, the anti-Hayek within the pro-capitalist camp, now goes so far as to question many of the basic postulates of the paradigm. The first is the notion of marginal returns and secondly, the invisible hand:


Neoclassical economic theory, which has dominated in the West for a century, holds that each individual’s compensation reflects his marginal social contribution...But Borlaug [inventor of the Green Revolution] and our bankers refute that theory. If neoclassical theory were correct, Borlaug would have been among the wealthiest men in the world, while our bankers would have been lining up at soup kitchens” (Stiglitz, 2009)

—and—


The first lesson is that markets are not self-correcting. Indeed, without adequate regulation, they are prone to excess. In 2009, we again saw why Adam Smith's invisible hand often appeared invisible: it is not there. The bankers' pursuit of self-interest (greed) did not lead to the well-being of society; it did not even serve their shareholders and bondholders well. It certainly did not serve homeowners who are losing their homes, workers who have lost their jobs, retirees who have seen their retirement funds vanish, or taxpayers who paid hundreds of billions of dollars to bail out the banks. (Stiglitz, 2009)

What all these counter-hegemonic ideologies have in common is the belief that the free-market, capitalist system is not perfect and that it is inherently and internally prone to crisis that, if the market is left to its own devices, the economy would likely implode akin to what occurred in the Great Depression. As Minsky writes:

Instability is due to the internal processes of our type of economy. The dynamics of a capitalist economy which has complex, sophisticated, and evolving financial structures leads to the development of conditions conducive to incoherence...But incoherence need not be fully realized because institutions and policy can contain the thrust to instability. We can, so to speak, stabilize instability (10).

This is a radical break, because it essentially proves that Marx was right in regards to the inherent tendency within capitalism to contradict itself and lead to repetitive and  successively worse crises as the contradictions amplify themselves—overaccumulation/underconsumption, which is a mirror of Keynes argument of the crisis of savings/investment caused by a lack of aggregate demand. However, unlike the marxists, they believe that capitalism can be successfully regulated and lead to a essentially crisis-free system, if only one can properly regulate it. What is needed is a ‘visible hand’ to create incentive structures to channel homo economicus to socially optimal outcomes and maintain a relatively crisis free capitalism, and to regulate away the ‘casino’ aspects of finance capitalism in particular. The question is, is this actually possible within a capitalist state?

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