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Getting neoclassical economics right

by Robert Teitelman | Published August 28, 2012 at 3:21 PM

Sometimes a bit of education can be a fascinating thing. Let's begin with David Glasner at his Uneasy Money blog. Glasner, an economist at the Federal Trade Commission, was exercised after reading a recent essay by Adam Davidson in The New York Times Magazine about Friedrich Hayek, mostly pegged to the fact that Paul Ryan is a Hayek adherent. Glasner is convinced that Davidson has not a clue about where Hayek fits into the larger body of the economic tradition, and he thrashes him pretty vigorously. Glasner starts off with Davidson's description of Hayek as "an awkwardly shy (and largely ignored) economist and a philosopher, who died in 1992." Glasner, who once took courses with Hayek and knew him for two decades, dismantles the shy part, stomps all over the "largely ignored" (he won a Nobel Prize, engaged John Maynard Keynes in a series of polemics in the '30s, wrote a best-selling book, "The Road to Serfdom," and was a founder of the conservative Mont Pelerin Society) and moves in for the kill. What Glasner is really getting at is Davidson's description of Hayek as a member of the Austrian School of economics and thus fundamentally at odds with the "neoclassical" tradition, which Davidson says includes everything from the communist critique to Keynes to Krugman. Here's Davidson's description of the neoclassical tradition:

"Neoclassicists can be left-wing or right-wing, but they share a set of crucial core beliefs, namely that it is useful to look for government policies that can improve the economy. Hayek and the rest of his ilk -- known as the Austrian School -- reject this. To an Austrian, the economy is incomprehensibly complex and constantly changing; and technocrats and politicians who claim to have figured out how to use government are deluded or self-interested or worse. According to Hayek, government intervention in the free market, like targeted tax cuts, can only make things worse."

This is Glasner's sputtering response: "Here Davidson doesn't just get Hayek wrong, he gets everything wrong." (This reminds me of a "This American Life" radio commentary Davidson and Alex Blumberg did in early 2009 introducing America to a "foul-mouthed, slutty British elitist who was called arrogant and supercilious and unbearably boorish -- and that was by his friends," that is Keynes. My favorite part from Davidson who had just read the abridged version of Robert Skidelsky's biography of Keynes: "He ran with the Bloomsbury Group, you know Virginia Woolf and all those painters and poets. They were into free love and raunchy language. And they used to complain in letters to each other that Keynes was just too dirty for them." The fact that he was gay seems to bother Davidson a lot. Where he got much of this -- and it goes on and on -- and what any of this has to do with Keynes' work or American life is mysterious to me.) Glasner offers his own historical definition of neoclassicism, which he traces roughly to the publication of Alfred Marshall's "Principles of Economics" in 1890, a matter Skidelsky in volume one of his Keynes biography handles brilliantly. On Davidson's identification of neoclassicism with government activism, Glasner notes: "The mind boggles. This is not just cluelessness; it's cluelessness masquerading as profundity." Could Karl Marx, who died in 1883, critique Marshall? How did Davidson go so awry? Glasner speculates that it might come from talking with current members of the Austrian School who use "neoclassical" as "a term of abuse" for any doctrine or policy they don't like.

Glasner goes into more detail on why he believes Hayek is actually a neoclassicist, which is much worth reading. But for another, believe it or not, less abusive set of reflections on neoclassicism there's Paul Krugman on his Times blog. Krugman doesn't mention Davidson -- after all, he's a sort-of Times colleague -- and he starts off on the high road. "So, what is neoclassical economics? There's a historical definition, having to do with the 'marginal revolution' of the late 19th century and all that, but what I think we mean in practice is economics based on maximization-with-equilibrium. We imagine an economy consisting of rational, self-interested players, and suppose that economic outcomes reflect a situation in which each player is doing the best he, she, or it can given the actions of all the other players. If nobody has market power, this comes down to the textbook picture of perfectly competitive markets with all the marginal whatevers equal." This is nicely put and quite useful, if also revealing a large gap between his own and Davidson's definition.

Krugman continues, wrestling with the inevitable limitations of such an approach that comes from building ideal models of a deeply complex reality. He asks what nonneoclassical economics would look like. "It would involve both the simplification of maximizing behavior, going for full behavioral, and rejecting the simplification of equilibrium, going for a dynamic story with no end state." He approvingly cites attempts like agent-based economics. As for the Austrians, well on that subject his claws come out. "They claim to reject neoclassical economics," he writes, "but their alternative is not an alternative model but a lot of verbiage."

Why should laymen care? Well, Davidson clearly feels he is giving economics to a world that needs to be spoon-fed with both racy gossip and current relevance. Keynes engaged in "gay porn" while Hayek frontally opposed the tenets of neoclassicism. In fact, the fabled "clash" between Keynes and Hayek is more complex than a simple opposition, and it does an injustice to the subtleties of both men's thought. The history of economics, like economic history, often gets short shrift in the war of sound bytes and ideologies of latter-day politics. (In fact, greater emphasis on teaching economic history, and a better sense of political context, are two recommendations for improving economics made by a conference sponsored by the Bank of England.) But these ideas do matter; they do have real consequences as the debate between a Hayekian GOP (with traces of Ayn Rand floating around) and the Keynesian Democrats (however you define that) suggests. Origins and history matter. - Robert Teitelman

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