Most of the chapters in this book are about visions of a new economy. This one is about a vision of a new economics. In 1936, John Maynard Keynes wrote the now famous quotation that ‘practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist’, and that ‘madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back’.1 The eighty years since his writing have seemed to prove him correct. As the Western world lurched from Keynesian mixed economies to neoliberal ‘hyper-capitalism’, politicians and policymakers like Margaret Thatcher and Ronald Reagan seemed to be acting out the scripts that had been written years earlier by men like Friedrich Hayek and Milton Friedman.
Most readers are probably familiar with this story of the tumultuous 1970s and the new era of politics that followed. What is less obvious is that, despite the dramatic shift in policies, within academic economics the core theoretical framework remained essentially unchanged. Both Keynesian planning and laissez-faire neoliberalism had their theoretical roots in what is called ‘neoclassical’ economics. Neoclassical economics is an impressively flexible tool – it provides a framework from which academics can draw radically different conclusions. But it is not all-powerful. It has substantial blind spots, and excludes many questions and lines of reasoning that could be helpful in meeting the economic challenges of the next century.
Neoclassical economics is now synonymous with ‘economics’ throughout much of academia. It is what is taught to students, it is what is published in major journals and it is what backs up the ‘sound’ economic advice presented to policymakers of all parties. Students around the world have begun to protest this narrowness, arguing that they are being short-changed out of receiving the critical examination of the economy they expected when they decided to study economics.
The political left is being short-changed as well. The dominance of neoclassical economics ensures that economic debates are framed in a way that limits what progressives see as possible. Indeed, it is part of the reason why left-of-centre parties have so often struggled to come up with bold new ideas to face the challenges of the twenty-first century.
Over the years, conservatives have not been shy about making investments in academic infrastructure that supported their political goals. It is time for progressives to start taking economics seriously. If we want to create a truly new economy, we need to work to open the discipline of economics to new ideas and new approaches. In short, we need to invest in the next generation of ‘academic scribblers’ who will be writing the political scripts for decades to come.
What Is Neoclassical Economics?
Neoclassical economics is a branch of economic thinking that developed in the late 1800s out of the ‘classical’ tradition of economists like Adam Smith and David Ricardo. As mentioned previously, neoclassical economics forms the backbone of the vast majority of economic teaching and research – so much so that economic approaches or schools of thought that do not have neoclassical foundations are often labelled ‘heterodox’. As neoclassical economics represents the bulk of modern economic theory, this section can only give the briefest introduction. As such, I will try to show what it looks like to ‘do’ neoclassical economics, especially as it relates to issues of economic policy. For a more thorough theoretical explanation of neoclassical economics, The Econocracy, a book written by members of the Rethinking Economics network, is quite helpful.2
Neoclassical economics operates in a world of markets. One of the key innovations of neoclassical economics was that economic value derives not solely from the cost of producing something, but also from how much people want that thing. Thus, both supply and demand work together to determine prices. When markets work well, prices are set at a level where supply meets demand. Everyone who is able and willing to pay the price for a good can do so (there are no shortages) and there are not large numbers of unsold goods (surpluses). These markets are ‘efficient’ in the sense that nothing could be done to make any market participant better off without also making someone else worse off – i.e. the economic pie is as big as it could possibly be with the resources available.
Much of the work of economics then turns to looking at situations where markets do not work so well – where something can be done to make the economic pie bigger without adding more resources. These situations are called ‘market failures’ or ‘market imperfections’, and they are caused by ‘frictions’ which make a real-world market deviate from a ‘perfect’ market. There are a large number of market failures, and the concept is used by economists to explain quite a lot.
For example, when a market transaction affects a third party other than the buyer or seller – a situation called an externality – markets can produce too much (an inefficiently high amount) of something like pollution or too little (an inefficiently low amount) of something like education. Externalities can lead to policy recommendations which aim to balance the market by, for instance, taxing or regulating pollution and subsidising education. In a similar vein, goods that can be used by everyone can be hard to fund with a market because everyone has a big incentive not to pay. That’s why, without government help, markets might build an inefficiently low number of roads or other elements of public infrastructure. Differences, or asymmetries, in who knows what within a market can also cause markets to operate inefficiently or break down entirely.
Using frictions, neoclassical economics was able to incorporate many of Keynes’s key insights about how governments can respond to economic depression (an adaptation called the neoclassical–Keynesian synthesis). For instance, because there is often a practical cost to changing prices (whether reprinting menus or renegotiating contracts), some prices can be thought of as rigid, or ‘sticky’. Wages are a particularly sticky price, as pay rates are sometimes locked into long-term contracts, and workers will often resist attempts to lower their wages. When the economy faces a general decline in demand for goods and services (typically characterised as coming from an ‘outside shock’, like a change in trade relations or the development of a new technology) the market price for labour should decrease. But, because wages are difficult to bring down, employers will instead lay off workers, creating a surplus of labour (i.e. higher unemployment). Governments can respond to this situation by temporarily propping up demand (by borrowing and spending money), either to allow a temporary demand shock to pass, or to give wages time to adapt downward to a more permanent decline in demand.
Using logic chains like this, a pretty large range of economic ideas can be expressed in terms of ‘deviations’ away from perfect markets, and a wide range of government action (or inaction) can be justified. That’s how both Keynesian economics and neoliberalism – the set of ideas arguing for freer markets and less government – came to share the same theoretical framework. The policy differences can often be boiled down to questions about the size of a given market failure and the corresponding efficiency of a given government response.
However, while neoclassical economics can certainly bend, it is only so flexible. By viewing a diverse array of social phenomena – from work to our relationship with the environment – as markets, neoclassical economics offers a toolkit that aims at improving or fixing those markets. Fixing markets is obviously a useful pursuit, but it will not be enough to face the myriad challenges of the twenty-first century.
How Does Neoclassical Economics Limit Progressive Politics?
The dominance of neoclassical economics limits the horizon of what is possible for progressive politics. The neoclassical framework limits the conceivable responses to familiar economic problems like unemployment or slow economic growth. It also has a tendency to frame most social phenomena as markets, even if other mindsets might be more useful in solving the economic problems at hand. Finally, by focusing primarily on markets and exchange, neoclassical economics takes many major economic issues off the table entirely.
HOW NEOCLASSICAL ECONOMICS SUGGESTS ANSWERS TO FAMILIAR PROBLEMS
A good example of the ‘limiting’ power of the neoclassical framework can be seen by expanding on the logic chain about unemployment explained above. In this story, unemployment in recessions is caused because some shock knocked the economy out of a full-employment equilibrium, and certain frictions (like price-stickiness) are keeping the economy from returning back to a full-employment equilibrium. As explained earlier, this story can be used to justify Keynesian government spending – a traditionally progressive policy – but in doing so it accepts some fairly important claims about the nature and causes of unemployment that imply far less progressive policies in other situations.
Unemployment in this framework is fundamentally caused by ‘frictions’ that keep prices from adjusting to changes in demand. In a perfect market, there should be no involuntary unemployment – wages should adjust up and down such that the supply of labour matches the demand for labour so that everyone can work as much as they want for the going wage. If a new technology is introduced that decreases demand for labour, wages should fall and everyone who wants to work at the new, lower wage should be able to. The only people who would be considered ‘unemployed’ in such a market would be those temporarily transitioning between jobs.
This framework prompts a division of unemployment into two categories: short-term and long-term. Short-term unemployment is caused by temporary frictions that keep prices from adjusting quickly to changes in demand. This is the kind of unemployment we see in depressions and recessions, and the kind which government deficit spending can alleviate. Long-term unemployment is then caused by non-temporary frictions that either permanently keep wages above the market rate, or make it harder for potential workers to match up with potential bosses. Unions, and other labour regulations, are often blamed for keeping wages above market rates (and creating unemployment for non-protected workers), and a host of ‘matching frictions’ like generous unemployment benefits are invoked to explain why potential workers may not be properly incentivised to find potential employers.
The impact of this kind of thinking on left politics is pretty clear. While the United Kingdom’s GDP (a common measure of economic activity) is still well below its 2007 peak, Jeremy Corbyn’s 2017 campaign effectively took government deficit spending off the table by promising to balance the government budget within five years.3 Politically this move feels strange – the most left-wing leader the UK has seen in decades decided to throw out the Keynesian playbook and instead promised rigid fiscal conservatism, despite the lingering sluggishness of the UK economy.
However, within the logic of the neoclassical–Keynesian synthesis, it’s hard to see what else could be done. Government deficit spending is designed to allow the economy to weather, or adjust to, temporary shocks. To argue for significant fiscal stimulus ten years after the crash, one would have to argue that either the shock of the financial crisis (or some other, similarly sized shock) is still somehow hitting the economy, or that downward wage adjustments are still ongoing. As neither of these seem likely, fiscal stimulus would not be an effective solution, and any lingering unemployment can be regarded as a longer-term, structural problem.
Where this story leads next can be seen quite tragically across the Channel in France, where socialist president François Hollande’s battle against long-term unemployment consisted almost entirely of attempts to make labour markets more ‘flexible’ by removing the various ‘frictions’ imposed by France’s relatively strict labour codes and strong unions. It is telling that France’s new president, Emmanuel Macron, for all his appearances of change, seems to share the same understanding of what is causing French unemployment, and likewise is proposing similar reforms to make French labour more flexible.
IF ALL YOU HAVE IS NEOCLASSICAL ECONOMICS, EVERYTHING LOOKS LIKE A MARKET
If all you have is a hammer, then the world looks like a nail. Something similar happens with neoclassical economics. Neoclassical economics is quite good at studying markets, so when neoclassical economists want to study something a natural first step is to conceptualise that thing as a market.
One particularly funny-sounding example of this tendency is the ‘family economics’ that developed in the 1960s to explain things like marriage, the sexual division of labour and altruistic relationships within families. This approach led to conversations about the market for marriages, the expected returns of raising children and the opportunity costs for men doing household work versus working outside the home.
However, if you were to actually ask people questions like ‘why did you marry your spouse’, ‘why did you have children’ or ‘how do you decide who does what kind of work within your family’, you would probably not get the same picture of the calculating decision makers described by family economics. That’s not to say that there’s no value in trying to think of families as if they were governed by the same logic as markets, but it should imply that relying entirely on a vision of families that ignores things like cultural and religious practices, or deeper human feelings like love or obligation, is at best a limited approach.
A more concrete policy example of this phenomenon can be seen in the British higher education system.4 Universities around the world face a similar squeeze: for decades, enrolments have increased while the costs per student of providing education have increased. The British response to this problem was to try to treat higher education as a market, and create competition between universities for students and the government funding that follows them.
Starting in 1997, Tony Blair’s Labour government allowed English universities to start charging £1,000 per year in tuition fees for British and EU students. This amount would subsequently be increased to £3,000 in 2004 and £9,000 in 2010.5 Part of the idea behind this move was to allow universities to differentiate by price, giving prospective students the option to ‘buy’ a higher- or lower-quality education as they saw fit.
The obvious problem with this plan is that most universities believe they are in the business of providing a high-quality education. Setting tuition fees under the cap simultaneously deprives a university of much-needed funds and signals to students and the wider academic community that they are a ‘low-quality’ option.
For the 2015/16 academic year, 113 of 120 English universities surveyed charged the full £9,000.6 Instead of offering students more options, this attempt to treat higher education as a market has left students with uniformly high tuition fees. Instead of rethinking the flawed market approach itself, much of the economic advice about fixing the higher education ‘market’ has centred around removing ‘barriers to entry’ so that newer, more competitive universities can enter the market.7
Healthcare reform in the United States has told a similar story. The American healthcare system is quite complicated. Most working people receive health insurance from their employers and most retired or very poor people receive insurance from the government, but everyone else is essentially on their own and has to buy insurance independently from private insurers. One of the big aims of the Democrats’ 2010 Patient Protection and Affordable Care Act (better known as Obamacare) was to help this third group of people by making the market for private insurance work better.
The broad strategy was to set up well-regulated, localised markets for insurance, where insurers would have to offer plans that met government standards, and people buying these plans would be eligible for government subsidies. In theory, competition would bring down costs and increase quality of insurance, as insurers fought over potential customers and the government subsidies that came with them.
Unfortunately, simply keeping the markets running has proved to be quite a difficult task. On one side, the government has had to spend significant amounts of money to advertise the markets to potential buyers to keep enough people in the insurance risk pools to make the markets viable. On the other, the government has had to constantly lobby (and provide additional subsidies to) insurance companies to convince them to actually participate in the markets. Each year there are worries about regions with either too few buyers or too few insurers to make the markets operate. For 2018, roughly one-third of the people buying insurance on the marketplace will only have one insurance company to choose from.8
Markets are powerful tools, but they are not the answer to all of society’s problems. The dominance of a branch of economics that thinks almost exclusively in terms of markets blinds policymakers to other alternatives that may be more appropriate.
TAKING ISSUES OFF THE TABLE
Neoclassical economics is designed to optimise the economic system we currently have, but it is much less equipped to think critically about some of the core features of the system itself. From economic inequality to our relationship with the environment, many of the biggest issues facing the world are effectively omitted from the neoclassical radar. This leaves policymakers with a shortage of rigorous economic proposals that do more than just tinker around the edges of the status quo.
One of the core conceptual tasks of neoclassical economics – to identify and remedy market failures – is very poorly suited to addressing economic inequality. As stated earlier, the primary definition of ‘efficiency’ used in economics is a situation in which no one can be made better off without making someone else worse off – when the pie is as big as it can be without adding more ingredients. Efficiency is, then, by definition, a very good quality for a system to have, as it simply ensures resources are not wasted. The goal of much of economics, then, is to think about how to make markets more efficient so they can operate at full capacity.
However, this concept of efficiency says nothing about how the wealth produced by said markets is distributed. Economists often refer to this as the divide between efficiency and equity. Equity is about fairness, about the really big picture of how society thinks a just economy should operate. Equity is sticky, and is best left to political systems to figure out. Efficiency is a more technical matter, and is the preferred domain of economists. Unfortunately, because of the critical position of economists in the decision-making processes of modern societies, this means questions of equity often get dropped entirely in favour of work focusing on efficiency.
This doesn’t mean that economists are incapable of studying inequality. But when they do try to take questions about power and distribution seriously, they often do so with empirical studies like, for example, analysing the statistical relationship between various measures of inequality and economic growth. This work is important, but without more substantial theoretical foundations it can only provide so much insight. For instance, empirical studies can suggest that very high levels of inequality dampen growth, but they cannot offer much insight about the deeper role of (or need for) inequality within a capitalist system, or the pervasive relationship between economic inequality and political power. Questions about the causes and consequences of inequality cut to the core of modern political debate, but in neoclassical economics they are uncomfortable side topics.
Neoclassical economics has a similar problem when it comes to the environment. While neoclassical economists do often talk about the environment – there is an entire sub-discipline called environmental economics – these conversations once again tend to frame environmental problems using the language of market failures and inefficiencies. Pollution is a negative externality, so left to their own devices markets will produce a sub-optimal level of pollution. With taxes and regulations, governments can then adjust the markets to create an ‘optimal’ level of pollution. Again, while this kind of work can be useful, it misses some of society’s biggest and most fundamental questions regarding the environment, sustainability and the future of our economy.
Investing in Ideas
Economics doesn’t have to be like this. Many of the theories that can supplement neoclassical economics already exist. For instance, post-Keynesians have very different notions of what causes (and cures) unemployment, while institutionalist economists are working to identify specific legal structures that exacerbate inequality. Ecological economists view the economy as a subsystem of the environment, and are starting to work out the details of how modern economies could operate without perpetual growth. Feminist economists examine the rich world of economics that exists outside of formal market structures, while cooperative economists think of alternative ways to organise both production and consumption without traditional, profit-driven markets. These examples are just the tip of the iceberg of the wealth of economic diversity out there.9
Unfortunately, much like an iceberg, most of these ideas remain below the surface, without the resources, publicity and perceived legitimacy needed to influence progressive policy in a meaningful way. Progressive politicians, activists and donors should take this problem seriously. It’s time for the left to start looking beyond the immediate economic fights of the day, and start working towards removing the deeper theoretical and institutional constraints that prevent more inclusive and progressive economic ideas from flourishing.
Conservatives have not been shy about investing in the ‘production’ of economic ideas, and for decades they have funded an endless stream of think tanks, research grants, popular publications and even university economics departments. This has allowed them to ensure that issues that are important to them (like debts and deficits) receive a central treatment by economists and the economics press, and has also helped subtly direct policy-makers on both the right and the left towards policies that are agreeable to a broadly ‘neoliberal’ worldview.
Luckily, a movement to open economics to new ideas is now in full bloom. Student organisations like Rethinking Economics and the International Student Initiative for Pluralism in Economics have been working for the past five years to build a movement that can alter economics education to make it more open, diverse and relevant to the real world. Other groups, like Promoting Economic Pluralism, have taken the movement outside of the university to both civil servants and the private sector, while the organisation Economy (ecnmy.org) is working to make pluralist economics engaging and understandable for a wider audience.
There’s plenty of work to be done, particularly in funding spaces like think tanks and policy shops where non-neoclassical policy work can receive serious attention. While much of the movement to reform economics is non-partisan in nature, that does not mean partisans should ignore the action. Many of our economic problems can be traced back to decades-old trends in economic thinking. Now is the time to start the hard work of creating a new economics that will be receptive to bold ideas for a new economy. In short, if there really is a ‘marketplace for ideas’ it’s time for progressives to start investing.