A strange view of economics

By Paul Walker 10/04/2015


From Gavin Kennedy at the Adam Smith’s Lost Legacy blog comes this bit of information:

jundalisay has authored an interesting new Blog HERE:

“This is the public site of the new proposed science of socio-economics or ‘Smithonomics’ or ‘Political Economy version 2.0′ which is meant as an alternative to economics.”

“Economic science was created in the 19th century by intellectuals who championed the cause of businesses, which is to maximize profits based on the paradigm of personal utility or pleasure for the benefit of the self. This is in stark contrast to the old science of the Political Economy which advocated to maximize the benefit of the whole society through proper government policies and regulation and was based on moral philosophy.

This all sounds a bit strange to me. For a start if economics today is about businesses and their profits and not about the benefit of the whole society then what are we make of the work of people like Amartya Sen or Tony Atkinson? I don’t see much an emphasis on firms and their profits in their work. Also, if the benefit of the whole society isn’t an issue in economics what do we do with the subjects like welfare economics? In addition how do we interpret work like that of Bergson, Samuelson or, most famously, Arrow on social welfare functions (SWFs)? Isn’t the whole point of an SWF to get a measure of total welfare of a society? Also even when working within a partial equilibrium framework the standard measure of welfare in the sum of producer and consumer surplus, not just producer surplus. So there is no singling out of firms’ welfare for special treatment. How does behavioural economics fit into jundalisay’s framework? Much of post-19th century economics is to do with proper government policies and regulation. The most obvious example would be that of Pigou and his taxes and subsidies for negative and positive externalities. Also what of competition policy? And there are a seemingly endless number of regulations on all aspects of the economy which are justified with reference to modern economics. So how does standard economics and ‘Political Economy version 2.0’ differ in this regard?

Who in post-19th century economics is it that championed the cause of businesses? Even today businesses are one of the most ignored institutions in economic theory.

“The theory of the firm has been a neglected area of study in mainstream economics. Despite Ronald Coase bringing the issue up for discussion in 1937, it was not on the research agenda until the 1970s. Even now, as both Coase and Oliver Williamson, the founder of and prominent scholar in the transaction cost-focusing analysis of firm organization, have received the Nobel Prize in economics, the area remains in the periphery of economic analysis” (Bylund 2011: 189).

Coase and Wang (2011: 1) remark,

“[b]ut the gain in rigor achieved in modern price theory comes with a heavy price tag. The most obvious and serious omission in price theory is that it sees no role for production, let alone entrepreneurship. How goods and services are actually produced, how new goods and services and new ways of production are constantly invented in the economy, how production and innovation are organized, and what forces are at work are rarely on the research agenda in economics. It is extraordinary that the process of production is virtually invisible in economic theory”

while Coase himself commented in an 2013 interview that

“[m]odern economics shows little interest in production” (Wang 2014: 118).

If we look back in the history of economics we find business have been ignored by most groups of economic thinkers.

With regard to the relationship between economic theory and business Edwin Cannan wrote,

“I do not mean to argue that a knowledge of economic theory will enable a man to conduct his private business with success. Doubtless many of the particular subjects of study which come under the head of economics are useful in the conduct of business, but I doubt if economic theory itself is. [ …] economic theory does not tell a man the exact moment to leave off the production of one thing and begin that of another; it does not tell him the precise moment when prices have reached the bottom or the top. It is, perhaps, rather likely to make him expect the inevitable to arrive far sooner than it actually does, and to make him underrate, not the foresight, but the want of foresight of the rest of the world” (Cannan 1902: 459-60).

Cannan was not alone in making this type of argument. Arthur Pigou wrote:

“[ …] it is not the business of economists to teach woollen manufacturers to make and sell wool, or brewers how to make and sell beer, or any other business men how to do their job. If that was what we were out for, we should, I imagine, immediately quit our desks and get somebody – doubtless at a heavy premium, for we should be thoroughly inefficient – to take us into his woollen mill or his brewery” (Pigou 1922: 463-4).

Lionel Robbins argued similarly, in that

“[t]he technical arts of production are simply to be grouped among the given factors influencing the relative scarcity of different economic goods. The technique of cotton manufacture [ …] is no part of the subject-matter of Economics [ …]” (Robbins 1935: 33).

In fact in the period following the classical economists, with the possible exception of Alfred Marshall, few economists, be they mainstream or heterodoxy, wrote anything much on the firm. When reviewing the contribution of the old institutionalists to the theory of the firm Hodgson (2012: 55) writes,

“[ …] we search in vain for a well-defined ‘theory of the firm’ within the old institutional economics”.

Carl M. Guelzo argues that one of the leading old institutionalists, John R. Commons,

“[ …] did not construct a rigorous theory of the firm since this was never his purpose” (Guelzo 1976: 45).

With reference to the German historical school Le Texier (2013: 80) writes

“[m]embers of the German historical school such as Gustav von Schmoller analysed at length the birth and growth of the business enterprise, but they were more historians than economists. None of these thinkers proposed a theory of the business firm”.

When writing about the work of Joseph Schumpeter, Hanappi (2012: 62) says

“[a] well-defined theory of the firm thus cannot be found in Schumpeter’s oeuvres”.

As to Austrian economics Per Bylund writes,

“[b]ut despite the focus in Austrian economics on [ …] “mundane economics,”

and the fact that

“the Austrians [have] so many necessary ingredients for a theory of the firm” [ …], there is no Austrian theory of the firm” (Bylund 2011: 191)

and

“[w]hereas the theory of the firm has been a neglected area of study in mainstream economics, it has been missing from the Austrian economics literature” (Bylund 2011: 191).

Hutchison (1953: 308) comments

“[t]he Austrian School, with the exception of Auspitz and Lieben, did not concern themselves much with the analysis of markets and firms, except in respect to their general principle of imputation”.

Hutchison also summarised the early neoclassical contributions to the theory of the firm, and markets, as

“Jevons has little on the firm. [ …] Walras’s assumptions of perfect competition (maintained virtually throughout) and of fixed technical ‘coefficients’, limited his contribution to the analysis of firms and markets, [ …]. Pareto’s contribution to the theory of firms and markets were not rounded off, and of very varying value, […]” (Hutchison 1953: 307).

So where the idea that economics was created in the 19th century by intellectuals who championed the cause of businesses comes from I don’t know.

Also there have been a number of alternatives to profit maximisation put forwards. We have seen models based on utility maximisation, sales revenue maximisation and output maximisation. There have been behavioural models put forward, along with cost-plus pricing and growth models but none of these have won out in the market place for idea since as a starting place, at least, profit maximisation is the most useful assumption. In addition there are models of no-for-profit firms and worker/consumer/producer cooperatives which are relevant in certain areas of the economy and need not assume profit maximisation.

So profit maximisation is the most common but not the only assumption utilised in the theory of the firm. Actually, for the neoclassical model at least, profit maximisation isn’t technically an assumption at all, its a result. Utility maximisation implies profit maximisation. Crudely put, to maximise utility a consumer wants to maximise income and as part of their income comes from forms’ profits they want firms to maximise profits. One could also add that there are not firms in the textbook approach to the production so championing the cause of businesses in the neoclassical model is championing something that doesn’t exist.