A Historical Discussion of Economics: Why Do Economists Disagree?

A Historical Discussion

of Economics:

Why do economists disagree?

George Arthur Lehmann

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Published by AuthorHouse 06/12/2014

ISBN: 978-1-4918-8292-4 (sc)

ISBN: 978-1-4918-8293-1 (e)

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Table of Contents

Abstract

Introduction

Chapter 1

Adam Smith and Jean-Baptise Say: The Beginnings of Economics

Chapter 2

David Ricardo: The Rise of International Economics and the Theory of Comparative Advantage

Chapter 3

The Rise of Dialectical Economics: Karl Marx

Chapter 4

From Classical to Neo-Classical Economics: The Marginal Revolution: The Beginning of Modern Economic Disagreement

Chapter 5

Alfred Marshall and the Beginning of Modern Economics

Chapter 6

Thorstein Veblen and John Kenneth Galbraith: The Beginning of Institutional Economics

Chapter 7

Ludwig von Mises and Friedrich Hayek: Two Generations of Austrian Economists

Chapter 8

The End of Laissez-Faire: Keynes

Chapter 9

The Rise of Welfare Economics and Birth of Neo-Institutionalism: Samuelson and Ronald Coarse

Chapter 10

The Years after Keynes: The Oil Crisis and the Breakdown of the Philips Curve

Chapter 11

Economics of International Development; Ricardo’s Theory Revised; the Economics of Sir Arthur Lewis and Neo-Liberal Reactions

Chapter 12

Evaluation

Chapter 13

Application

Conclusion

Bibliography

Abstract

Since the days of Adam Smith (and probably since the physiocrats), economists have disagreed on the nature of their profession as well as on policy-related issues. One could not agree with the other in their entities; a new generation would oppose their predecessors. Marx opposed Smith, while the marginalists criticised Marx, who was later opposed by Alfred Marshall, Keynes, and other prominent economists. This is something historians cannot say about the academic development of chemistry, biology, or physics. But why? Why is economics a science of disagreement? Or more importantly, is economics a science anyway? And does that matter?

To discover why economists have always disagreed with each other, we must define certain terms and then look at the major economists and their contribution to the field. We must also take a look at the nature of economics and how it differs from other academic disciplines.

Most economists disagree about economic theory when it comes to the implementation of policies. However, policies are implemented by governments, and governments are very often guided by academic theories. Therefore, in order to decide why so many economists disagree on policies, it is necessary to take a look at the reasons why academics have disagreed.

My hypothesis is that the causes for economic disagreement are far more centred towards very few basic fundamental assumptions than academics tend to assume. In order to demonstrate this, we must take a look at the first economists in history, dating back from Adam Smith. We have to analyse the concepts economists borrowed from their predecessors (most of which are methodological). This is how we will be able to trace back the flaws of certain economic theories, which might have influenced many generations of economists (consciously or unconsciously).

We also have to ask ourselves why certain theories developed at different times. The fact that certain ideas survive at different stages of development also tells us something about the uniqueness of the subject. Part of this thesis will discover the uniqueness of this (almost mythical) subject, as this might have something to do with the causes of economic disagreement.

This book will also answer the following question: What are the primary reasons for economic disagreement? Of course, there are many secondary reasons for economic disagreement (or specific disagreements with regards to specific topics). But this book will focus on the primary reasons why economists have disagreed with each other.

Introduction

Disagreements and discussions between economists have become increasingly complex, and people often believe that two economists, talking about the same subject, are in fact talking about different subjects. Economic debates have become much more difficult to follow, and whenever two economists share a stadium, they disagree with each other, and this has been true since the origin of economics. Why do economists disagree in the first place, and are there generic points of disagreement that we can all relate back to? In order to answer these questions, we will have to take a look at the origins of economics; as I will demonstrate, economics started with methodological simplifications.

It is the aim of this book to argue that the primary reasons for economic disagreement can be limited to only a few points, which economists should define before every discussion; this would make economic disagreements easier to understand and would enable others to understand them. In order to do this, we need to define the primary methodological assumptions behind economists.

We will analyse the beginnings of economics as an academic discipline and demonstrate why classical economics was not wrong, as many people believe today, but was a methodological simplification and should therefore not be used as a guideline for contemporary economists.

In order to understand why economists have disagreed with one another, we must go back to the origins of economics as an academic discipline and see why economics is such a unique subject, and has always been.

Many have argued that economists disagree with each other because they have different political views; while this might be true, economists need to justify their arguments economically, instead of normatively (which is not to deny that moral or ethical arguments are important). So economists need economic justifications for their conclusions, and it will be the economic justifications we will be focusing on; for example, while Marx might have had interesting points to raise regarding the normative justification against the capitalist system, he also explained why capitalism was deemed to fail economically. This book will focus on the economic issues Marx raised against capitalism.

Moreover, many economists have also argued that economists disagree over the role of government intervention; while this is true, I believe we must go deeper into the methodological reasoning of theories, as even pro-interventionists disagree with one another, as well as pro-laissez-faire economists; after all, we must not forget that many economic theories start with the analysis of the individual, and this book will start with the beginning of economics itself, in order to see why economists tend to disagree with their intellectual predecessors.

Our analysis of economic theory will argue that economics, as it is such as a complicated discipline, started with methodological simplifications and ethnocentric assumptions, as political economists (the forerunner of modern/contemporary economists) had to build the foundations for coming intellectual generations. Deductive simplifications helped to build the intellectual foundations of economics.

Economics was not an easy discipline to start, as economic interactions are so invisible and difficult to measure; to this extent, economics is unique amongst other social sciences. It started with very generic assumptions of human interactions. It would take centuries until economists would analyse their theories in an institutional context.

It order to simplify the analysis of economic activities, economies had to simplify economics in the first place, to develop the foundations of this discipline.

1) Economic agents were assumed to act totally rationally, and economic resources were assumed to be totally mobile; consumers and producers were supposed to be totally aware of their relative prices, as well as actions.

2) Interrelated changing factors, as a response to a change in one interdependent factor, had to be held constant (ceteris paribus). Before their analysis, economists should decide which factors they prefer to hold constant and which factors they estimate to change—and in which direction.

3) Secondly, while economists might have assumed a short-term analysis at the micro level, this cannot be said about the macro level. At the macro level, economists were primarily concerned with the long run, as the short run was still too specific to pay attention to; historical evolutions, which might have shaped the structures of national economy, were not taken into account either. In addition, actors were also assumed to react to changes as soon as possible. This is reflected in the rational choice theory (RCT) of classical economists.

4) Finally, theories arose in an institutional vacuum, as assertions were supposed to be universally applicable, regardless of different time periods and geographical regions.

The first economists, like Adam Smith, started with generic assumptions of the market economy. Smith’s invisible hand is usually understood as advocating for the free market; the invisible hand guided demand and supply. Later, the French economist Jean-Baptiste Say would add that the market systems would not affect goods unsold, as supply would create its own demand. Consumers did not wish to hold money for a very long time; due to workings of the free-market economy, there was also less need for institutional intermediators. As we can see, the first economists explained economics with rather ethnocentric theories and without reference to institutional environments; theories were agency centred.

The third classical economist this book will discuss is David Ricardo. These days, most economist realise that economies in different countries are subject to diverse institutional surroundings and therefore need to be treated differently in terms of economic analysis; this was not the case with David Ricardo. Apart from his labour theory of value (LTV), Ricardo is most commonly remembered for his workings on comparative advantage. In Ricardo’s political economy, nation-states are supposed to specialise in their strengths and promote trade accordingly. This, Ricardo said, encourages economic growth and lowers the cost for consumers. Due to the nature of classical economists, Ricardo assumed economic resources to be totally mobile and economic agents to be totally rational, having full knowledge about each other’s prices, as well interests. Even though the International Monetary Fund (IMF) still treats Ricardo as the intellectual guru of international trade, his theories remain flawed and have been attacked by many institutional economists.

The next two economists were ahead of their time: Karl Marx and Thorstein Veblen. These economists brought unique contributions to the discipline, bearing in mind that Veblen and Marx were conducting economic research in the nineteenth century.

We all know that Marx criticised the normative surroundings of capitalism, but he also distanced himself from capitalism, as he believed it resulted in a society’s collapse. This book will ask why Marx managed to come to this conclusion, which contradicted with classical economists. First of all, while classical economists related events to the long run, Marx thought in terms of the very long run. Secondly, whilst most classical economists treated other factors to be equal (ceteris paribus), this book will demonstrate how Marx considered different factors to be interrelated, while at the same time and by contrast, assuming many socio-economic conditions to remain unchanged over centuries.

However, Marx certainly failed to see how the twentieth century would come with new opportunities for everyone. And as much as Marx criticised the methodological simplifications of the nineteenth century, Marx himself assumed the hyper-flexibility of resources, with the exception of labour.

To this extent, he wanted economics to be a broad discipline, and to include many interrelated and changing factors. However, what Marx failed to consider was the limit to big corporations which would be embedded in the capitalist system in the twentieth century.

In contrast, this book will demonstrate how Veblen was ahead of his time and included the analysis of institutions into the working of the market economy. In his Theory of the Leisure Class, Veblen argued that institutions have a capability of shaping the behaviour of economic agents. To that extent, this book will demonstrate how Veblen challenged the ethnocentric notion that human beings were rationally acting agents, as human nature was constantly evolving; the significant legacy of this theory would become important in the days of Sir Arthur Lewis, who argued that inhabitants and consumers in Third World countries have alternative habits of things and economic practices. During his days, Veblen did not gain much attention as an economist. However, if he had worked during the twentieth century, I am sure he would have been considered by Ronald Coase as his intellectual equal. Although many academics see Coase as a free-market economist, Coase talked about institutions, which brought about transaction costs and the introduction of legal systems to create efficient institutions, to reduce these costs of social interaction.

While Marx and Veblen were far from being classical economists, this book will dedicate a stronger emphasis to the workings of William Stanley Jevons and Leon Walras, as well as the Austrian economists. Jevons was one of the harshest critics of Ricardo’s LTV; Jevons did not believe that the value of a product was derived from its labour costs, but from the marginal utility it would provide to the individual consumer. While Ricardo, compared to contemporary economists, did not pay a great deal of attention to past or previous interactions, he did so when he argued that the value of a product was derived by its labour cost. Jevons believed this to be inadequate and had a more preset-oriented concept of economic analysis. Jevons believed that current consumers were in a position to dictate prices. As we will see, different perceptions about the concept of time has always been an issue economists have argued about for a long time.

While Jevons attacked Ricardo’s LTV, Carl Menger (as well as other Austrian economists) was more concerned with the individual; these economists placed a huge significance on rationality and the intelligence of economic agents (consumers); this is how Menger’s analysis of price formations differed from other alternative marginal economists. Menger placed a higher faith in the rationality and intelligence of human beings, and it is due to Menger that the Austrian school of economics still places a huge importance on individual actions, as well as free markets. Indeed, we will also explain why Friedrich Hayek argued that credit expansions would naturally lead to distortions in the natural rate of interest and therefore the business cycle.

Alfred Marshall and John Maynard Keynes criticised classical and neo-classical economics. As we will see, Marshall, the teacher of Keynes, argued that classical economics was flawed in its assumption to hold other factors equal. As we discussed earlier, this was necessary, as it is essential for economists to start with simplifications. But in The General Theory of Employment, Interest, and Money, Keynes applied some of Marshall’s most important methodological contributions and analysed the economics of the Great Depression. This book will dedicate a disproportionate amount of time to the economics of the Great Depression and will demonstrate how Keynes’s General Theory broke with most of the methodological simplifications of classical economics. This analysis will demonstrate how Keynes advocated the inclusion of short-term factors at the macro level and included an assessment of interrelated factors into his own analysis of the economy.

Finally, during the Great Depression, it also became clear that resources were not always totally mobile and individuals did not always have perfect information about each other’s interests and coming commercial figures.

The final section of this book is dedicated to the workings of the international economy. After the Second World War, people started to see the world with different eyes and began to realise that Third World countries had different institutional surroundings, with alternative historical evolutions, with regards to socio-economic conditions. This is when economists started to challenge the ethnocentric view provided by David Ricardo and started to argue that Third World countries were first in need of institutional reform, before they could make use of each other’s competitive advantage; this was the intellectual legacy of Veblen, who wrote about institutions with capabilities of shaping the commercial mind and behaviour of citizens and inhabitants in a region, which economists began to study in the 1950s and 1960s.

But apart from institutions at the international level, laissez-faire critiques have also called for institutional intermediators at national and local levels, to promote the efficiencies workings of the market economy.

Throughout the book, I will link fundamental problems and major disagreements back to the methodological simplifications that economics started with. I will demonstrate how economists have disagreed with one another as they differed on how flexible resources are and how