Deraco, Rona Eilsel E.

November 21, 2017

Reyes, Anthony Luisse F. Prof. Charito Sebastian, PhD

COULD NEOCLASSICAL TOOLS BE APPLIED TO PLANNED ECONOMIES?

In the early 1920’s, an Austrian economist named Ludwig von Mises claimed that
planned economies are impossible to push through because an economy needs the elements
of neoclassicism –money, market and prices. He claimed that without these, as Bockman
(2001) said, “It would be impossible to decide rationally how to act in the economy and thus
also considered socialism and markets as mutually exclusive categories.”

Are the neoclassical tools applied in market economies really in contrast and “mutually
exclusive” to planned economies that are based on socialism? Or could these two actually
go hand in hand and be supplementary?

Before going into detail with the argument if neoclassical tools could be applied to
planned and socialist economies, what exactly is neoclassical economics and what planned
and socialist economies really are?

Neoclassical economics is an approach to economics that uses the interaction

between the supply and demand –driven by an individual’s rationality in making decisions
based on utility maximization –to determine price and output. In neoclassical economics, a
good’s value goes beyond the costs incurred because consumers also have their perceived
value of the good that in turn affects its price and quantity. This approach also emphasizes
that competition results to an efficient allocation of scarce resources because it establishes
the market equilibrium between supply and demand. The well-known tools used in
neoclassical economics include indifference curves, marginal revenue curve, theory of ordinal
utility, and mathematical modelling especially in game theory, linear programming and
econometrics.

On the other hand, a planned economy such as a socialist economy, is an economic

system that assumes the market does not work in the best interest and welfare of the people
that is why the government should have the total control in economic decisions –from the
allocation of resources to pricing –in order to meet social and national objectives. In this
economic system, rather than the letting the interaction between consumers and businesses
happen, centralized state planning and administrative decision making is held.
 Seeing how neoclassical economics highlights the importance and usage of supply
and demand in organizing and allocating resources as well as the presence of competition in
the economy, which is totally in contrast with what prevails in planned economies, it has
always been a debate if these divergent ideologies could also be complementary.

In an article by Peter Murrel, he said that in terms of economic reform economies such
as planned and socialist ones, neoclassical economics is not strong enough to serve as a
foundation, and that, other theories could be much more relevant. He added, “The
comparative economic experience of capitalist and socialist economies and modern
economic theory offer only a diverse assortment of facts and results. There is unlikely to be
a single unifying idea.”

Another analyst who believed that neoclassicism is inapplicable to socialism, Ingrid

Rima, said that there is little basis to see the accordance between neoclassical economics
and socialist economies, especially in terms of macroeconomic analysis and policy. Further
saying that “thereon hangs the difficulty of reconciliating the generally perceived dichotomy
between neoclassical and social economics.”

Even in the early onset of neoclassicism, it has been difficult to see the relationship
between neoclassical economics –that is based in criticism of Marx’s application of labor
theory of value –and socialism that traces its roots in Marxism.

However, not all analysts and economists were so pessimist in seeing the accordance
between the two. In 1936, economist Oskar Lange, in response to Mises’s claim, said that
neoclassical tools and models can also be applied in planned and socialists economies
wherein economic planners will set prices and subsequently allow markets to adjust these
prices.

The economist Leon Walras who is well-known for creating one of the most important
neoclassical tools, the general equilibrium model, had always believe that neoclassical
economics can be used in achieving socialist ideals because according to him, “production
in a market ruled by free competition is an operation by which services can be combined and
converted into products of such a nature and in such quantities as will give the greatest
possible satisfaction of wants.”
 Another economist who envisioned the potential of applying neoclassical tools to study
planned economies was Chicago School economist Ronald Coase. According to him, a firm
is like a “little planned society” and said to himself that if his professors were right about prices
being the only reason why competitive market economy functions, then, why did firms exist
even with their nonmarket authoritarian hierarchies?

In a published dissertation by Abram Berson, an economic professor, he recognized

that there were similarities in the inequalities in wages in the Soviet Union and United States
and therefore suggesting that the supply and demand worked in both systems.

These economists who advocated the application of neoclassical economics in

socialist states will not be complete without Vilfredo Pareto. Pareto pioneered three of the
most important neoclassical tools that were later called the “social planner,” the “social
welfare function,” and the “Pareto optimality.” He also followed one of the traditions in
neoclassical economics which is associating the competitive free market and the socialist
state. As he said, “Both systems are not different in form, and they lead to the same point.”

By the 1980s, neoclassical economists already realized that pure competitive markets
and centrally planned states were identical mathematically and from the nineteenth century,
neoclassical economists assumed that the optimal results from free competitive markets
could also be provided by central planning which gave rise to the concept of market socialism.

As this paper exhibited, there is no single definitive answer as to whether neoclassical

economics could be applied in planned economies or not. The answer lies to our own
understanding whether we will agree with those economists who were vehement in the
exclusivity of the two or if we will side with those who believed that the two could actually
function hand-in-hand.

Sources:

Bockman (2001) Markets in the Name of Socialism: The Left-Wing Origins of Neoliberalism. California :
Stanford University Press

Murell (1991) Can Neoclassical Economics Underpin the Reform in Centrally Planned Economies.
Retrieved November 4, 2017 from http://jdeanicite.typepad.com/files/murrell-economics-and-socialism.pdf

Rima (1996) Can Neoclassical Economics be Social Economics. Retrieved November 4, 2017 from
https://link.springer.com/article/10.1007/BF02778861