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The Academic Scribblers
By William Breit, Roger L. Ransom
PRINCETON UNIVERSITY PRESS Copyright © 1998 William Breit and Roger L. Ransom
All rights reserved.
A few years ago a distinguished national magazine asked the following questions of some twenty-seven historians, economists, political scientists, educators, and philosophers:
1. What books published during the past four decades most significantly altered the direction of our society?
2. Which may have a substantial impact on public thought and action in the years ahead?
Although the participants represented wide areas of interests and were invited to submit as many titles as they desired, the book cited most often would scarcely be expected to attract a large reading public and would most certainly not be a likely candidate for sale to a motion picture studio. It was The General Theory of Employment Interest and Money by John Maynard Keynes. Among those who voted for it were a political columnist, a philosopher, two historians, a political scientist, and over a half-dozen other representatives of the intelligentsia. This wide-ranging agreement on the importance of a work by an English economist would probably be surprising to the general public, which might have expected the result to favor such authors as Toynbee, Kinsey, or Marshall McLuhan.
And yet, by almost any standard of influence, the choice seems unerringly right. For this work truly has left its mark on our times as has no other single volume, even leading one writer to christen the period since World War II as "The Age of Keynes." The widely held notion of the necessity for a strongly interventionist state to maintain full employment was unquestionably established in large part by this work.
It would be superficial, of course, to suggest that the "new economics" of post-World War II America is simply the product of one man's ideas. The new economics encompasses much recent theoretical analysis which implies that laissez-faire under free competition will lead neither to an efficient nor to full employment of resources. These ideas involve not only Keynes's concept of inadequate demand but also the wastes of competition, the irrationality of the consumer, and divergencies between private and social interests. Such considerations ostensibly lead to the conclusion that free-market capitalism is viable only with the help of an activist government stepping in to maintain demand; to provide goods and services neglected by befuddled, ignorant, or wrong-headed consumers; and generally to levy the taxes and provide the subsidies that would bring about the maximum degree of economic welfare. Keynes was, in the main, silent on such topics as advertising, excess capacity, waste, pollution, congestion, and inadequate provision of public services. Yet these problems are coming to play just as important a role in the exercise of economic policy as is the maintenance of adequate demand. Although August Heckscher has called Keynes's book "the prophetic work which laid the basis for the economics of the welfare state," others must share in this accomplishment.
But if the general public is only slightly familiar with the name of Keynes, it is even less aware of the names of other economists who helped provide the rationale for the interventionist economic policy of our times. As we shall show, the writings of Thorstein Veblen, Arthur Cecil Pigou, and Edward H. Chamberlin taken together have probably had at least as much influence as Keynes in setting the tone for economic policy in the second half of the twentieth century. These men, along with Keynes, were to shape the thought and policy prescriptions of some of the most influential economists of our time: Alvin H. Hansen, Paul A. Samuelson, Abba P. Lerner, and John Kenneth Galbraith. It will be demonstrated that contemporary economic thought and policy run largely in terms of the arguments and tools provided by these economists.
Yet there is another story to be told in this volume. Revolutions have their counterrevolutions, and upheavals in economic thought are no exception. In American economics the counterrevolution has been led by three important scholars, who happen to have been associated with the University of Chicago. These economists have presented ideas intended to clarify the meaning of neoclassical economics—the body of thought with largely laissez-faire policy implications which was the accepted doctrine before the strictures of Veblen, Pigou, Chamberlin, and Keynes tended to cast it into disrepute. In so doing, they extended, refined, and drew new implications from these theories in attempting to rebut the interventionist themes of the new economics. It is important that the contributions of Frank Knight, Henry Simons, and Milton Friedman be understood. We shall, therefore, describe some of the intellectual and empirical work associated with these counterrevolutionaries, who have attempted to see economic problems more from the standpoint of pure economic theory and less from that of the political process. The clash and conflicts between the new economists and the new neoclassicists constitute the subject matter of this study. As will probably become clear, whichever school of thought gains ascendancy in the calculable future will be decided as much by the force of its adherents' personalities as by the logic and elegance of their arguments.
It was Keynes who wrote the words about the "academic scribblers" which we have quoted on the frontispiece and which gave this book its title. In the final sentence of his magnum opus Keynes warned, "it is ideas, not vested interests, which are dangerous for good or evil." This book is about those academic scribblers who, for good or evil, are influencing the agitators, civil servants, and politicians who will shape economic events today and tomorrow.CHAPTER 2
The Intellectual Gantry of Neoclassical Economic Policy
The economist, like everyone else, must concern himself with the ultimate aims of man.
The policy conclusions dominating the reasoning of most economists during the first 40 years of the twentieth century followed from the logic of what is known as neoclassical economic thought. The date 1871 is used to mark the beginning of this way of thinking about economic problems. In that year two books appeared—one in England, one in Austria—which deviated sharply from the mainstream of classical economics. The Englishman was William Stanley Jevons and the Austrian was Carl Menger. Working independently, they simultaneously discovered (or "rediscovered") a way of thinking which subsequently came to be known as "marginalism." The basic logic of this approach gave to the analysis of political economy a degree of systematization unrivaled by the earlier classical writers. In so doing it marked the transition from "political economy" to "economics." The suffix "-ics" is significant, for it decisively arrayed economics along with such subjects as mathematics and physics, as having a rigor equal to the formal and physical sciences.
The Scope and Method of Neoclassical Economics
Neoclassical theory is distinguished from classical doctrine by significant changes in both scope and method. The shift in scope involved a redefinition of the economic problem; the methodological change was the introduction of marginal analysis.
The classical economists saw the economic problem as being essentially "dynamic." The measure of economic welfare to Adam Smith and his followers was the quantity of output. But output was a function of the quantity of labor available and its productivity. The question they presumed to answer was: How can the capital stock be augmented and markets widened so as to increase the productivity of labor, physical output, and, therefore, welfare? The neoclassical economists, on the other hand, conceived the economic problem as the attempt to get an optimal result by allocating a given quantity of scarce resources among competing uses. Scarcity became the central problem of economics. Jevons stated the problem as follows:
Given, a certain population, with various needs and powers of production, in possession of certain lands and other sources of material; required, the mode of employing their labour which will maximize the utility of the produce.
Thus, there was a marked shift from a concern over the dynamic problem of growth to a concern over the static problem of efficiency.
Perhaps the most striking feature of neoclassical economics is its concern with changes which involve a slight increase or decrease in the stock of anything under consideration. The meaning and significance of this technique were so well stated by one of the school's leading adherents, Philip H. Wicksteed, that it is worth quoting at length.
... The marginal service rendered to us by any commodity is that service which we should have to forego if the supply of the commodity in question were slightly contracted; our marginal desire for more of anything is measured by the significance of a slight increment added at the margin of our present store. And the importance of this service, or the urgency of this desire, depends ... on the quantity we already possess. If we possess, or have just consumed, so much of a thing that our desire for more is languid, then additions at the margin have little value to us; but if we possess, or have consumed so little that we are keenly desirous of more, then marginal additions have a high value for us.... Thus by increasing our supply of anything we reduce its marginal significance and lower the place of an extra unit on our scale of preferences; and suitable additions to our supply will bring it down to any value you please. Thus, whatever the price of any commodity that the housewife finds in the market may be, so long as its marginal significance to her is higher than that price, she will buy; but the very act of putting herself in possession of an increased stock reduces its marginal significance, and the more she buys the lower it becomes. The amount that brings it into coincidence with the market price is the amount she will buy.
The assumption that the utility of a good declined as its stock increased meant that the process described by Wicksteed was an equilibrating one. As the stock of a good changes, the value of additional units changes, thus creating a situation where the marginal value is just equal to the price.
This tool enabled the neoclassical writers to solve a problem which beset classical economic thought from Adam Smith onward, namely the paradox of value, or the "diamond-water paradox." Adam Smith had reasoned that since water has greater utility (that is, is more useful) than diamonds, and yet diamonds are more expensive than water, utility could not be a determinant of price. Marginal analysis made it blindingly clear that the key factor in the determination of price is the marginal significance of having slightly more or less of the item. Although the total utility of water is doubtlessly greater than the total utility of diamonds, the marginal utility of diamonds is very high (because the stock of diamonds is relatively low), while the marginal utility of water is low (because the stock of water is plentiful). In this fashion, the neoclassicists introduced the role of demand as an important determinant of price.
The Emergence of Economic Man:
The fact of scarcity creates a necessity for choice and a careful comparing of alternatives. Accordingly, a new view of human nature came into focus in the writings of neoclassical economists. The individual is imagined in a constant process of delicately balancing his marginal expenditures and marginal utilities. This rational, calculating human, who emerges most clearly in the pages of Menger's Grundsatze, also appears in most of the works of neoclassical writers, including Jevons, Pareto, and Wicksteed. The significance of the notion of the "economic man" is that it provided a rationale for the doctrine of consumer sovereignty. This concept implies that, as Adam Smith put it,
Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only in so far as it may be necessary for promoting that of the consumer.
Consumer sovereignty provided one of the cornerstones in supporting the laissez-faire policy prescription of neoclassicism. For, granted the maximization of utility as the problem, marginal calculations as the tool, and economic man as the actor, the state has little or no role to play. Standards are set by economizing consumers and scarce resources allocated so as to maximize welfare. The specific refinement made in the consumer demand criterion for production is in the concept of cost. Cost is ultimately determined by consumer evaluations. In considering how much of any commodity should be produced, the relevant question is whether it will cover the costs of production. Here again, the use of "margins" comes into play. An increase in the consumption of a commodity by a consumer represents an increase in his welfare or benefit. However, it involves a withdrawal of resources from the production of something else. This means a decrease in the benefit (and hence a cost) to the would-be consumers of the alternative commodity. As long as the benefit is greater than the cost, production of the item in question should be expanded, and where the cost is greater than the benefit, the production should be contracted. The appropriate output is reached where the additional benefit is precisely equal to the additional cost, or, as the economist says, where marginal benefit equals marginal cost. At this point, neither an expansion nor contraction of output can increase welfare. But what mechanism guarantees this felicitous result? The answer lies in the neoclassical doctrine of perfect competition.
The Doctrine of Perfect Competition
As in the case of the consumer demand criterion of welfare, the doctrine of perfect competition was already implicit in classical economics. But precision is the keynote of neoclassicism, and thus the doctrine was refined and elaborated. In its refined neoclassical form, there are three major conditions for perfect competition. These are worth listing formally:
1. Perfect Knowledge. This assures that in a given market at a given time, there will be only one price for identical commodities, and no scope for higgling.
2. Large Numbers. This assures that no producer or consumer has any appreciable effect on price so that both are price takers rather than price makers in all markets. (Hence, collusion among buyers and sellers is ruled out.)
3. Homogeneous Products. This assures that the products of an industry are perfectly substitutable for one another.
Granted the above mentioned conditions, it should be obvious that the competitive firm can sell any output it desires at the given market price. With even a slight increase in price, it would lose all its customers.
The doctrine of perfect competition is the required corollary of the doctrine of consumer sovereignty. This is true for two reasons. First, only under perfect competition is there a guarantee that the entrepreneur, in the quest for profit, will submit to the will of the consumer. Second, perfect competition assures ideal output, in the sense that marginal benefit is always equated with marginal cost. As we have seen, for the consumer the price of an item is the measure of the importance of an additional cost incurred in producing an extra unit of output. The rationality of the economizing consumer induces him to equate his marginal evaluation of the item to its price. But we can see that the conditions of competition will induce the producer to equate marginal cost to marginal revenue. Since marginal revenue is the addition to total revenue from selling one more unit of product, under perfect competition (where the firm is a price taker), it is also precisely equal to the price of the output. So the producer will expand as long as price is above marginal cost, since the excess of price above marginal cost represents the extra profit that can be made by producing more units. By similar logic, if marginal cost exceeds price, the entrepreneur will reduce output. Thus, the producer as an economic man is motivated, under perfectly competitive conditions, to equate price with marginal cost. With consumers and producers so motivated, the conditions of competition create an equilibrium where marginal costs always equal marginal benefits. From a social viewpoint, economic efficiency (or welfare) is then maximized. In short, freedom of choice and competition are the best instruments for promoting the welfare of society. But was there any guarantee that this solution would provide employment for all resources in the economy? This question was answered by Say's Law.
Excerpted from The Academic Scribblers by William Breit, Roger L. Ransom. Copyright © 1998 William Breit and Roger L. Ransom. Excerpted by permission of PRINCETON UNIVERSITY PRESS.
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