By MARCOS DE QUEIROZ GRILLO*
The neoclassicists, in their attempt to develop a precise analysis, rejected reality and obvious universal truths, clinging to fiction
Introduction
Economic science has been following history for decades. Many economists, who describe themselves as scientists, cannot reach basic agreements about almost anything regarding economic policies. Without a correct theory, assertive practice cannot be achieved. If there is no consensus on economic theory, how can effective economic policies be carried out?
From classical economics, they derived, on the one hand, the Ricardian Marxist economic theory and, on the other, the neoclassical economic theory. The latter completely dominated the economic debate until the publication, in 1936, of the General Theory, by John Maynard Keynes.
The fathers of neoclassical theory were the 18th century classical economists David Ricardo and Adam Smith. They created the foundations for rational laissez-faire, non-governmental intervention in the economy, free market economy, “full employment” and “equilibrium prices”, provided by the concept of the invisible hand of the market, with all economic agents acting rationally based on their own interests.
Keynesian theory questioned the concept of laissez-faire based on the understanding that the world is not governed from above, so that private and social interests always coincide. According to John Maynard Keynes, the concept of laissez-faire would have contributed to the advent of the 1929 recession, as the concept of long-term employment and price balance, advocated by the laissez-faire, was not only misleading, but also, very dangerous.
The crisis had causes in economic management, and did not occur by accident; and inaction in the face of current facts could be disastrous, since the long term is a misleading guide to the concrete reality of current affairs. At the end of the 20th century, monetarists, neoclassical Keynesians and Post-Keynesians were involved in an endless debate about the economy's biggest problems: employment, inflation and money.
The philosophical and axiomatic differences/similarities between the different schools are described here, emphasizing the importance of theory in the day-to-day practice of economic policy and raising warnings of the danger, for society, of mistaken theoretical concepts that permeate the application of economic policies misleading.
Neoclassical theory x Keynesian theory
John Maynard Keynes published his General Theory in 1936. Europe, unlike the USA, experienced from 1922 to 1936 an unemployment rate exceeding 10% per year. In the USA the same did not happen, and in 1929 unemployment was only 3%. However, from the end of 1929 to 1933 the American economy plummeted, with a drop in GDP per capita of 52% in the period. In 1933 unemployment was around 25%. All of this seemed to indicate the complete failure of the American dream and the neoclassical theory of balance itself.
Even so, with all this evidence, neoclassical economists argued that this was a temporary aberration in a free market economy and that high unemployment could not persist in the long term, with the market's tendency towards price rebalancing and full employment being certain. . According to them, to govern well, you must govern less. Economic interventions would only deteriorate the momentary situation of imbalance.
In the understanding of Adam Smith, in the book The Wealth of Nations, “each individual is continually seeking to discover the most advantageous use of their capital, an advantage for themselves and not for society. He seeks only his own gain, but he is led by an invisible hand that promotes an end that was not the individual's intention. He, in pursuit of his individual interest, ends up promoting the interest of society as a whole, more effectively than if he consciously wanted to do so.”
The neoclassical belief that the free market economy would inevitably generate full employment and prosperity is based on an “axiom” created by French economist Jean Baptiste Say that “products are always exchanged for products”. This concept was rephrased by the English economist James Mill as “supply creates its own demand”, which came to be known as Say's Law. Basically, things are produced (supply) that are placed on the market to earn income to buy other products on the market (demand).
In this sense, there would never be a depression because production creates enough income to buy everything that is produced. Likewise, unemployment could never exist since entrepreneurs, seeking profit, would always be able to find sufficient demand to sell the products produced by workers. In this view, goods are exchanged for goods. Money would just be a medium of exchange to facilitate transactions. Changes in the supply of money would not affect macroeconomic variables such as the level of employment and aggregate product, since money would be nothing more than a veil behind which the real economy would function.
Subsequently, this issue was reconceptualized, emphasizing the technical axiom of the neutrality of money, as it does not affect the employment and production of goods and services. In this sense, the increase in the amount of money in the economy would only affect prices, causing inflation, since there would be a lot of money trying to buy few goods and services.
John Maynard Keynes thought differently. In his work, he rejected the concept of neutrality of money and Say's Law, concepts in force without any questioning for more than a century. According to him, a system where money would not have any interference other than just being a means of exchange, theoretically, would be a real economy of exchange which, in practice, does not exist, since money has its own implications in the economy, affecting motivations. and short- and long-term decisions, which characterizes a monetary economy, in which peaks and valleys are peculiar, where the influence of money would not be neutral, but, on the contrary, could affect production.
John Maynard Keynes and the 1929 crisis
During the four years of the Hoover administration in the USA (1929-33) the American economy suffered a significant deterioration, despite the “certainty” of neoclassical economists who advised him that a free market system, without government interference, would return to equilibrium on its own. Producers discovered that anything they produced and put on the market would suffer price deflation causing them losses.
While people in the cities went hungry, nearby farmers used their produce to feed pigs. Unemployment increased and production continued to fall. Even so, President Hoover continued to follow his neoclassical advisors, believing that the best solution would be non-intervention in the economy, which, in the long term, would adjust itself.
In the 1932 elections, fear of socialist revolution and anarchism predominated. The people began to demonstrate, demanding urgent measures. Camped near the Potomac River in Washington, the Hoovervilles, as they were known, many of whom were veterans of the 1st. World War, were violently repressed by General Douglas MacArthur, who forcibly dispersed them.
In 1933, with the election of Franklin Delano Roosevelt Jr., the “New Deal”, which was nothing more than a set of legislative measures of compensatory policies. He knew that if he did not take urgent action, the American capitalist system itself would be at risk. Roosevelt discarded the neoclassicists and called upon young men he defined as his “brain trust”, including economist Rexford Tugwell and lawyer Adolf A.Berle, who implemented some Keynesian ideas to stimulate the economy.
Employment was stimulated with the aim of generating income. It went from 39 million in 1933 to 51 million in 1941. Per capita income grew 70% in this period. Roosevelt was re-elected with a bang, in 1940, for an unusual third term. The American people were convinced of the success of New Deal and the new Keynesian political economy.
The main measure was the increase in workers’ income (known as “pump priming”), which would encourage entrepreneurs to return to production, feeding back into the creation of new jobs. It was, therefore, a matter of prioritizing pumping the heart of the economy through the creation of jobs, which worked.
Post-Keynesians and neoclassical Keynesians
Post-Keynesian logic continued to deny the most important neoclassical assertion of the neutrality of money and, as a consequence, the false conclusion that a free market economy, in the long term, would always ensure full employment for those who want to work.
Even so, neoclassical economics remained standing. This is because young American economists, winners of Nobel Prizes, such as Paul Samuelson, from MIT, James Tobin, from Yale University, as well as others such as Hicks, Debreu and Arrow, with mastery of neoclassical theory and very keen on the formalism and rigor of mathematical models , broke away from the orthodoxy of traditional neoclassical economists (Wilfredo Pareto, Leon Walras, James Mill, among others), and sought to amalgamate neoclassical theoretical analysis with Keynesian policies of government incentives for employment, aggregate investment and treatment of price levels in the economy, developing an analytical structure, strongly based on complex mathematical symbolism, which they called the neoclassical Synthesis of Keynesianism.
Basically, they reduced Keynesian theory to a manual for curing short-term imbalances in the economic system that, in the long term, would continue to self-regulate. According to them, short-term policies were only necessary due to the delay in correcting imbalances by the market itself, requiring small doses of Keynesian remedies.
Thus, in the post-war period, Keynesianism focused on macroeconomic aggregates and neoclassical principles continued to dominate the microeconomics of economic agents. However, in the 1970s, the theoretical foundations of neoclassical economics expanded their domains, expanding from microeconomic theory (the theory of consumer and producer behavior) to macroeconomics (the study of the behavior of economic systems). This was possible due to the firm intention of many of the renowned neoclassical economists to transform economics into an exact science, seeking to differentiate it from sociology and political science.
The neoclassical model gained a new look with the article by English economist John Hicks, from 1937, called “Mr.Keynes and the Classics” which consisted of an attempt at a neoclassical synthesis of Keynesianism, with its famous IS-LM System, intending to summarize the four basic pillars of Keynesian theory: I for Investment, S for savings, L for the demand for liquidity and M for the supply of coin. According to Hicks, his IS-LM system of simultaneous equations provided the mathematical framework for the integration of Keynesian theory with the mathematical modeling of neoclassical economics, known as the General Equilibrium Theory, or also, Walrasian Equilibrium Analysis, as he was the French economist Leon Walras (1834-1910) who developed the first mathematical version of neoclassical theory. Sir Hicks later won the 1972 Nobel Prize.
The IS-LM system has become a “universal truth” for most American economists, leading Duke University professor Martin Bronfenbrenner to baptize it as the ISLAMic religion of economists. Universities incorporated the writings of neoclassical Keynesians into their literature, advising their students against heavy and tedious reading of General Theory by Keynes. Instead, they should delve deeper into the Hickisian IS-LM system, which contained all of Keynes's important ideas.
Hicks himself later converted to Keynesianism, stating that he was not satisfied with the premises of his model, as it violated the order in which events occurred in the real world.
Neoclassical economist James Tobin, Nobel Prize winner in Economics, comments: “in the modern version of neoclassical theory, where would the Invisible Hand be?” According to him, the good news is that the intuition of Adam Smith and his followers can be rigorously formulated and proven mathematically; The bad news is that the theorem depends on special conditions and premises, which are difficult to prove nowadays.
As for the principle of neutrality of money, James Tobin recognizes it as fallacious, simply paying attention to the monetary policy of expanding or shrinking the supply of money, so commonly applied in today's economy. But, as he himself says, the General equilibrium theory has been the biggest challenge for the most prepared professionals in economics. Elegant, rigorous, mathematically powerful, the theory goes far, differentiating itself from other social sciences and enchanting everyone, much more because of the challenges than because of its ability to solve real-world puzzles and problems. And he concludes: therefore, “the recognized unrealism of its premises is beside the point”.
For their part, the English Keynesians, including Sir Roy Harrod, from Oxford University, Joan Robinson, Lord Richard Kahn and Lord Nicholas Kaldor, from Cambridge, observed that the Keynesian revolution reached both the theoretical plane and economic policies. They warned that the General Theory by Keynes showed the importance of monetary and financial institutions in the functioning of the real economy, where money is a necessary aspect of an economy in which the future is uncertain.
These and many other Keynesian teachings were forgotten, with the return of the predominance of economic orthodoxy. In this sense, Joan Robinson accused the IS-LM System of bastard Keynesianism, as they distorted Keynes' teachings by accepting government policies only for specific interventions to alleviate short-term imbalances in employment and income. Subsequently, true Keynesianism was revived in the USA by the economist Sidney Weintraub of the University of Pennsylvania and his student Paul Davidson.
However, the vast majority of economists have embraced neoclassical economics, especially in periods of performance satisfactory economy. Only in periods of economic crisis did a few economists return to Keynesian principles. With the advent of inflation in the 1960s and then with its acceleration in the 1970s, three lines of thought were characterized: post-Keynesian, neoclassical Keynesian and the purer and less hybrid neoclassical thought, known as monetarism, led by Keynes's contemporary, Frederick Von Hayek and his successor Milton Friedman.
Nowadays, the debate still continues, with comings and goings on public economic policies. In the real economy, macroeconomic equilibrium remains vulnerable to many types of factors. Stagflation, which still continues without an adequate explanation, brought the monetarists into the picture.
But one thing is certain. Wages and prices do not have the flexibility required by neoclassical mathematical models. The preference for liquidity, which occurred in the 1930 crisis, was and is a relevant fact, and monetary and fiscal stimuli, in the old Keynesian style, are the order of the day around the world. And this is not to mention the complete proof of the failure of the quantitative theory of money, after the 2008 crisis.
Predictable or uncertain future?
Most economists recognize that all theories are abstractions and therefore simplifications of reality. The purpose of theories is to seek to make the real world understandable, and not to replace the real world with an ideal and simplified world, just to be able to treat it mathematically. Milton Friedman, author of Positive Economy Methodology doesn't seem to agree with that. According to him, the relevant question to ask about the premises of a theory is not whether they are realistic, because they never are; but rather it is whether they are good enough approximations of the object in question.
This question can only be answered by proving whether the theory works, by producing sufficiently accurate predictions of the future. For Friedman and his followers, the acceptance, without question, of the axioms and simplifications is a basic condition for the construction of any economic theory of utility. The only test is whether the model makes good predictions about future events. And yet, according to him, studies carried out on changes in the quantities of money, in the long term, would have a negligible effect on income; therefore, only non-monetary variables would be important for real income, which would prove the hypothesis of the neutrality of money on the product.
Milton Friedman did not define and measure what would be the long term in his model, leaving unclear the volume of evidence that would have to be collected to prove the hypothesis of the neutrality of money in the economy.
Neoclassical economists argue that if economics is a science comparable to astronomy (or physics), it must also be subject to immutable rules or laws, and therefore its future position can be predicted. The basic assumption is that the future of the economy would already be predetermined by the condition that existed in the first moment. It is as if the deterministic principle of economics existed in economics. Big Bang of creation of existence, where the position of the initial instant determines the position of any star or planet in the future. By analogy, taking into account people's rational expectations, it would also be possible to anticipate the future of the economy.
The English mathematician Alan Turing demonstrated that if nature always behaves according to immutable mathematical rules and laws, then the future can be predicted using the TURING machine, a hypothetical apparatus that works for any mathematical calculation under fixed premises and conditions. Neoclassicists argue that they have discovered and developed a complete set of unique and immutable economic laws and that therefore economic research can and should engage in Turing-like analysis and prediction.
Several theories were developed, all based on the same basic principles, such as the neutrality of money, among others: Walrasian general equilibrium, Arrow-Debrew Systems, rational expectations theory, neoclassical synthesis of Keynesianism, monetarism or chaos theory. As Robert Lucas and Thomas Sargent define, neoclassical theory deals with models that build statistical inferences about future behavior based on past time series. The belief in the possibility of a non-experimental empirical economy provides the basis for such inferences, which allow the construction of a decision-making model that can be confronted with various scenarios and produce answers for each one.
This conceptualization can be understood as Darwinian, where only those who, having correct intuitions, would have built their decision-making models based on rational expectations. Here, businesspeople would make decisions like robots using mathematical models based on behavioral assumptions and past historical series.
For Keynes, on the contrary, economics is essentially a social science and not a natural science. The belief in the possibility of predicting future economic conditions as in statistical laws of probability underestimates the role and importance of human error and ignorance about the future. In fact, what must be emphasized is the institutional and historical evolution of economic development.
For Keynesians, there are no immutable quantitative relationships and correlations that allow accurate predictions about the future. The time lapse between the decision and the result is a fact of fundamental importance. The time lag between the decision to produce and the actual availability of the product can be weeks, months or even years. The time elapsed between the acquisition of a capital or durable consumer good and its subsequent effect producing profit or satisfaction is commonly measured in years, not to say decades.
Economic events are asymmetric; Verification of past events cannot ensure their repetition in the future, which is created by human action and is not determined by any immutable economic law, much less being capable of being calculated by any TURING machine. Here, businesspeople live in an economic scenario of uncertainty about the future, without reliable models to determine the risks of success or failure of their ventures. Investment projects create employment and, consequently, income, or demand, for the acquisition of products from the company itself and from other industries. According to Keynes, the entrepreneurial spirit, which is characterized by the decision to invest in the long term in an environment of uncertainty, is the indispensable condition for prosperity in a monetary economy.
When investment declines, the economy deteriorates, workers lose jobs, businesses close, and production declines. Thus, for Keynes, understanding the economic cycles of growth and depression is closely linked to the factors that lead businesspeople to invest or, alternatively, postpone their investment decisions, preferring liquidity, which has to do with optimism or pessimism. of businesspeople. According to Keynes, the more or less bold stance of businesspeople derives from emotion and business culture, which he calls “animal spirits”, and not from mathematical modeling based on weighted averages of results multiplied by the respective quantitative probabilities of occurrence.
Fears of losses and expectations of profits may alternate, with no real basis for mitigating them through mathematical calculations. Therefore, investors are not TURING machines. Investment decisions are made based on animal spirits, knowing that there are no formulas to mitigate uncertainties about results that will only occur in the future. Investors' expectations are given in an environment of future uncertainty. In this context, they can be cautious, waiting, with a clear preference for liquidity; or bold, following their intuitions, in choosing productive investments, both not necessarily fully rational.
John Hicks, already in his final phase of recognizing Keynesian theory, says that economics differs from natural sciences since, in economics, unlike those, one cannot be sure that an event or correlation existing in the past will remain in the future . According to him, economics is on the frontiers of science and history.
This understanding reinforces the need to study the evolution over time of economic institutions and processes for the effective establishment of policies.
Neoclassical Keynesians tried to pacify the conceptual impasse between neoclassicals and Keynesians, by accepting Keynesian criticisms of the equilibrium model and recognizing the possibility of imbalances in the short term, with the economy's self-adjusting return to equilibrium in the long term. But this is far from acceptable to Keynesians.
In fact, for neoclassicists, Keynesian theory does not replace neoclassical theory. For Keynesians, neoclassical theory is based on inapplicable axioms and is not capable of solving real-world problems. But the unbeatable Keynesian maxim that there is no point in waiting for the invisible hand to bring the economy back to balance in the long term remains valid, because by then, “we will all be dead”.
Let it be clear that the neoclassicists, in their attempt to develop a precise analysis, rejected reality and obvious universal truths, clinging to fiction, due to the weakness of the premises used, torturing mathematical models to “achieve” the results by they desired.
*Marcos de Queiroz Grillo He is an economist and has a master's degree in administration from UFRJ.
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