The Marginalists
The tension between the libertarian elegance of the self-regulating market and the conflict implied by the postulate that all value is produced by human labour would not do for those who would wish to make a Newtonian science of economics. The natural laws of the physical sciences at the time had no such conflict—only equilibria. No historical inquiry was required to predict the trajectory that an apple might choose in falling from a tree. The tendency of classical political economists to historically and socially situate their analyses and to shroud talk of the efficacy of the invisible hand with discussions of its failures could only distance economics from the status of pure science. Near the end of the nineteenth century, however, the marginalist movement managed to change the study of economics substantially. To Jevons, Walras, and later Marshall, this accomplishment represented a substantial move towards the perfection of the science of economics. It involved the permanent transformation of the historically situated social science that was classical political economy into the ahistorical mathematical pure science of neoclassical economics. In this transition, however, as much was lost as was gained. Among the gains were parsimony, elegance, and stature within the (social)scientific community. Among the losses were any engagement with the ideas of politics, culture, or development.
An important change that marked this revolution was made to the theory of value. Jevons (
1871/1882) adamantly opposed the “prevailing opinions” that “make labour rather than utility the origin of value” and asserted instead that “value depends entirely on utility” (I.2). For marginalists, there must exist, a priori, a human want, or there can be no value. Humans would engage in exchange in order to maximize their utility by satisfying pre-existing wants and, in doing so, would establish, through the laws of supply and demand, the market price for all goods (Walras
1892/1996). The trick here is that it is not the total utility gained through consumption that is important in determining whether an exchange will take place at a particular price—it is the utility gained from the consumption of the last amount of commodity exchanged (the “marginal” utility). Furthermore, the utility gained through consumption decreases as the same commodity is consumed successive times (the marginal utility is diminishing). I may be willing to pay $5 for a glass of milk if I am really thirsty, for example, but not so much for my second glass, and I may refuse to purchase the tenth glass even if it is offered for free. Notice that the value of the milk does not depend on how much labour was used in its production here—it changes depending on the utility the consumer can expect to gain.
There is a lower bound to this price, of course, and it is determined by the marginal cost of production—the cost of producing the last unit. The price of labour would be included in this, as would the price of capital and land, but it is not the process of production that is thought to be the determinant of value—rather, it is the price for which labourers, capitalists, and landowners are willing to exchange their services in a competitive market. Given that the marginalists assumed that exchanges were entered into by free individuals who simply calculated utility gained minus utility lost for any given action, it seemed fair to Marshall (
1890) to claim that “by far the greater number of events with which economics deals affect in about equal proportions all the different classes of society” (I.II.15). In a state of equilibrium (which is presumed to hold), all inputs are paid their proper price, and the proper price is presumed to be the equilibrium price. In this tautology, economics moved from being concerned with the study of the spheres of production and distribution with the aim of increasing national wealth, to being concerned only with the act of exchange which Walras (
1892/1996) claimed, “constitutes the very foundation of the whole edifice of economics” (p. 44). Economics, as a result, was depoliticized—since value was presumed not to be the result of labour exerted but the act of free exchange, tensions between labouring and capitalist classes over the product of labour were removed from economic theory. This move from intrinsic conflict to harmonious exchange precipitated the change in moniker from “classical political economy” to “neo-classical economics.”
Besides the depoliticization that resulted from the marginalist revolution, ideas related to culture were dropped as well. For either general (Walras
1892) or partial (Marshall
1890) equilibrium to hold, it was necessary to presume economic actors to have stable, unchanging preferences. As Jevons (
1871/1882) asserted, “anything which an individual is found to desire … must be assumed to possess for him utility,” and the impulse that drives the action of this individual is “to satisfy … wants to the utmost with the least effort” (III.2). The “utility” that each actor derives from his or her action, Walras (
1892/1996) claims, “remains
fixed for each party” (p. 117). This assumption of stable preferences precluded any idea of socially organized beliefs and values, unless these were presumed to be pre-formed and immutable. Thus, culture either did not exist, or existed outside of the purview of exchange, and therefore outside of the purview of economics.
Inquiries into wealth, development, or progress were set aside as well. At least since the publication of
The Wealth of Nations, political economy had been given the central goal examining the mysteries of national economic development. This goal became secondary after the neoclassical turn. Economics became the science of exchange, and equilibrium models presumed that free exchange in competitive markets was, by definition, efficient in that it would only occur if the end result increased the utilities of all involved. The efficiency of markets implied that the maximum possible utility would be attained in the aggregate, given the current state of technology. Questions regarding the causes of technological change were set aside. Wealth, then, was assumed to be maximized as the result of free exchange, and economists, as a result, had no need to be worried directly about the laws of its production (Heilbroner
1999, pp. 197–228; Hunt
2002, pp. 372–395).
The ejection of politics, culture, and development from the purview of economics was part of the neoclassical turn from a methodological holism to methodological individualism. The former had looked at the actions, motives, positions, incentives, and beliefs of groups of people in its analysis. Methodological individualism mixed with marginalism tended to deny the significance of groups and conflict between them and focus analysis on individuals who engaged in free and harmonious trade. Importantly, humans are assumed in this model not to communicate directly with other humans. Homo economicus can communicate only through prices. The type of non-price communication that might lead to the social development of understandings and values cannot exist in a neoclassical world, since it would imply changeable, negotiable utility functions. This would introduce a nonlinearity into equations, which would make it impossible to claim that markets function efficiently, and would make the application of linear calculus impossible as well.
Basing analysis on the marginal unit, and combining this with the assumption that economic action was conducted by rational, atomistic individuals with stable preferences, was methodologically expedient in that it allowed “the application of differential calculus” to the concepts of “utility, value, demand, supply, capital, interest, labour, and all of the other quantitative notions belonging to the daily operations of industry” (Jevons
1871/1882, I.4). This mathematization finally gave economics the look of Newtonian physics, as “the pure theory of economics or the theory of exchange and value in exchange” became, as Walras (
1892/1996) emphatically claims, “a physico-mathmatical science like mechanics or hydrodynamics” (p. 224). Such mathematical theory-building was to be the basis of a deductive, apolitical science of economics that focussed on the idea of efficiency at the expense of virtually all other concepts.
Despite the claims of the marginalists that theirs was an objective science rooted in laws of nature, neoclassical economics was endowed from the beginning with an ethical bias. Theory and mathematical exposition, as Walrus explained, was to come first in neoclassical methodology, followed by empirical observation which economists should use “not to confirm but to apply their conclusions” (qtd in Heilbroner
1999, p. 225). The assumption that economic life was rooted in the action of free individuals, then, was not to be questioned, but assumed, and historical or social data would not be permitted to show otherwise in analysis. This tended to lend itself to the scientific fortification of liberal ideals. Following in the libertarian tradition of Say and Mill, for example, Menger (
1871/1950) used neoclassical assumptions regarding human nature to make a case for the sanctity of private property:
Human economy and property have a joint economic origin since both have, as the ultimate reason for their existence, the fact that goods exist whose available quantities are smaller than the requirements of men. Property, therefore, like human economy, is not an arbitrary invention but rather the only practically possible solution of the problem that is, in the nature of things, imposed upon us by the disparity between requirements for, and the available quantities of, all economic goods. (p. 97)
Similarly, Walras (
1892/1996) touted the inevitability, naturalness, and optimality of equilibria established in free-market transaction, arguing that “any value in exchange, once established, partakes of the character of a natural phenomenon, natural in its origins, natural in its manifestations and natural in essence” (p. 69), and that “the equations we have developed do show freedom of production to the superior general rule” (p. 256). More precisely, Walras believed that his equations showed that “exchange of several commodities for one another in a market ruled by free competition is an operation by which all holders of one, several or all of the commodities exchanged can obtain the greatest possible satisfaction of their wants” (p. 173).
1
By depicting the economy as nothing more than a simple aggregate of rational, egoistic, autonomous individuals, by restricting the study of economics to the study of exchange, by jettisoning the labour theory of value for one based entirely on utility, and by formalizing their claims in mathematics (other than Menger), early neoclassical economists were able to add a strong discursive force to the argument for
liaises faire—one that did not have to be validated by, or situated in, a study of history. In fact, to do the latter would, according to the proponents of the new science, be purely inductive and therefore ascientific. As a result, pure neoclassical economics is ultimately conservative and avoids any questioning of this ethic, as Hunt (
2002) explains:
Neoclassical welfare economics accepts as the ultimate ethical criteria of social value the existing personal desires, generated by the institutions, values, and social processes of existing society, and weighted by the existing distributions of income, wealth and power. Thus the theory becomes incapable of asking questions about the nature of an ethically good society and the ethically good person that would be its product. (p. 396)
The Keynesian Challenge
A major revision of neoclassical economics did not occur until the mid-twentieth century, in the writings of John Maynard Keynes. Although the extent to which Keynes’ work represents a substantive challenge to neoclassical economics, as opposed to a mild revision, is debatable, Keynes did, at least in rhetoric, take issue with much of the core of neoclassicalism. For Keynes (
1936/2006), economics was a human science—a social science—and it followed that attempts to mimic the physical sciences were misguided:
The classical [and neoclassical] theorists resemble Euclidean geometers in a non-Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straight—as the only remedy for the unfortunate collisions which were occurring. (p. 15)
This was a direct reproach of the neoclassical insistence on deductive methodology. Contrary to this, Keynes chose to build his theory from empirical observation first—inductively. He set out primarily to explain the existence of the violent economic waves of high economic output and low that were business cycles—those which seemed arbitrarily to either call on the great populations of the Western countries to employ their industriousness nearly completely, or to cast them in the thousands on the streets as vagabonds (Deane
1978).
His methodological break with mainstream neoclassical economics, however, did not represent a substantial break with neoclassical technique. In his
General Theory (
1936/2006), Keynes maintained the important neoclassical convention that wages were equal to the marginal productivity of labour. This generally led to the assertion that there was no such thing as involuntary unemployment—just that there were many workers who would not agree to work unless they were paid at a rate higher than the value of the extra output their labour created. He explained the obvious existence of intra-war involuntary unemployment as the result, ironically, of affluence combined with diminishing propensity to consume relative to wealth. The wealthy, Keynes argued, simply did not consume enough output to justify the employment of the entire labour force—this would produce both a glut of goods and high unemployment. The remainder of wealth in the hands of the more affluent was generally saved since, in absence of effective demand, there was little opportunity to undertake in employment-inducing investment.
Other than this assertion, and his accompanying insistence that monetary policy can have an impact on the general output of an economy, Keynes adopted virtually every neoclassical principal in his General Theory. Importantly, this included the maintenance of the theoretical construct of homo economicus. He took, for example, “the tastes and habits of the consumer [and] the disutility of different intensities of labour” as “given” (p. 221). He also assumed that this creature was involved in calculations regarding how best to maximize his or her utility function—although restricted by an inability to accurately predict the future or know completely the nature of the current economic universe.
Changing the postulates that he did, however, yielded some important revisions in economic thought. The most important implication of Keynes’ work was that the economy was not self-correcting. The problem of unemployment and stagnation amidst glut could not work itself out, and would instead result in a permanent downward spiral in absence of substantial countervailing external shock or government intervention. Keynes, therefore, called for the extensive use of monetary policy coupled with substantial government spending that would be designed to replace the lost consumption that affluence had created. Abhorring communism and highly disrespectful of Marxism, Keynes believed this to be the only way of saving the capitalist system from self-induced collapse.
The need for intervention made it necessary for an evaluation of ends and means by policy analysts. This, for Keynes, meant that ethics were a necessary part of economic thought. He wrote in a letter to Harrod in 1938 that economics “is essentially a moral science and not a natural science.” He continued,
I mentioned before that it deals with introspection and with values. I might have added that it deals with motives, expectations, psychological uncertainties…. It is as though the fall of the apple to the ground depended on the apple’s motives on whether it is worthwhile falling to the ground, and whether the ground wanted the apple to fall, and on the mistaken calculations on the part of the apple as to how far it was from the centre of the earth. (Keynes
1994, pp. 297–300)
Whether this quotation represents an allusion to something resembling the idea of culture, is unclear. This is the case with the bulk of Keynes’ writing. In his earlier work (
1920), he alluded to the idea that propensities to save could be impacted by public policy, for example, but his
General Theory (
1936/2006) treats humans very much like neoclassical automatons. Humans do interact and communicate in Keynes’ depiction, but only with the inclination to guess the intentions of others in conditions of uncertainty based on incomplete information—the underlying tastes of economic actors remain stable, and they are therefore expected to react in more or less expected manner when government policy is exerted.
Although Keynes was emphatically not a Marxist, he did touch on the idea of ideology, which, as we will discuss, is central to the Marxian concept of culture. For Keynes, however, ideas, it seems, had impact by changing people’s conception of the way in which the world and economy work. This does not necessarily imply an ideological influence on the tastes, propensities, and attitudes of human actors, rather the power of ideas to influence perceptions (in conditions of imperfect information) regarding the complexities of economic life. Furthermore, Keynes (
1936) comes to different conclusions regarding the independence of these ideas from vested material interests compared with the Marxian conception:
The Ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. (p. 351)
The idea of
development exists only in seed form in Keynes’ work. Developmentalism—the idea that “less developed countries” could be reformed in the image of capitalist Europe via government intervention—would be strongly influenced by Keynes’ General Theory. He was instrumental in the founding of the Bretton Woods Institutions, including the World Bank—whose role it would become to oversee development projects in the Western-influenced post-WWII world (Martinussen
1997, p. 25). His General Theory, however, was more concerned with problems of unemployment and instability inherent in a capitalist system than with development per se
. Nonetheless, he did realize that these phenomena impacted the “growth of wealth” in economies and the general well-being of populations (
1936, p. 342).
The Austrian School
Another stream of economic though that is closely related to the neoclassical school should be discussed here, as it will influence post-WWII development theory substantially. This is the Austrian school of marginalist economics. It is not clear if this school should properly be thought of as a stream of marginalist economics that is to be distinguished from the neoclassical school of Walras, Jevons, Marshall, and Keynes, for example (de Soto
2008, pp. 2–4), or if Austrian economics is, in fact, neoclassical itself, and should be differentiated from the latter in terms of mainstream versus Austrian streams (Hunt
2002, pp. 264–276). If neoclassical economics is to be defined simply as a mode of analysis that uses marginal theory, assumes an actor with stable preferences, and tends towards the
laissez faire, then the Austrian school is neoclassical. If it insisted that neoclassical economics must engage in mathematical exposition based on static equilibrium models, then Austrian economics is not neoclassical.
From its inception with the early marginalist work of Menger (
1871/1950), the Austrian school has shunned mathematical exposition, since the latter is presumed to unsatisfactorily restrict the descriptive capabilities of the discipline. Other than this aversion to mathematics, three distinguishing features emerged through the evolution of Austrian thinking, via notable contributions from von Mises (
1949/1996), von Böhm-Bawerk (
1895), von Weiser (
1911/1994), Hayek (
1945), and Schumpeter (
1942/1976).
2 These three distinguishing features are based around the idea of the entrepreneur, the way in which information is understood, and the treatment of time. Unlike mainstream neoclassical economics, the human actor in the Austrian conception is not just a docile calculator who tends to choose the easiest of a number of choices in maximizing his or her utility. According to Austrian theorists, the economic actor is motivated by an innate desire to create and discover his or her own world—of which there is always imperfect information—in the pursuit of increased utility. As opposed to the reacting atom of homo economicus, then, the Austrians have conceived an active, adventurous economic agent: the entrepreneur.
Austrian economists depict this entrepreneur as an engine that propels the ever-changing, ever-advancing economic system through time. This characterization of human nature allows the Austrians, unlike mainstream neoclassical theorists, to explain technological change. Through his or her creativity and inquisitiveness, the Austrians argue, the entrepreneur discovers and creates new information in an economy where information about the world is dispersed and subjective. Discovered or created information is then transmitted through price signals which ripple through the economy as the action taken by an entrepreneur with new information impacts his or her valuation of particular goods, thus provoking price changes. The progressive change this inspires in the pricing scheme of an economy in effect reorders the economic system—changing the economic landscape for all entrepreneurs. This inspires others to change their actions and create or discover new information—inciting further change. This, unlike the static depiction of mainstream neoclassicism, is a story of an economy that is constantly changing, and never quite in equilibrium, as it advances through time.
This is also a story of development. And development has a clear hero: the entrepreneur—whose action should not be interfered with. Menger (
1871/1950) had insisted that the process of “development” begins with the entrepreneurial discovery of the division of labour, which “signifies a considerable step forward in economy and comfort” (p. 238). Schumpeter (
1942/1976) lauded the gales of “creative destruction” unleashed by the capitalist businesses, as new opportunities and information are continually discovered by entrepreneurs which provided temporary advantage—yielding profits—and continual change and improvement. Entrepreneurs, for the Austrians, can create such innovation because they are masters of knowledge regarding their particular situation. Much of this knowledge is tacit and virtually unknowable to others. The portion of his or her knowledge that is pertinent to others, however, is transmitted through market prices. Austrian economists claim that it would be ludicrous for any individual, government, or other agency to presume to be able to apprehend all information, since information is nearly infinite, is constantly being invented or changing, is subjective, and is dispersed. No agent, then, should be allowed to constrain the action of the entrepreneur or the functioning of the price system. To do so would be to stifle efficiency, suppress entrepreneurial energy, distort price information, and consequently retard progress—perhaps precipitating economic crises. This, combined with an entrenched fear of overly powerful government, led Hayek (
1944) to conclude that the strict economic controls and public works projects advocated by Keynes would lead countries down “the road to serfdom.” “Development,” for the Austrians, needs the entrepreneur, and regulation inhibits his or her heroic creativity, and misdirects his or her energy.
Culture is not a prevalent theme in Austrian thought. We are all entrepreneurs in this thinking. Some of us simply prefer current consumption to future discovery, or may not have the talent necessary to be successful. People have set interests, they,
tend to discover that which interests them and, hence, if they are free to accomplish their ends and promote their interests both of these [ends and interests] will act as incentives to motivate them in the exercise of entrepreneurship. (de Soto
2008, p. 24)
Culture has not crept in here to impact these interests. Insufficient information about the world has, as Menger (
1871/1950) argues, caused traditional peoples to misinterpret the “causal connection with the satisfaction of human needs” connected with certain objects and therefore to falsely value things such as “charms,” “divining rods,” and “love potions” (p. 53). But these are informational problems, not differences in cultural value systems. Traditional societies consist of individuals with specific interests just as do modern capitalistic ones. People’s preferences, it seems, remain stable for Austrian economists—it is the constellation of prices, information, and institutions that changes, resulting in different behaviours (Menger
1871/1950).