Arnold Kling

@arnoldkling

Overthrow Neoclassical Economics: my personal moonshot

My personal moonshot is that I wish to be a leader in overthrowing neoclassical economics. A better approach would focus on mental-cultural factors and rapid evolution.

As I see it, neoclassical economics is characterized by two essential propositions.

  1. Production is a process that employs two primary factors — labor and capital.
  2. The distribution of returns to labor and capital reflects their respective contributions to the production process.

There are many economists, particularly on the left, who reject (2) in favor of theories of distribution that stress the role of political power. This criticism may have merit. But my criticism is more fundamental than that. I reject (1) as a useful description of the contemporary economy.

The importance of cultural evolution

The actors in neoclassical economics are not affected by their individual beliefs or by their cultural influences. Instead, a firm is just a machine for transforming inputs into outputs. A consumer is just a machine that pursues the satisfaction of wants.

I insist that in order to understand economic behavior, you have to pay attention to what people believe. What they believe affects what they value, what they think constitutes a good investment, what conduct they believe is appropriate when buying and selling, how they interact in their work environment, and so on.

Furthermore, if we are going to pay attention to what people believe, we have to pay attention to their culture. People get most of their beliefs and habits by copying other people.

Once we concede that mental-cultural factors matter, then we must allow for rapid evolution. Humans are capable of transmitting to others what we learn, and as societies we are capable of accumulating new knowledge and habits. As a result, our behavior can and does evolve much more quickly than that of any other species on the planet.

From a historical perspective, cultural evolution is speeding up. That means that the economy gets exponentially more complex over time. This gives the economist a daunting task. Imagine how challenging botany would be if plant vegetation were evolving at the same speed as human culture!

Beyond “labor” and “capital”

Given this evolution, it cannot be appropriate to interpret economic phenomena in terms of “labor” and “capital.” Perhaps in the days of Karl Marx there was something to be said for this two-factor simplification. Perhaps there was still something to be said for it in the 1940s, when Paul Samuelson established the neoclassical approach as the dominant method for teaching and research in economics. But now it is long past time to jettison this overly simplistic two-factor approach.

We no longer have a mass of interchangeable workers that could be described as “labor.” We see instead a mind-boggling degree of specialization. Chances are, only a fraction of people in the world could do the job that requires your skills. By the same token, you could do only a tiny fraction of the jobs that are involved in providing you with the goods and services that you enjoy.

As workers, we differ in terms of training, experience, personality, social networks, and other characteristics. This variation, when combined with timing and chance, shapes how we work and how we are compensated over our lifetimes.

On the other side, “capital” does not fit the neoclassical model, either. The most important capital these days is intangible, including know-how, brand recognition, business strategy, organizational culture, and legally recognized intellectual property. See my story on Economic Classification Systems.

The neoclassical concept of productivity is outmoded

For neoclassical economists, the most important barometer of performance is labor productivity. But when “labor” and “capital” are not valid categories, then “labor productivity” is pretty close to a nonsensical number.

In practice, government statisticians add up the value of all goods and services produced, calling this number GDP. This is a dubious measure to begin with. Then they divided it by the total number of “hours worked,” ignoring the myriad differences in specialized skills of different workers, and they call this ratio of GDP to hours worked “productivity.”

Next, economists take this “productivity” at two points many years apart and draw a trend line, calling this “productivity growth.” Going one step further, they look for breaks in this trend line, and they call these breaks “changes in our economy’s growth rate.” This is nothing but nonsense piled on nonsense, piled on nonsense.

I understand that people want to have some measure that they can use to track economic performance. I attempted to suggest an alternative in my essay on measuring occupational satisfaction. But there may not be any measure that can keep pace with the rapid evolution of the economy.

What is certain is that the neoclassical approach of trying to interpret economic performance by computing “labor productivity” is utterly anachronistic. It is like measuring the fighting strength of an aircraft carrier by counting the number of cannons on board.

Conclusion

This is not your grandfather’s economy. Your grandfather was taught to think in terms of “labor” and “capital.” Instead, you need to think in terms of extreme specialization, intangible factors, and rapid evolution.

Further Reading

For a lengthier treatment of these issues, see my book Specialization and Trade: A Re-introduction to Economics.

For more on the role of Paul Samuelson in shaping neoclassical economics, see MIT and the Transformation of American Economics, edited by E. Roy Weintraub.

For the notion of a personal moonshot, I thank Tyler Cowen.

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