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Why Neoclassical Economics
Explains Nothing At All1
Steve
Fleetwood (Lancaster
University, UK)
© Copyright 2002 Steve
Fleetwood
Introduction
Critical realists (c.f. Lawson 1998; Fleetwood 1999a&b,
2001a&b) argue that neoclassical economics is rooted in the deductivist method.2 Deductivism seeks to 'explain' something by
deducing or predicting a statement about that something from a set of initial
conditions, assumptions, axioms and a covering law and/or some other form of
constant conjunction of events which drives the inferential machinery. These
conjunctions, where for every event y there exists a set of events x1,
x2...xn such that y and x1,
x2...xn are regularly
conjoined, only occur in, and are constitutive of, closed systems. There
are, however, very few spontaneously occurring closed systems in the natural
world, and virtually no non-trivial ones in the socio-economic world. Using deductivism, therefore, means engineering artificially closed systems by means of known
falsehoods, reducing neoclassical economics to what Hodgson (1999: 11) calls ‘the
economics of nowhere’. What is not always
appreciated, however, is that the presence of known falsehoods removes all explanatory power from
neoclassical economics.
This paper illustrates the point via a brief analysis of the theory of labour
demand.
Closed system theorising: the example of the theory of labour demand
The law of labour demand, which states that the quantity of labour demanded
varies indirectly with the (real) wage, is an example of one kind of constant
conjunction of events - a Humean law. Incidentally,
the significance of this apparently arcane law should not be underestimated:
it underpins the entire neo-liberal project of making labour markets more
flexible. This constant conjunction is artificially engineered via (at least)
four assumptions known as the Marshall-Hicks conditions. Demand for labour is
alleged to be more elastic if:
1.
The elasticity of substitution
between labour and capital is high. The demand for labour will be more
responsive to a change in wages the more easily labour can be substituted for
capital.
2.
The elasticity of demand for the
final product is low. The demand for labour will be more responsive to a
change in wages if the cost increases caused by wage increases can be passed
directly to the consumer without a loss of revenue.
3.
The share of wages in the total
cost of production is high. The demand for labour will be more responsive
to a change in wages if production is labour intensive because ages constitutes a relatively high proportion of
overall costs.
4.
The elasticity of supply of
other factors is high. The demand for labour will be more responsive to a
change in wages if, when capital is substituted for labour, the suppliers of
this additional capital are able to increase their supply immediately and
effortlessly.
The M-H conditions close the system: without them there would be no constant
conjunctions between changes in labour demand and changes in the wage.
Unfortunately, however, the M-H conditions also introduce known
fictions into the theory. Let us consider the four M-H conditions as four closure
conditions.
Intrinsic closure conditions (ICC)
To close the system, the internal state of individuals must be
artificially engineered so that the individual (person, production system,
firm or whatever) always responds
in the same predictable way. The ICC is maintained,
for example, by assuming ubiquitous substitution between labour and capital.3
Where production involves a relatively fixed crew of workers operating a
relatively fixed set of machinery it is often impossible to substitute a
worker for a machine. Where production requires human emotion such as a
helpful attitude, a machine cannot be substituted for a human. In some cases
substitution of labour for capital is not feasible: how does one substitute a
machine for a nurse to carefully bath an elderly patient? Even where is it
technically possible, substitution is often not socio-politically possible.
If, however, the ubiquity of substitutability is not assumed, a change
in relative factor prices cannot be said to cause the substitution of labour
for capital, and the constant conjunctions of events that constitute the law
of labour demand fail to emerge. Assuming ubiquitous substitution is a
falsehood. Where non-substitutability is recognised it is
treated as a special case. Knowingly false claims are, thereby, treated as
the norm, and knowingly true claims (e.g.
that firms may offset a legislated wage rise by introducing flexible working
practices that raise efficiency and reduce costs) are relegated to an
afterthought.
The extrinsic closure condition (ECC)
The ECC ensures that the system is
completely isolated from any external
influences that would violate closure. This occurs by assuming things like:
(a) the suppliers of other factors of production can increase their supply
immediately and effortlessly should need arise, which is unrealistic,
especially when the economy is running near to capacity; and (b) the
elasticity of demand for the final product is low so that firms can pass wage
increases onto customers, which is a rather tenuous assumption in highly
competitive global markets. Maintaining the ECC,
then, often requires falsehoods.
The aggregational closure condition (ACC)
The ACC ensures that the response
remains constant, irrespective of the level of aggregation. Hence, the need
to assume that the share of wages is high no matter what the industry. If for
example, the industry was, or became, highly capital intensive, an increase
in wages might be lost in the overall costs and demand for labour might not
fall following a wage increase. In capital-intensive industries, then, the
ACC is a falsehood.
The reducibility closure (sub) condition (RCsC)
The RCsC requires the existence of assumptions
whose sole purpose is to ensure mathematical tractability. These are
merely technical assumptions used to ensure the relevant functions are well
behaved, thereby preventing perverse outcomes. Even where substitution of
capital for labour is possible, it is often not continuous or ‘smooth’ but
‘lumpy’. Production functions would have ‘lumps’ in them and could not be
differentiated.
If any of these four closure conditions are not met (and there are, of
course, more ways of meeting them than mentioned here) constant conjunctions
will not emerge. Incidentally, that
there are four M-H and four closure conditions is merely
coincidence. Moreover closure requires far more than the M-H conditions: the
latter are merely those explicitly mentioned in the theory. Other assumptions
lie buried within the ceteris paribus
clause; are attached to sub-components of the theory, such as diminishing
marginal returns; or are made by omission.
Neoclassical economists know perfectly well that they are using
falsehoods (hence the reference to known falsehoods) but often ignore
the causes and consequences of constraints on their freedom to
choose the M-H conditions, or assumptions in general. They cannot
choose assumptions on the grounds of their truth-likeness because the need to
maintain systemic closure often overrides these (and other) considerations –
such as descriptive adequacy. Faced with a decision between adopting an
assumption that is known to be false
yet closes the system, and one that is known to be true yet violates closure,
the known falsehood must be chosen or the constant conjunctions will
not emerge.
Removal of explanatory power
A damaging consequence of adopting known
falsehoods is that their presence removes explanatory power, for (at least)
three reasons - on explanation see Runde (1998).
Explanation is not merely
efficient causality
Many critical realists share with Lipton
(1993; 33) the thesis that to ‘explain a
phenomenon is to give information on the phenomenon’s causal history’. The
causal history of a phenomena is not merely (if at all) one couched in terms
of the event(s) that precede the phenomena, but in terms of the underlying causal mechanisms. One does not, for
example, adequately explain (the event of) a lamp becoming illuminated simply
by pointing to the (event of) flicking of the switch that preceded it. One
does not adequately explain an increase in the demand for labour by pointing
to the fall in wages that (allegedly) preceded it. Yet this form of
‘explanation’ is all deductivism offers. The
overriding necessity of closure requires the removal (theoretically of
course) of all causal mechanisms that might violate the closure conditions.
So, for example, the theory of labour demand omits reference to trade
unions, the introduction or abolition of labour laws and responses to them,
government policy, political ideology, management systems, different working
practices and so on, mechanisms that have considerable causal impact on
labour demand. But here is the rub: once
removed from the theory these causal mechanisms cannot subsequently be
recalled and offered as part of the causal explanation. Relevant causal
mechanisms are either included in the theory, in which case they can
contribute to the causal explanation, or they are excluded, in which case
they cannot.
Explanation is not prediction
Prediction does not constitute explanation. The conflation of
prediction and explanation is
referred to as the ‘symmetry thesis’ whereby the only difference between
explanation and prediction relates to the direction of time (Caldwell 1991;
54). Explanation entails the deduction of an event after it has (or is known
to have) occurred. Prediction entails the deduction of an event prior to
(knowledge of) its occurrence. One can, however, predict without explaining anything at all. One can predict the onset of
measles following the emergence of Koplic spots,
but the latter does not explain measles. Even supposing an econometric model
successfully predicted an event (and the predictive power of neoclassical
economics is arguably weak), the regression might be grounded in no economic
theory whatsoever, or be grounded in a theory that contains known falsehoods.
In this case, even a successful prediction would not constitute an
explanation.
Explanation does not allow known falsehoods
If, as part of a causal account, one
includes a known falsehood, or,
leaves out some important causal mechanism (falsehood by omission) then the
‘explanation’ can immediately be rejected as a bone fide explanation
by pointing to this falsehood. Consider an
analogy. In explaining how my rubbish bags get ripped during the night, I
might hypothesise that it is the work of a fox or I might hypothesise that it
is the work of a ghost. The explanation involving the fox is advanced because
I believe it to be true. The ‘explanation’ involving the ghost is known
to be false but is advanced for a pragmatic reason: I want to frighten my
young nephew and stop him playing with the bin bags. Whilst the explanation
involving the fox is valid (even if it turns out to be mistaken) the
‘explanation’ involving the ghost, pragmatically useful as it is, is invalid
because it is known to be a falsehood. One only has to reflect upon
this for a moment to see this conclusion is self-evidently correct: if known
falsehoods are allowed to constitute ‘explanations’ imagine the bizarre
explanations that could be advanced!
Counter arguments considered
Two
counter-arguments are commonly deployed to legitimise the use of known
falsehoods. The first runs as follows: ‘all theory has to leave out the
inessential, has to abstract from reality, has to make unrealistic
assumptions, so all theory is inevitably false in the strict sense of the
word’. Now whilst abstraction is legitimate, the process is complex and
cannot be elaborated upon here (c.f. Sayer
1998). I defend my claim with the following observation. Theories like that
of labour demand are replete with such obvious falsehoods that to suggest
they are really (legitimate) abstractions is merely a rhetorical ploy to
avoid methodological discussion. In any case, as noted above most
neoclassical economists admit to knowingly using falsehoods. The
second counter-argument invokes the ‘method of successive approximation’ (Sweezy 1968; 11) or the ‘method of isolation’ (Maki 1992,
but see Pratten 1999), and runs as follows. ‘The
initial stages of theorisation use known falsehoods. Explanatory power is
added in stages as realistic assumptions are successively substituted for
false ones’. There are two objections to this.
- The method
of successive approximation or isolation might be appropriate
when the successive analytical steps merely involve the mechanical addition of factors
that were previously assumed away. This mechanical addition is, however,
not appropriate for systems where the elements possess emergent
properties. When, for example new technology is introduced to a
workplace or a new management regime is installed, its behaviour often
evolves, giving rise to properties that were not present before. Many
theoretical propositions derived on the basis of pre-emergent properties
provide no grounds for the analysis of post-emergent forms of behaviour.
- Theory is still reliant on closed systems. All that has happened
is that one closed system has been added to another (slightly larger)
closed system. A succession of closed systems does not, however, add up
to an open system. Consider the following example:
·
Closed system1 assumes demand for
labour is determined solely by wages.
·
Closed system1 generates the
deduction/prediction1 that the introduction of a minimum wage will
cause a fall in labour demand.
·
losed system2
now allows labour demand to be determined by wages and (say) aggregate
demand.
·
System2 is, however, still a closed
system: it just contains more variables. Many of the previous (false) assumptions
remain in place and, new (false) ones are added to ensure closure in this
more complex system. Falsehood is then piled upon falsehood – and the dream
of one day removing all false assumptions evaporates.
The
method of successive approximations, or successive closures might, therefore,
be more accurately termed the ‘method of successive falsehoods’ or the
‘method of successive closed systems’. In short, the counter-arguments do not
evade the critical realist critique.
Conclusion
To the extent that neoclassical economic theory is rooted in the deductivist method, constant conjunctions of events,
artificially closed systems and known falsehoods, it explains nothing at all.
Notes
1. I
wish to thank Paul Lewis for his careful comments.
2. Deductivism is also found in some heterodox
(Austrian, Institutionalist, Marxist and
Post-Keynesian) economics whereupon these perspectives also become vulnerable
to the following critique.
3. Neoclassical theorists do, of course, recognise that substitution between
labour and capital is not ubiquitous and attempt to deal with it via
non-convex isoquants. ‘L’ shaped isoquants imply only one production technique based upon
one capital-labour combination and allow no substitution. Isoquants
with n ‘flat’ sections imply n-1 production techniques and allow limited
substitution. But, where tangency between the isocost
curve and the isoquants is at a corner, factor
prices could change without ‘causing’ substitution. Where tangency occurs
along the face of one of the ‘flat’ sections of the isoquant,
then the choice of technique becomes indeterminate.
References
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Lipton P.
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Fleetwood S. (1999a) ‘The
Inadequacy of Neoclassical Theories of Trade Unions, Labour Vol.13, No.2, pp 445-80.
----- (1999b ed.) Critical Realism in Economics: Development and Debate, (1999) Routledge.
----- (2001a) ‘Causal Laws,
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(ed) Intelligibility in Science IV, Rodophi.
Pratten S. (1999) ‘The “Closure” Assumption as a First
Step’, in S. Fleetwood (ed) Critical
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Runde J. (1998) ‘Assessing Causal Economic
Explanations’, Oxford Economic Papers No.
50, pp 151-172
Sayer A. (1998) ‘Abstraction: A Realist
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T. Lawson, A. Norrie, (eds)
Critical Realism: Essential
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Sweezy P. (1968) Theory Of Capitalist Development, Modern Reader.
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SUGGESTED CITATION:
Steve Fleetwood, "Why Neoclassical Economics Explains Nothing
At ”, post-autistic economics review,
issue no. 17, December 4, 2002, article 2. http://www.paecon.net/PAEReview/issue17/Fleetwood17.htm
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