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Some thoughts on economics

from Peter Radford

My instinctive entry point into economics is through business. What is called the “Theory of the Firm” plays a key role in shaping what I see, think, and try to explain. Business, of course, gets frequent mention throughout economics, with most varieties of general theory claiming to place it somewhere inside the theoretical constructs. But pick up almost any textbook and the treatment of business is at best a weak caricature and at worst a laughable display of ignorance. Economics as it exists today in its mainstream form is of no use whatever to anyone seeking to understand the reality of business. Our extant theories of the firm are failures in that they attempt to see the world through a neoclassical lens whilst that lens obscures anything remotely real from view in an effort to retain the equilibrating perfection of the closed system envisaged by Walras. The contradiction between the pursuit of equilibrium explanations and the open ended nature of the real world defeats neoclassicism at the starting gate and dooms it to subsequent nonsensical irrelevance.

But it must mean something to someone since it is still, despite its evident silliness, the most preferred theory within the profession.

In this context I have to attribute a great honor to the Arrow-Debreu effort to complete the Walrasian episode. Arrow-Debreu deserves our constant indebtedness. It shows, definitively, how the Walrasian tradition cannot be an explanation for a real economy. It achieves completion by imposing such horrendously, and obviously, unreal constraints on itself that it proves Walras wrong. It is thus great science. It is the falsification of a tradition shown to be worthless.

On another matter: mainstream economists have never adequately, in my opinion, responded to Coase’s challenge of 1937. He asked simply: if markets do what classical economists and their followers say they do, why do firms exist? They ought not. That they do suggests something is very wrong at the heart of orthodox thinking. So I add the ‘Coase conundrum’ to Arrow-Debreu as adding weight to the critique. Mainstream economics is alchemy.

I am aware of the post-Coase tradition of ‘transaction costs’. Williamson represents the clearest version of this tradition. He seems, though, to be more concerned in not upending neoclassical thought than in explaining why firms exist. Asset specificity, cheating, agency issues and the like are nice ideas. Important ones. But they sit ill at ease within a theoretical world where everything is neatly defined and all information equally available. Such things cannot exist in the weightless world of neoclassical thought. So all Williamson and his ilk have done is to redefine the Coase conundrum. Instead of the original ‘why do firms exist’ we now have ‘why do transaction costs exist’. Nothing fundamental has been explained.

Then there is the problematic relationship of economics with information. References to information abound. Reputations have been made discussing it or its absence. Asymmetrical information is another challenge to orthodoxy that is too often ignored. Information about things is patchy in the real world. Very patchy. It is non-existent with regard to the medium and long term future. Yet this never deters the neoclassical theorists. They march along as if asymmetry was an inconvenience that can be assumed away for simplicity’s sake, rather than a dagger in the heart of their work.

Uncertainty and complexity characterize the real world. Certainty and simplicity characterize neoclassical economics. Hence it irrelevance. It is complicated though, as Arrow-Debreu shows. It has to be. Its epicycles weigh it down. But no amount of clever formalism can turn unreality into reality, just as lead is pretty tough to turn into gold. This doesn’t mean that neoclassical economist aren’t very bright. They are. They have to be to to tend to those epicycles. Newton, after all, spent more time on alchemy than on recognizable physics. No indeed, they are very bright. Just wrong.

There are, of course, other forms of economics. I find particular relevance in anything that considers evolution as a guideline. The economy seems to act in a very Darwinian way: variation, inheritance, and selection help explain the apparent paradox of both persistence and change within the same system.

Then again, learning seems paramount. Perhaps the economy is a giant learning device in the mode of Popper. Trial and error. Falsification of hypotheses. The adoption of successful routines, and then their replication, is exactly what goes inside business. Firms then can be viewed as search engines exploring the space of possible combinations of ideas. They grope around on the edge of our knowledge looking for new things to combine, and whenever they succeed they expand that space of the possible. They move our boundary deeper into the infinite. In this view growth is limitless, constrained not by resources, but by our imagination and thus our ability to make and do more with less. It is an optimistic rejection of Malthusian and neo-Malthusian gloom. Although Malthus was onto something. He saw dynamics and change. He had processes in mind. So I am with Keynes and his disappointment that economics followed Ricardo and not Malthus.

This thought leads me to another: firms covet information. They actively prevent its spread. They use all sorts of institutional methods to prevent information leaking out beyond their borders. Economics thus has to be institutional in some way, as Veblen well knew. Firms rely on them.

Control of its boundaries is critical to a firm. Information beyond its borders cannot accrue profit. Only information within its boundaries can add value. Setting those boundaries correctly is a major task of management. Insourcing versus outsourcing is the common parlance. Understanding the boundaries and calibrating against the market is what goes on.

But is this correct?

What do firms do with the knowledge they acquire?

They in-form. By this I mean they impose order. They tease order from prior disorder. And by so doing create value. For it is order that we seek. Ordered resources. Only resources that have been accumulated and ordered can satisfy our needs – basic or otherwise. When we consume we extract those resources by destroying the order. This is the entropy that Georgescu-Roegen mentioned. From this persecutive an economy is a fight against entropy. The physical world is dominated by an incessant tendency towards disorder. Things dissipate. They depreciate. Useful resources are scattered and become useless. Only creativity – the creativity embodied in all life – can stave off entropy. Then only locally. Then only temporarily. There is no equilibrium in such a system, only a perpetual fight, a dynamic against disorder.

Think it through: the iron in a motor car is not lost when it rusts in a scrap yard. The iron remains. It just isn’t in a useful form. The in-forming has become dis-formed. The order lost. Thus the value destroyed.

So economics is about learning new ways of imposing order. And it does this in the face of uncertainty. So as our learning produces more complex ways to impose order the economy becomes more fragile, more entangled, more interdependent, and in need of more control to offset those things. Imposing order takes time and space. It takes energy. It takes planning. It requires ever greater control over the process of ordering.

Thus the need for firms.

They are spaces, both physical and logical, within which our practical knowledge is deployed to impose order on resources. This imposition requires energy and skill. Energy can come from labor or it can come from more basic sources. Skill can come from current labor or it can come from the embodiment of past labor. For current capital is simply the ordering – the inheritance and selection of – past learning in the form of useful machinery or equipment. The substitution of labor for capital or vice versa tells us that neither if fundamental. The energy and skill are.

Energy and knowledge deployed to order resources for subsequent disordering. That’s the economic process.

The apparent smooth surface of an economy – the supposed matching of supply with demand – has beguiled us long enough. It is emergent. It belies the seething below the surface. It cannot be predicted by understanding the lower levels. It just is. It is illusory to think otherwise. Building upwards from below does not necessarily end up with the whole. Nor does decomposing the whole necessarily end up with the constituent parts. Supply and demand are an accounting of the contest between creativity and entropy. The artifacts associated with them are important to our understanding of allocation, but not at all to the more fundamental issue of growth.

That is a question of knowledge. Of the institutions and culture needed to exploit that knowledge. And of the way in which we solve problems and add order to our environment.

One last thought: primary and secondary knowledge. They are my way of parsing the total knowledge. Primary knowledge is the replicated and selected part. It is coded. It is thus easily re-used. It is also thus reliable. It is the source of efficiency. Or rather I should say pseudo-efficiency, since in the face of open ended discovery and uncertainty there can be no such thing as certain efficiency. Primary knowledge is what firms embody into the routines that constitute production. Either a machine or labor can perform the routine. It is the routine that is paramount. And a routine is simply a discovered or learned solution to a problem. Firms prefer primary knowledge because of its ease of replication and its reliability. It gives them control within their space over the outcome of the in-forming process.

Secondary knowledge, in contrast, is inefficient. It is more complex. It is the intelligence to solve problems ad hoc. It is thus essential for learning. New problems negate the validity of old knowledge. Novelty – exploring the edge or our possibilities – cannot be discovered, shaped, and made useful without intelligence. And this is where evolution does not help. Our exploration of novelty is directed. It is not random. Chance may play a role, but our exploration is highly contingent on what came before. Innovation is never ex-nihilo. It builds on the foundation. It moves outwards from the center. Nor does innovation take place only at the edge or our knowledge. It can take place deep inside. For discovery is not just of new knowledge, but of new applications for old knowledge. Having a store of intelligence – what I call secondary knowledge – is essential to both forms of discovery. But is is expensive. This is because there is no certainty of outcome.

Primary knowledge replicates old order. Secondary knowledge creates novel order. Business translates novelty into processes consisting of routines based upon innovation. It thus translates secondary into primary knowledge and extracts value by so doing. As long, that is, as the primary knowledge is not superseded by novelty.

Creativity fending off entropy. Knowledge and learning at the heart of it all. Problem solving. Dynamic, constant, unpredictable, and fraught with uncertainty. No direction. No equilibrium. Riven through with asymmetries. The temporary imposition of order on our surroundings so that we can survive and enjoy life.

Economics in the real world.

Or at least that’s what I think.

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  1. Paul Schächterle
    August 8, 2013 at 3:34 pm

    Good article.
    I think the main problem with mainstream economics is that they no longer observe and describe and then try to derive abstract principles from those observations. Instead they speculate wildly and build mathematical models for the sake of model building, no matter whether those models describe something real or not. Even worse they “define” away important parts of reality and make ridiculous assumptions because those assumptions are “convenient” for their models.
    Reading classical economists is quite different. They observe and describe and argue about and defend the principles they propose.

  2. sergio
    August 8, 2013 at 3:58 pm

    Well, too much criticism on neoclassical economics from any other school. But, actually, does it even deserve critics at all? Does it even deserve to spend efforts and time to criticize?
    If that nonsense that they believe in was not mainstream, than no would criticize it.
    The problem however, is that this nonsense is mainstream. Our efforts should not be to criticize only, but to do anything possible, in education or in policy making, that their nonsense was not mainstream. Say briefly – stop tyranny of nonsense, primitive vision of reality. But this requires more than just criticism.

  3. Herb Wiseman
    August 8, 2013 at 4:11 pm

    Brilliant article. Is there a typo in this sentence? “The substitution of labor for capital or vice versa tells us that neither if fundamental.”

  4. Robert Locke
    August 8, 2013 at 4:20 pm

    Let’s put some glamor in the distinction between primary and secondary knowledge.

    Nietzsche made it through Dionysian and Apollonian mythopoeticism. The Apollonian “is the principle of clearly delineated images, permanence, optimism, individuation, and rationality. It is striving for clarity.” This is the ethos of the classical American corporate manager trained in business schools. The Dionysian expresses “the principle of flux, impermanence, suffering, and pessimism…an irrational force, impulsive, wild, and instinctive.” This the creative power behind entrepreneurialism. Accordingly, whereas the Apollonian vision is timeless and “responsible for the constant formulation and reformulation of the forms of knowledge and rationality that order our everyday life, thereby concealing the underlying Dionysian reality from ourselves,” the Dionysian urge, “which is momentary, exceptional, and counter-intuitive, is dangerous to any structure of reality. … It contains the maelstrom of every impulse caught in the flux of time.” It characterizes precisely the creative/destructive behavior of the great entrepreneur. For this reason “the Dionysian is the more profound of the two modes; it can only be ignored at the price of cultural sterility and ultimately economic extinction. Quotes in Carl Pletsch (1991). Young Nietzsche: On Becoming a Genius (New York: Free Press), pp. 131-32.

  5. BFWR
    August 8, 2013 at 4:38 pm

    Philosophy needs to precede process, that is, policy. Align policy with a humane philosophy whose primary goal is individual economic freedom and that also accurately assesses productive potential and you will be able to balance lesser forces.

  6. August 8, 2013 at 5:50 pm

    Republicou isso em Gabriel Regae comentado:
    Pequena resenha muito bem organizada sobre as críticas à teoria de firma. Cita Darwin mas não Nelson ou Winter (parece proibido… é rara essa citação). Ajuda a correlacionar essas ideias micro ao contexto econômico geral.

  7. August 8, 2013 at 6:06 pm

    I like to make two comments. In your essay you seem to be preaching as much as neoclassical people. You try to explain things as a basis for prediction. But a partly different purpose is to contribute constructively with a conceptual framework that is helpful in understanding what goes on in business and in the economy. In business management literature you can find many kinds of models of firms and other organizations rather than only one.
    My second point is that neoclassical theory of the firm plays an ideological role in present society and is therefore appreciated and defended by many. The simplistic assumption of monetary profit maximization is making it legitimate to focus on the monetary dimension at the expense of all non-monetary impacts, equality issues etc. Issues such as Corporate Social Responsibility (CSR) are discussed in management literature but typically absent from neoclassical textbooks and studies.

  8. August 8, 2013 at 7:08 pm

    Good arcticle…

  9. Bruce E. Woych
    August 8, 2013 at 11:05 pm

    An organization acquires competitive advantage when it develops essential attributes or combination of attributes that allows it to outperform its competitors. Collectively the corporate ‘firm’ is institutionalized succession in socio-economics more than political economy. Business economics is a practical but teleological story of survival and omits with a vengence all the failures of business that is perennial. Ultimately the firm is a power structure that emerges from essential demands and market forces that mediate relations, and in turn the sociopolitical relations are fostered into political economic formations and the formalistic myths of neo-colonial (neo-class-economics) still falls under the spell of some academic or pragmatic managerialism (both public and private and often at odds).

    In a chapter previewed on this blog :http://www.paecon.net/PAEReview/issue61/BichlerNitzan61.pdf Capital as power: Toward a new cosmology of capitalism (p65)
    Shimshon Bichler and Jonathan Nitzan the reference is made to power relations that bifurcated in intellectual history and specialized as political and economic subdivisions of reality (the real world…). They refer back to an interesting observation by Thorstein Veblen that postulates a contradictory schism in modern Western Society between Industry and Business (p77). Everyone, regardless of their disciplinary membership, correlates production with profit indiscriminately. This undifferentiated “agreement” is a mutual myopia that conditions the outcome of circumstantial explanations. In reality the process leads to business “sabotaging” industry (which appears to have been most confirmed in recent contemporary emergence of finance over commercial industry and monetary gains over real production). Empirically, business is a many sided entry point and ultimately we must submit that economics is in the business of framing the expedience of profit-productive rationality. The ambiguity of Coolidge’s statement that “the business of government is business” postures the contradiction as that phrase gets interpreted from decade to decade, and the “firm” emerges as an evolving entity of debt and insurances as measured, not by real production, but more and more by pure profit. The jargon and distinctions dissipate quickly when the question of microeconomic power relations are posited as the foundation for business as usual in macro mapping the cosmology of economic power and its political mediation.

  10. August 9, 2013 at 12:51 am

    A good start. But it is not just the firm which has been caricatured. It is all important economic institutions which have been trivialized, including the market and the government, the two which underpin neoclassical and Keynesian dichotomy.

    Agree with you that Arrow-Debreu proved the non-existence of equilibrium by showing many false assumptions have to made to obtain it: a form of “reductio ad absurdum”. But that’s not how most of the world sees it. They assert Arrow-Debreu proved the existence of equilibrium, as the world approximates or can be made to approximate those assumptions. Any failure to reach equilibrium is due to regulation they claim and so justified the deregulation mania we are still witnessing.

    So rational individuals voluntarily exchanging in markets optimized social welfare? But the actions of individuals have very little to do with how the economy behaves. Prices of goods are determined by firms, monopolies, banks, regulators etc and hardly by individuals. Interest rates are set by banks and not by depositors and borrowers. Asset prices are set by fund managers, pension funds, investment banks, central banks etc and hardly by individual investors. Actions of firms are hardly determined by individual shareholders.

    The principal/agent problem has never been brought to bear on economic calculation. Markets are often rigged and governments are run by politicians and bureaucrats who have their own agendas and are “pragmatic” in trading principles and public interests for “results”.

    Macroeconomics assumes that none of the underlying structures matters. For example, if the central bank print plenty of money, the money will eventually get to the consumers to stimulate aggregate demand. The clear evidence is, this may take a long time. Does anything change? Will anything change?

    Economics is mostly nonsense, because it does not even recognize the real-world, let alone describe it correctly, and never mind understand how it all works. We need a clean slate.

  11. kaptain kouk
    August 9, 2013 at 5:18 pm

    in all honesty i really doubt if competition is the best way to allocate resources. i think this is the starting point for an alternative economic theory

    • sergio
      August 10, 2013 at 5:01 am

      1. Where do you see competition in neoclassical economics?
      2. Is competition a way to allocate resources only or is it driver of innovation and change?
      3. Is economics about allocating resources in best way or is it “An Inquiry into the Nature and Causes of the Wealth of Nations”?

      All huge empire of neoclassical economics is grounded on one single a doubt, pointed by you. And they believe that people will never doubt about it, because what is expressed in complex mathematical models must never be doubted. Your doubt possess real threat to neoclassical economics. If your doubt turns out to be true, and you could persuade others about it, then all neoclassical economics will turn into garbage. In material garbage. Because it is already a intellectual garbage.

    • Robert Locke
      August 10, 2013 at 5:13 am

      Good point. The idea that competition is a good way to allocate resources is a particularly strong one in Anglo-saxonia, which has been pushed by Americans worldwide after WWII. Germans believed in Kartells until they lost WWII, because they considered competition wasteful of resources. That is the idea behind the visible hand of management, as opposed to the invisible hand of markets.

  12. BFWR
    August 10, 2013 at 5:55 am

    The truth is this. Markets do not exist because of management….and markets do not exist WITHOUT it either. The point is that we need to create markets that are a reflection of the best and the whole of what Man is. He is NOT homo economicus. He is homo sapiens…flawed but wise and discerning Man. With Man you get what you enable and contemplate. We need to stop enabling merely economic man, which actually inhibits homo sapiens from progressing and becoming more real. I suggest we create systems which enable and encourage wisdom…because their policies actually reflect that wisdom. That would be wise. And not doing that, particularly in view of present circumstances, modern weaponry and Man’s flawed and imperfect nature….would be incredibly stupid.

    • davetaylor1
      August 10, 2013 at 11:21 am

      Agreed, BFWR. The ancient wisdom was, “Know Thyself”. I’ve just been recommending Myers-Briggs personality type testing as the way to do that,so here’s the link again:

      http://www.myersbriggs.org/my-mbti-personality-type/mbti-basics/.

      • Bruce E. Woych
        August 10, 2013 at 7:46 pm

        Since I have been contemplating this I also consider that the people who identify as economists are
        not only “differentially” divided, but asymmetrically divided in
        distinctive categories of membership that they defend and entrench
        themselves, to the great contradiction to their own sense of unity and
        historic identity. The results are a labyrinth made of glass. Economists see each other
        but on very distinctively from disconnected pathways. As such the definitions of economy reflect the
        full dimension of how isolated and unified whole sectors feel…in their
        own unique “pathways through transition crisis” that are part of everyday
        survival. A national event, no matter how spurious, is
        permission to assume a common cause and interpretations trumpet predictors and anticipate pathways. The presumption, however, is less
        than authentic and does not approach any true comprehensive
        understanding, let alone solutions, to what is truthfully dividing
        society or themselves…and that might start with market supremacy over their lives…but
        it certainly involves political economy, competitive conflict as norm, and crime /
        fraud & corruption as sub-cultural (public/private secret) rules of engagement. There is a certain fragmented cognitive dissonance going on throughout its history of ideas, with a ritual acceptance that acts as barriers to understanding as much as it makes claim to specialized knowledge.

        Situational consensus is driven and hidden all at once at the baseline
        concerns of a country under disequilibrium and economics is drawn apart at the false
        seams of stratified rank and file self interests (the invisible hands) that are otherwise
        nullified as apolitical and socially self evident under a pasychological spectrum of
        confirmation biases http://psy2.ucsd.edu/~mckenzie/nickersonConfirmationBias.pdf
        And it is all
        one grand distortion that has no true center. It is all one
        confirmation bias that seeks to coerce an irrational sense of Unity in a
        country that is systemically divided…and the false pretext that One Economy exists.

      • BFWR
        August 11, 2013 at 7:33 pm

        I don’t disagree with any of that. What is means though, is that the system dominates Man instead of serving him. This is the philosophical, monetary and economic point that current policy needs to change from. The system cannot be truly free unless the individual who is an integral part of it….is ACTUALLY free as well. The system must be adapted to the psychological and physical needs of the individual, not the other way around.

  13. Bruce E. Woych
    August 10, 2013 at 4:48 pm

    Like most other categorical social practices, “management” as a concept comes in a rainbow of colors. Practical, pragmatic, realistic, generally precede theoretical and idealistic.
    Unfortunately negativity stands out in the short run while positive features tend to fade into the sunset as pressures and selectivity become more compressed and narrow. Overall, American “leadership” and management has a wide set of cross boundaries. But I like the sound of a visible hand in a viable market that includes the greater good of society.

    In that regard, it is a “top down” consideration (against the tide) to take a moment to consider Robert K. Greenleaf http://www.carolsmith.us/downloads/640greenleaf.pdf and his impact upon American industry (but seemingly not on the economics that might facilitate such idealistic practice). Cost benefits are never projected into how much “cancer” or negative “externalities” are consequence to profits and gains. A more benevolent concern for full spectrum economics and business would anticipate such restraints. Not so in markets, and it is not possible to say that a very visible hands do not guide and navigate the intentionally opaque market arrangements; so the distinction is only as good as its actual (often peer driven) practice. Bounded rationalities have proven themselves quite amendable to perverted incentives and the opportunities of market driven interests that see profits as golden calves and the ends do justify the means over time. The ideological foundations to these practices are adjusted in the process, and engineering simply creates methods over purpose. R.K. Greenleaf is the exception and the inspiration. Put that “blueprint” into the hands of engineers and prospects will be created, but the power dynamics of wealth succession will fight such prospects rather than surrender to them. Succession has its ramifications, and economics does not want to measure consequences that are in contradiciton to progressive profit growth and class sustainability.

    Worth noting: http://en.wikipedia.org/wiki/Robert_K._Greenleaf who’s work and visionary constructs are subtitled… “A Journey into the Nature of Legitimate Power & Greatness.” T

  14. BFWR
    August 12, 2013 at 12:20 am

    I’m in full agreement with what Greenleaf says. However, a management style itself is not adequate to resolve our current crisis or to make it permanent. For that we need to align the system’s policies precisely with philosophical insights along those lines and that address the actual problems that the current systems are afflicted with.

    It is hard for intelligent people to submit to something higher than intellect. Scientists and sceptics need to get past their scientism and scepticism. They don’t need to, and should not drop science and scepticism, However, they DO need to recognize that Wisdom is a higher order level of both thinking (philosophy) and acting (policy) that can be inclusive of science and scepticism. If they doubt this they need to define Wisdom in general and contemplate the condensations of Wisdom in particular, and find out that the above is true.

    • Bruce E. Woych
      August 12, 2013 at 10:36 pm

      Interesting and relevant. I am not sure “Greenleaf” is simply managerial however, and I think there is a conscience and consciousness to it that is counter to the driven greed of capture all and at all costs.

      I read and re-read your comment. There is a subtext there, that implies that human behavior is not aligned with human intentions (or intended direction). It seems to suggest that what people actually do is not what we say they do, and that gos back to the old adage …”do what I say not what I do” in habitual motion.

      Perhaps it might be said that ‘thoughts on economics’ (the subject here) have neglected or is blind to what we most historically have called human nature (a controversial phrase now a days). In denying ‘human nature’ perhaps the real time / fact checked “reality” of the feet on the ground transactional world…is someone missing from “economics” as we ‘say’ it exists? In any case, Greenleaf comes more or less out of Harvard…and that is a curious conundrum all to itself.

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