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Coase and Reality

from Peter Radford

In his introduction to a collection of his own work, Ronald Coase tells us:

‘Becker points out that: “what most distinguishes economics as a discipline from other disciplines in the social sciences is not its subject matter but its approach”’.

He then goes on:

‘One result of this divorce of the theory from its subject matter has been that the entities whose decisions economists are engaged in analyzing lack any substance. The consumer is not a human being but a consistent set of preferences. The firm, to an economist, as Slater has said, “is effectively defined as a cost curve and a demand curve, and the theory is simply the logic of optimal pricing and input combination”. Exchange takes place without any specification of its institutional setting. We have consumers without humanity, firms without organization, and even exchange without markets.’

All true, too true. 

Criticizing the bulk of modern economics for its extraordinary lack of realism has become a tiring and unproductive exercise. All that happens is that each such essay engenders the usual torrent of criticism from the unorthodox islands within the archepeligo of economics. This criticism is usually of the form “well, we all know that”. The critique from the much larger island of orthodoxy – if anyone there is bothered to respond – is either a yawn or a paternal pat on the head to signify that they understand that one day I will get why they do what they do, but until then they will tolerate my childish naivety.

My problem is that it isn’t me being naïve. The orthodox are. They are naïve and myopic. No: naïve, myopic, and very, very limited.

I read recently, I forget where, that cosmologists have answered a question that worried them for a while. Apparently there is a vast ‘cold spot’ in the universe, whose coldness is explained, somewhat, by it being relatively bereft of matter and so on. The universe is a very lumpy phenomenon full of spaces surrounding concentrations of stuff. This distribution seems to be a result of the origins of the universe. Cosmologists look at all this lumpiness and concern themselves with developing theories about how it all came to be. This gets them, no doubt, into deep formal modeling, but those models are to explain what they see. This is because physics seeks to explain stuff.

But, as Coase no doubt realized, and as Becker proudly proclaimed, economists do not seek to explain stuff they see around them. They seek to explain things they only imagine.

Hence the ability of orthodox economists to ignore the context, structure, and even the cost of operation of such things as markets. And hence their willingness to begrudge even a smidgeon of humanity to the consumers who patrol those markets like so many robots marching to an internal code written by an anonymous and evidently vastly under socialized and inexperienced programmer.

Coase repeatedly refers to modern microeconomics as ‘price theory’. We could call it ‘choice theory’ too. It really doesn’t matter what we call it because it is largely a fairytale without much relevance to the economy. It is, however, a hugely successful and well-constructed set of ideas. It is a marvel of consistency and logical thoroughness. That it floats free in the air above the reality far below seems not to concern those who revel in it. It takes several hundred pages of dense verbiage and scads of mathematics to lay out the entirety of microeconomics. Looking at the doorstop sized books inflicted on students – not to mention the price of said books – one has to assume that great insight can be gained by slogging through their pages.

Naturally, for instance, we could reasonably assume that somewhere within those hallowed pages we would be told where prices – the magical glue of the entire system – come from. But we would be wrong. The question is left unanswered. Instead we are given a series of highly unreal possibilities. We are told we can imagine an ethereal ‘auctioneer’ sitting presumably on some mountaintop performing the task of figuring out the prices that we need to ‘clear the markets’. Or we can imagine all our robotic consumers submitting acceptable prices to some authority who then digests them and announces those that establish the same market clearing result.

And so on.

In other words the central character in the entire narrative that the orthodox economists want us to accept as a theory of actual market activity appears magically from nowhere. Or, rather, appears from some make-believe hocus-pocus that we are supposed to ignore and/or accept so we can move on and explore the logic of their models.

Well, no.

I refuse.

I refuse to give economists a free ride. Prices do not appear magically. They are constructs of thought by actual human beings. They are thus within the system being explained. Those humans reside, most likely, within business firms with limited information, facing deep uncertainties, and thus resorting to all sorts of dodges and wheezes to approximate what they think ‘the market will bear’. And, no, orthodox theory is not a pretty good approximation of this messy reality. It relates in no way at all.

Coase is correct in his assessment. Economics is divorced from its erstwhile subject matter. Which means Becker is correct also: economics is a technique. Economists are technicians roaming around looking for opportunities to apply their technique. That their technique seems inappropriate when applied to the economy is of no concern to them. It is what they know.

Whether it is what the rest of us need to know as we grapple with our economic issues is another matter entirely.

  1. Nietil
    May 3, 2015 at 7:51 pm

    Actually I believe there is even worse than ‘prices’ coming from nowhere : ‘goods’ flying down from the clouds on their little, fluffy, white wings. I don’t think I have ever seen a textbook that even took the trouble of explaining where goods come from. And under close examination the concept doesn’t work out the way mainstream economists think it does.

    • Ack Nice
      May 4, 2015 at 2:20 pm

      Shut your textbooks and come back to reality.

      Goods and services are produced and provided ONLY when a human being sacrifices a portion of the irreplaceable hours of their life to producing goods or providing services. No sacrifice of a human being’s time to working = no goods produced. Anybody out there who is not yet certain this is true? Prove it yourself right now. Right now, take a dollar bill out of your wallet – and command it to fix you a sandwich.

      ONLY work creates wealth.

      Work is one of only 2 things. It is either the work Mother Nature did for all for free, like giving us land, animals, plants, beautiful ocean views, putting the minerals in the ground, giving us bees to pollinate food crops – or it is the sacrifice of a human being’s time to producing goods and/or providing services.

      Money is symbolic wealth, symbol of real, substantial wealth: goods and services.

      Money is a license to take workproducts from the pool of workproducts produced only by work. Mother Nature demands no pay for her work. All humans have the same uncontestable physical limits as to how much work they can possibly do imposed upon them – we all eat and sleep or we die. So how much wealth it is possible to put into the pool of wealth by your own work is absolutely limited. But wait – humans allow unlimited withdrawals from the finite pool of wealth! Humans who face inarguable limits to how much wealth they can produce face no limits to how much they can withdraw! There is no economist who will tell the world that this means the human economy has been entirely erected upon a foundation of legal theft.

      Humans – with the blessing of economists – are just using division of labor as an excuse to let different specialized jobs pay amounts that differ wildly unjustly while the work is spread a million times more equally.

      Division of labor begat trade. The purpose of trade is to give out the specialized products we ourselves produce, and get the products we want that are produced by the other specialists.

      What is supposed to happen is that a working person’s wealth after a transaction is the same as it was before, just in different work-products. Trade shouldn’t leave us better off or worse off in work-value. The amount of work in the products we buy should be equal to the amount of work we do. Anything else is theft, is unilateral or one-sided shift of wealth from an earner to a freebie-getter. People should – in justice economics, would – share the substantial wealth (produced only by work) in the same proportions they would without trade, when each person consumes what she produces, which is natural automatic justice.

      The very simple, very dangerous fact that has been overlooked by all economists and virtually all thinkers, and which has never entered the common mind of humanity, is that in any transaction the two things exchanged cannot be equal in workvalue. There must be more work gone into one thing than the other thing. There is no way to determine with absolute precision the exact workvalue of the two things. They must be unequal. The chance of them being of exactly equal workvalue is infinitesimal, and equality of workvalue will occur in almost no transactions. This necessarily means that wealth will pass automatically from one person to another in every transaction, with or without human agency helping this occur.

      Every transaction will be a fair-exchange-no-robbery, plus a robbery. The two things will be of workvalues x, and x + y. The x’s will be the fair exchange and the y will be the robbery. One will get out more than he put in, the other will get out less. On top of the fair exchange, in which both work and both reap, one will work and the other will reap. Inevitably. Unavoidably.

      Both may think they profited, but if both profited, the mere exchange would have caused an increase in net value of both products, and mere exchange cannot increase value.

      What is supposed to happen in a trade is each party takes from the pooled wealth the amount he or she put in by virtue of his or her own sacrifice of time – just in different goods/services.

      The surgeon can only be a surgeon because others grow her food and make her shoes. Without the babysitters and teachers and shoemakers and farmers, the surgeon does not exist.

      Money does NOT trickle down, it PERCOLATES UP.

      You do not create a healthy economy by giving all the incentive to work to a fraction few!

      You do not stimulate an economy by putting all the wealth at the top – you put it at the bottom where it is spent immediately on unmet demand and it percolates up through every level of the economy.

      A fountain dries up if you capture the water at the top and prevent it going back down into the pool to recirculate again and again. Money is the lifeblood of an economy – it must recirculate or the economy dries up. The entire body dies if all the blood is kept in the brain.

      Only demand creates jobs. And the demand belongs to the people. There are no jobs without people demand for the goods and services. One in six humans is going hungry. 1 in 50 humans is killed every year by lack of money no matter how hard they work. There is far far far too much demand existing that cannot be met simply because the banksters and employers withhold money – the means to purchase the needs to stay alive. All while economists keep asking the ludicrous, insane, ridiculous-as-it-is-lethal question of whether or not low wages is good or necessary!

      No one works harder than the poor do – just to try to stay alive.

      Humans are not born equally gifted but they are born equally needing a place to put their feet while they live, equally needing shelter, food, clean water, clothing, education, medical healing, the fruits of their own labor, and their fairshare of the value of the earth – in order to survive. Equal rights derive from our equal needs. Your having won a bigger brain in the birth lottery than Tommy did does nothing to give you rights to reap what Tommy sows – you sacrificed nothing to get that better brain – and Tommy did not choose to win fewer gifts than you got.

      Your need to be seen as superior proves your inferiority.

      Money and power and manure – all stink in heaps and must be spread to do us good, wealth is rightly spread as evenly as the work is spread. Money is good servant, bad master – humans must make a promethean mastering of money – but with economists around they’ll never do so. economists just keep money mystified when real world economics is hilariously easy to understand.

      Economists should either focus on and speak to these crystal clear observations about the fundamental situation we humans are in or they should shut the bleep up before they get us all killed.

      Every transaction robs somebody, intentionally or not.

      It is the richest who write all the laws and put themselves above the laws.

      The overpay-underpay ratio is giga-extreme and growing and the violence on earth is proportional to the overpay-underpay ratio.

      Money is power.

      How many Mozarts and Einsteins has humanity cheated itself out of by keeping most brains too poor to be educated to the maximum possible for each person?

      Where are the monuments to all the working poor families wiped out by the perpetual economic warring?

      You are living on a planet of abundance that has never been richer!

      The human species: billions with trillions starving millions every year!

      What in the above is SO BLOODY HARD TO UNDERSTAND???????????????

  2. May 3, 2015 at 9:58 pm

    Freaky games
    Comment on ‘Coase and Reality’

    “Criticizing the bulk of modern economics for its extraordinary lack of realism has become a tiring and unproductive exercise.” (See intro)

    Really? It seems that the protagonists show no signs of tiredness. On the contrary. The Heterodox ridicule utility maximization, the Orthodox escalate with even more ridiculous rational expectations. The Heterodox point to uncertainty, the Orthodox escalate with ergodicity. The Heterodox say equilibrium is impossible, the Orthodox escalate with the outer worldly fixpoint theorem. In the course of a lively debate the distance from reality grows in fact exponentially. What goes wrong?

    “The moral of the story is simply this: it takes a new theory, and not just the destructive exposure of assumptions or the collection of new facts, to beat an old theory.” (Blaug, 1998, p. 703)

    And exactly at this crucial juncture the differences between Orthodoxy and Heterodoxy vanish.

    “… most economists neither seek alternative theories nor believe that they can be found.” (Hausman, 1992, p. 248)

    Thus, the funny game goes on, with occasional regrets.

    “Whether it is what the rest of us need to know as we grapple with our economic issues is another matter entirely.” (See intro)

    High time that ‘the rest of us’ simply leaves traditional Orthodoxy and Heterodoxy behind in their cojoint proto-scientific cul-de-sac.

    Egmont Kakarot-Handtke

    Blaug, M. (1998). Economic Theory in Retrospect. Cambridge: Cambridge University
    Press, 5th edition.
    Hausman, D. M. (1992). The Inexact and Separate Science of Economics. Cambridge:
    Cambridge University Press.

    • blocke
      May 4, 2015 at 8:49 am

      “High time that ‘the rest of us’ simply leaves traditional Orthodoxy and Heterodoxy behind in their cojoint proto-scientific cul-de-sac.” Pie in the sky Egmont. late 19th century Walrasian thought they were doing just that, but there “science” was pseudo. PostWWII Economists, drawing heavily on new operational methodologies (from engineering and econometrics) thought they had solved it too. But they hadn’t. My guess is the subject matter is not subject to science methods a la physics. All you got is the “science” currently in vogues that is circumscribed by powerful interests. That science can only succeed if the social interests are made part of it.

      Egmont Kakarot-Handtke

  3. Larry Motuz
    May 4, 2015 at 12:35 am

    There is no such thing as an axiomatic-deductive science. It is merely a logical form of thinking ‘logically’ consistent with one’s axioms, one that requires no external evidence to be ‘verified’ or ‘shown’ by relevance to any reality except the axiomatic-deductive noumenal one. So, economics differs from science — including the social sciences — insofar as it has no inherent relationship to what it describes. The consumer in economics is not a life form, for life forms have to realize their needs for real and measurable benefits from consumption, rather than maximize their so-called preferences, if they to survive.

    This is easily demonstrable if anyone is interested.

    • Paul Schächterle
      May 4, 2015 at 12:14 pm

      Quote: “There is no such thing as an axiomatic-deductive science.”
      Agreed. Axiomatic deductive reasoning is just the use of formal logic.

      Quote: “The consumer in economics is not a life form […]”
      Agreed as well. Additionally the “model” of an average or ideal consumer in neoclassical theory is totally unrealistic. No person in the world has preferences similar to those used in neoclassical theory. If one thinks about consumer decisions in a very very superficial way, non-satiation and convexity might be plausible at first. But if you think about the structure of the goods people choose from and the consumption plans real people make, one quickly realises that the neoclassical model of human preferences is outright ridiculous.

      Despite being already of the same opinion I am interested in your demonstration or argumentation why neoclassical preference theory is false. Could you post a link or something? Thanks!

      • Larry Motuz
        May 13, 2015 at 4:28 pm

        Sorry I couldn’t get back to you earlier. I have the following sets of arguments which lead to reconstructing the micro-foundations of economic thought.

        The first is that diverse, always measurable instrumental benefits arise from the various uses goods and services provide in those uses. In this framework, firms are consumers like other consumers.

        The second is that, for any specified use, instrumental benefits can be defined and measured, and that the instrumental terms of trade between goods in specific uses are constants which have nothing to do with value-in-exchange terms of trade between goods.

        Put differently, instrumental benefit (always measurable) values-in-use are not the same as with market values-in-exchange, particularly given that similar goods have a variety uses with variable instrumental benefits. A good that is used to provide nutrients essential for life is not necessarily restricted only being used for that purpose. Whereas a firm might wish to realize some measured profits from its use during a period, human beings need to realize measured level nutrients. While both types of consumers are in the ‘business’ of staying alive and healthy, what this involves in terms of how goods are used by each is clearly very different. (I do not accept Marshall’s distinction between firms and consumers, since both use goods to obtain different benefits from those uses.)

        For all consumers (firms and human), rationality always concerns how income is to be allotted into budget groups across sets of goods during a specific, measured time period.

        Total budgets for a period contain fixed and variable allotments. Budget allocations fall into fixed vs flexible allotments for the period under consideration. Fixed budget allotments are just that: required essential expenditures. Flexible allotments are variable. Monies can be transferred between variable allotments within the period under consideration.

        It is the set of budget formation decisions within means constraints wherein forethought (i.e., what the Greeks meant by rational decision-making) is displayed as rational.

        One can construct aggregate demand out of these micro-foundations.

        If you are interested in how I am proceeding, please write me at larry[dot]motuz@gmail[dot]com.

  4. ihtis69
    May 4, 2015 at 4:42 am

    Reblogged this on ihtis69.

  5. Macrocompassion
    May 4, 2015 at 10:26 am

    All of this discussion is weird! It is all very well trying to describe the nature of the expert and his attitude to his/her subject, but none of this counts if you are unable to understand what is going on (in more physical terms) and why, in realistic terms. And even if these terms are not perfectly true with the actual situation, at least their amount of approximation is sufficiently small, as to make some better representation than the basic drivel that some choose as a replacement.

    Even if it is not ideal, an attempt to represent macroeconomics as a model (based on axioms, assumptions and good definitions) that is capable of analysis and can subsequently allow one to experiment with various combinations of decision-making or policy–all of this is the right way to go, and not more claims about the imperfect nature of a transient and mysterious but ill defined world.

  6. May 4, 2015 at 4:59 pm

    Economics is not what most economists think it is
    Comment on Larry Motuz

    Imagine for a moment a rather elementary economy. Total employment is L and there are two firms. The wage rate W is equal and fix. So total income Y=W(L1+L2) is fix. The household sector spends this total income, hence total consumption expenditures C are equal to Y and fix. No saving/dissaving. The productivities R1, R2 are fix in both firms. Under the condition of zero profit the respective market clearing prices are equal to unit wage costs, i.e., P1=W/R1 and P2=W/R2. Labor can be shifted between the two firms at short notice, so the ONLY question that is open from the viewpoint of the business sector is how will the households split consumption expenditures C between the two goods? As soon as the firms know this they will allocate total labor input accordingly. As a result, consumers get exactly want they want, markets are cleared, all budgets are balanced, labor is fully employed and gets the whole product.

    How does standard economics answer this elementary question? The partitioning of C is defined by the equality of the marginal rate of substitution MRS and the price ratio.

    Seems to be a sensible answer. We have the price ratio — but how exactly do we get the MRS?

    This is the moment of truth. In this way, nobody can ever answer the most elementary question of consumer theory because MRS is a nonentity.

    This, though, is not the end of the story. Now phantasy gets busy. Can you imagine a set of preferences? Yes, I can, but then the MRS follows from my definition of the set. That is, I put the answer in the hat in the form of well-defined preference curves and then get it out as MRS. Obviously, this is scientifically illegitimate. End of story. Nice try. Orthodoxy is gone.

    Not yet, because now the heterodox economist steps in and tells us:
    “The consumer in economics is not a life form, for life forms have to realize their needs for real and measurable benefits from consumption, rather than maximize their so-called preferences, if they to survive.” (See previous post of Larry Motuz)

    Very true, nobody can say much against survival. But, wait a minute! The question was how do the households partition the total consumption expenditures C?

    Heterodoxy is correct in pointing out that the introduction of preferences is a methodologically unacceptable move. But frankly, is the waffling about life form, benefits and survival one iota better?

    Actually, it is worse. Because now we are entangled in a discussion about the motives of the consumers. And, clearly, this is psychology, sociology, politics, and what you have, but it is NOT economics. Economics is first and foremost about how the economy works* and not about how people tick.

    Egmont Kakarot-Handtke

    * For the correct approach see cross-references

  7. Larry Motuz
    October 31, 2015 at 4:06 pm

    My goodness, I never realized that you (Egmont Kakarot-Handtke) had responded until last night. If you can imagine a ‘science’ of biology without life forms in it, then you can imagine the dismal state of economic theory without life forms in it. But, you seem to believe that you can have an economics without life forms, or, for that matter, human beings. You wonder if I can answer you about how budgets are formed.

    Well, yes I can. The process of budget formation is basically one of providing for human needs from most essential in basic biological/material terms across the hierarchy of needs human beings have. This comes down to a matter of what one can afford to provide for, and also reflects the distribution of income within society. It is easily demonstrable that ‘income’ allows for a diversity in what one can budget for — namely how and what needs can be met and in which ways.

    You are quite correct that Hick’s MRS has no foundation: that it is merely the mathem-magical outcome of choosing a form for preference functions that ‘builds in’ the idea that more and more of anything provides ever lower increments of ordinal satisfaction. (In this, Hicks remains fully Marshallian). To be noted is also his idea (an assumption) that whatever one ‘spots’ a consumer purchasing, this necessarily represents an equilibrium rather than merely what the consumer can afford to purchase given nominal prices. So, Hicks starts from an equilibrium and moves to another equilibrium, all by assumption.

    Economics is the body of knowledge about how we provide for ourselves individually and together. You may not like my definition, Egmont Kakarot-Handtke, for, as you recognize, it introduces ‘motives’ for consumption that lie in the reality that we are life forms first and not algorithms. Your distaste lies in the reality that you believe that one can remove the word political from “Political Economy” and be left with something sensible.

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