Fundamental Flaws of Conventional Economics
from Asad Zaman
My recent post on RWER Blog asks if there is a “CORE of heterodox economics” which we can all believe in? From the responses to my previous post on whether or not there was a core set of heterodox beliefs, it became clear to me that I have started in the wrong place. Before starting the task of constructing an alternative paradigm, we must clear away the debris of the ruins of the conventional paradigm. Frederic Lee & Steve Keen remarked in the introduction to their article on the “The incoherent emperor: a heterodox critique of neoclassical microeconomic theory” that heterodox economists often come to the defense of conventional economics, because they are ignorant of the vast range of devastating critiques against these theories. To create a revolution, we must change from lukewarm heterodoxy (a partial rejection combined with a partial acceptance of the errors of conventional theories) to a genuinely radical approach requiring a complete rejection. When the errors of the conventional approach become as obvious as the error in “2+2=5”. we will not waste time coming up with new proofs that this is a fallacious calculation.
I would like to put forth a few propositions which provide a clear demonstration of the errors of conventional economic theory. I am hoping that disagreements about these central propositions can be cleared away by discussion, so that we can create consensus about complete rejection of conventional economic theories. After this step is completed, we could move forward to thinking about how to construct alternative foundations.
Propositions: Methodological Mistakes
- Logical Positivism is a theory of knowledge. It describes scientific knowledge as being based on observations (facts) and logic. It also excludes huge chunks of human experiential knowledge (such as morality) from the domain of knowledge. As one its early and enthusiastic proponents A J Ayer put it, moral statements are as meaningless as a cry of pain.
- In the early twentieth century, foundations of economic theory were revised to put them in line with the ideas of logical positivists about science, in an effort to make economics a “science”. Cooter and Rappoport showed how Lionel Robbins’ definition of scarcity, in line with positivist ideas, drove out earlier definitions of economics based on “material welfare”.
- Logical Positivism had a spectacular crash. Even its most enthusiastic exponents admitted to having been wrong. HOWEVER, the foundations of economics (and econometrics) were never revisited. Thus the foundations continue to be based on ideas which have been proven wrong. In my paper Methodological Mistakes and Econometric Consequences, I have shown how positivist foundations for econometrics have led to a seriously defective methodology currently in use.
- In my paper on The Normative Foundations of Scarcity, I have explicitly shown that apparently objective concept of “scarcity” conceals within it at least three normative principles. Thus, contrary to a central claim of conventional economic theory, it is a normative theory, and not a positive one.
The above critique is deep and philosophical. There are more obvious and direct approaches to a complete rejection.
Proposition: Empirical Failures of Conventional Economics
- Economic theory of consumer behavior is completely wrong as a descriptive theory. The massive amount of evidence is gathered in my paper: Empirical Evidence Against Utility Theory: A Survey of the Literature.
- Economic theory of the firm is completely wrong as a description of firm behavior. A massive amount of evidence is gathered in “Debunking the Theory of the Firm” by Steve Keen and Russell Standish
- The economic theory of price determination via equilibrium between supply and demand is completely wrong. I have provided a simple example and explanation of its failure in my paper on “Conflict Between General Equilibrium and the Marshallian Cross”. This shows that partial equilibrium supply and demand analysis in one market is in conflict with general equilibrium results, so both cannot be right. Steve Keen and Russell Standish, and perhaps others as well, have gone much further, and provided an alternative theory of price determination.
- Once we see that consumer theory, producer theory, and equilibrium theory of price determination are all clearly and obviously wrong, does there remain any further issue to discuss about errors of conventional economic theory? Why should we waste time discussing theories which take all three of these basic building blocks for granted and then construct more complex arguments?
In practice, I have found that to create the courage of conviction required to launch a revolution, it is not enough to just provide a logical argument, or an empirical demonstration, of the fallacies of conventional economic theories. It is so hard to believe that highly intelligent people, capable of mastering the complexities of technical mathematics required for general equilibrium, could go so seriously astray. Thus, in order to make plausible the idea that massive amounts of effort are being poured into completely fallacious theories, one must study the story of the rise and fall of logical positivism. This is the key to understanding why current economic theories are so seriously defective, and also how we can avoid making the same errors which led to this disaster. Instead of answers, I pose the following questions which we must learn the answers to, in order to understand HOW an intellectual tradition became corrupted by logical positivism.
- What is the theory of logical positivism? More importantly, why did it become so wildly popular? How is it that some of the most intelligent people in the twentieth century came to believe in its central propositions? It must be the case that the defect in logical positivism is a subtle one, to take in so many innocents into its trap.
- Interestingly, a recent survey by Hands, cited in my paper on Normative Foundations of Scarcity, shows that most economists continue to believe in some the key propositions of logical positivism, even though it has been thoroughly refuted by philosophers. Here is the key to the failure of heterodoxy: most heterodox economists also continue to believe in some key propositions of logical positivism. As a consequence, it is impossible for them to construct a sound alternative to conventional economic theories.
- FOR STARTERS: we must learn WHY the argument for revealed preference, which deceived Samuelson, is wrong. As per standard positivist ideas, preferences are internal to the heart and unobservable; hence they cannot be used in scientific theories. So Samuelson came up with the idea of using the observable Choices – unobservable preferences are revealed by observable choices. Instead of unscientific arguments about unobservable preferences, we can make scientific arguments about observable choices. Samuelson’s Nobel Prize cites his contributions in making economics a scientific subject. Yet the basic argument is wrong; one cannot eliminate the unobservable preference from economic theories. Understanding this error, which Samuelson failed to do, is the first knot to unravel, in order to clear our minds and hearts of the logical positivist illusions.