Tuesday, September 2, 2014

Breaking the Neoclassical Monopoly in Economics

For 25 years, the so-called “Washington Consensus” – comprising measures aimed at expanding the role of markets and constraining the role of the state – has dominated economic development policy. As John Williamson, who coined the term, put it in 2002, these measures “are motherhood and apple pie, which is why they commanded a consensus.”

Not anymore. Dani Rodrik, a renowned Harvard University economist, is the latest to challenge the intellectual foundations of the Washington Consensus in a powerful new book titled One Economics, Many Recipes: Globalization, Institutions, and Economic Growth . Rodrik’s thesis is that though there is only one economics, there are many recipes for development success.

Rodrik has rendered a major service by stating so openly the claim of “one economics.” A critic who made the same claim that economics allows only one theoretical approach would be dismissed as paranoid, whereas Rodrik’s standing creates an opportunity for a debate that would not otherwise be possible.

The “many recipes” thesis is that countries develop successfully by following eclectic policies tailored to specific local conditions rather than by following generic best-practice formulas designed by economic theorists. This challenges the Washington Consensus, with its one-size-fits-all formula of privatization, deregulated labor markets, financial liberalization, international economic integration, and macroeconomic stability based on low inflation.

But, while the many recipes thesis has strong appeal and empirical support, and suggests a spirit of theoretical pluralism, the claim of “one economics” is misguided, for it implies that mainstream neoclassical economics is the only true economics.

Part of the difficulty of exposing this narrowness is that there is a family split among neo-classical economists between those who believe that real-world market economies approximate perfect competition and those who don’t. Believers are identified with the “Chicago School,” whose leading exponents include Milton Friedman and George Stigler. Non-believers are identified with the “MIT School” associated with Paul Samuelson. Rodrik is of the MIT School, as are such household names as Paul Krugman, Joseph Stiglitz, and Larry Summers. This split obscures the underlying uniformity of thought.

The Chicago School claims that real-world market economies produce roughly efficient (so-called “Pareto optimal”) outcomes on which public policy cannot improve. Thus, any state intervention in the economy must make someone worse off.

The MIT School, by contrast, argues that real-world economies are afflicted by pervasive market failures, including imperfect competition and monopoly, externalities associated with problems like pollution, and an inability to supply public goods such as street lighting or national defense. Consequently, policy interventions that address market failures – as well as widespread information imperfections and the non-existence of many needed markets – can make everyone better off.

None of this is about fairness, which is a separate issue. Indeed, neither the Chicago School nor the MIT School say that market outcomes are fair, because actual market outcomes depend on the initial distribution of resources. If that distribution was unfair, current and future outcomes will be unfair, too.

Chicago economists seem to believe that real-world outcomes are acceptably unfair and, more importantly, that attempts to remedy unfairness are too costly, because tampering with markets causes economic inefficiency. They believe that government intervention tends to generate its own costly failures because of bureaucratic incompetence and rent-seeking, whereby private interests try to steer policy to their own advantage.

MIT economists tend to espouse the opposite: fairness is important, the real world is unacceptably unfair, and government failure can be prevented by good institutional design, including democracy.

These differences reflect the intellectual richness of neo-classical economics, but they provide no justification for the claim that there is one economics. On the contrary, heterodox economists like Thorsten Veblen and Joseph Schumpeter long ago raised many of today’s cutting-edge issues in neoclassical economics, including the role of social norms and the relationship between technological innovation and business cycles.

Heterodox economics includes core theoretical concepts that are fundamentally incompatible with neoclassical economics in either of its two contemporary forms. These concepts result in significantly different explanations of the real world, including income distribution and the determinants of economic activity and growth. Moreover, they often result in different policy prescriptions.

The late Robert Heilbronner – one of Schumpeter’s most renowned students – viewed economics as “worldly philosophy.” Just as philosophers are divided on the nature of truth and understanding, economics is divided on the workings of the real world. Paradigms should co-exist in economics, just as in other social sciences. Yet, in practice, the dominance of the belief in “one economics,” particularly in North America and Europe, has led increasingly to a narrow and exclusionary view of the discipline.

This reality is difficult to convey. One reason is that liberal neo-classical economists like Stiglitz and Krugman share values with heterodox economists, and shared values are easily conflated with shared analysis. Another reason is that heterodox and MIT School economists also often agree on policy, even if their reasoning is different. Finally, most people are incredulous that economists could be so audacious as to enforce one view of economics.

The “many recipes” thesis enriches neo-classical economics’ contribution to the development debate, and many of its policy proposals will find support from heterodox economists. However, it fails to engage the deep intellectual divisions regarding economic development, trade, and globalization, because it refuses to admit the legitimacy of such disagreements.

By repeating the claim of “one economics,” Rodrik inadvertently reveals the censorship embedded in contemporary economics. The great challenge is not to admit that there are many recipes, but rather to create space for other perspectives on economic analysis and policy.

Hide Comments Hide Comments Read Comments (1)

Please login or register to post a comment

  1. Commentedsrinivasan gopalan

    The contention that there is only one economics but there are many recipes for development success can be used not only to debunk Washington Consensus but also the demise of Communism in the 1980s when the Soviet Union and its satellite East bloc economies collapsed like a pack of cards. Even when India fell into Washington Consensus after it had to contract a jumbo IMF loan to bail itself out from the brink of bankruptcy in 1991 by burying licence raj and ushering in trade and industrial policy reforms, the reform architect and the former Prime Minister Narashima Rao realized the danger of persisting with it. So in 1994 when he addressed the world economic forum in Davos and also subsequently in Berlin's famous Humboldt University, he coined the familiar 'middle-path' India wanted to pursue in her measured march to liberalize its economy. In all subsequent happenings and by the various governments including the present one, the sweeping reforms that were sought by global institutions or developed countries could not be put into practice as India firmly believes in its own self-styled joint sector approach to development. India's private sector dare not step into long gestation infrastructure project unless public investment of substantial amount is made. It is time that developed world particularly the US, the citadel of capitalism, recognized this bitter truth. In point of fact even at the height of global financial meltdown, most of its investment banks had to be bailed out by public money on the premise that they were too big to be lost! As Mr. Palley rightly put it that in both philosophy and economics, the path to eventual goal is the same but there are several ways to reach the final destination!
    G.Srinivasan, New Delhi, India