PART THREE

NEO-CLASSICAL ECONOMICS

Introduction

In the world of neo-classical economics, the focus of analytical attention was directed to the process through which a market system allocates an economy's resources. This theme, though not altogether absent from the classical and Marxian traditions, had been far overshadowed in these theoretical systems by the paramount concern with inter-relationships between long-period dynamic change and the distribution of income among the various orders of society. The approach to economic analysis developed by neo-classical theorists reversed the earlier orderings of analytical priorities. In their type of theoretical structure, market behaviour within carefully delimited spans of time supplied the organizing principle of thought. Meanwhile, the grand themes of long-period development faded far into the background.

The re-orientation in economic thinking brought by neo-classicists was connected with changes in the economic environment of Western societies. Men of the high Victorian age could, with considerable justification in events, hold that de-emphasis of the problems with which the classical tradition had been preoccupied was appropriate. Western economies had enjoyed prosperity in unprecedented measure and without the checks anticipated by the classical and Marxian traditions. Continued economic expansion, though not unimportant, appeared to be capable of taking care of itself. Moreover, in the face of observable improvements in real wages, the Cassandra calls of Marx and his classical forerunners about the likely consequences of growth for the condition of the working class appeared to be misplaced.

From the point of view of the neo-classical economists the problem deserving study was the functioning of the market system and its role as an allocator of resources. Clearly a re-thinking of this issue was timely. In the years since the classicists had written about the economy's natural order the economic structure had altered significantly. Industrial concentrations had grown in size and in capacity to wield unchecked economic power. Trade unions, though still in their infancy, were beginning to claim a voice in wage setting. In the language of classical writers, it could no longer be taken for granted that the normal operation of the economy would tend to make 'natural' and 'market' prices converge.

Changes in the economic environment, however, could go only part way towards accounting for the re-orientation in thought represented by neo-classical economics. Intellectual currents of the time also influenced the choice of theoretical issues and the manner in which they were treated. In the main, neo-classical writers absorbed the late nineteenth-century faith in progress and in the benevolence of its consequences. Their conclusions pointed to the existence of certain 'imperfections' in the economic system that called for policy remedies. Nevertheless, they restored a temper of optimism to economic discourse that - with only a few exceptions - had been suppressed since Malthus. Progress, they could hold, appeared to resolve social tensions rather than to aggravate them.

These influences converged to direct the attention of economic theorists to an analysis of economic behaviour focusing on its decision-making units - households, firms, and industries - and on the ways in which choices made by their economic agents were converted into an orderly process. The answers supplied at least purported to demonstrate that the market system was essentially an instrument of integration through which the resources at the disposal of the economy could be allocated to the most socially beneficial uses. With this concentration on the behaviour of small units of the system (as opposed to the dominant concern of earlier theoretical traditions with aggregate income and its share-out between profits, wages, and rents), micro-economics - i.e. the study of economic behaviour of households, firms, and industries - was brought to the centre of the stage.

This adjustment of analytical priorities was to have sweeping implications for the organization of economic thought and for the selection of issues deemed worthy of attention. One of its immediate consequences was to elevate the status of the theory of market price. For the purposes of analysing the behaviour of a market system, an understanding of the factors shaping the prices of both outputs and inputs took on a paramount importance. No longer was the discussion of price subordinated to concerns about natural 'value' and its long-period determinants. It became instead the lynch-pin of the whole network of micro-economic relationships. The elaborate embellishments to the analysis of market price formation worked out by the neo-classical economists opened up analytical horizons undreamed of by the John Stuart Mill of 1848, who had declared the theory of value to be complete.

The primacy of price-theory, however, necessarily implied a downgrading of other themes - and particularly of the long-period growth and distribution concerns of the classical and Marxian traditions. Even so, most major neo-classical theorists felt obliged to offer a few comments in passing about the longer-term prospects of the economy. This matter, however, was not close to their hearts and was, in the main, treated rather cursorily. From their standpoint the important issues were more immediate in time. One commentator has described this shift in emphasis as a displacement of the big classical questions of growth and distribution by such little ones as 'why does an egg cost more than a cup of tea?'*

It was not simply by chance that neo-classical modes of reasoning should have been so far removed from those adopted in earlier theoretical traditions. Indeed, some of the pioneer formulators of neo-classical theory consciously designed their categories of analysis as refutations to Marx. In their hands economics was effectively removed from historical time and detached from the ‘laws' of history. The search for the laws of motion of society was largely abandoned to be replaced by the investigation of market processes and their allocative properties. Human behaviour (or at least a stylized interpretation of its economic mainsprings) became the point of departure. On this basis neo-classical writers addressed their attention to the decisions reached by producers and consumers in market situations and to the analysis of their consequences. Worlds separated this approach from Marx's conviction that human behaviour was driven by impersonal forces beyond challenge or control. Within a neoclassical perspective the scope for conscious choice and policy initiative was enormously widened. Though many who worked within this theoretical framework opposed governmental intervention in economic life, they were still prepared to argue that policies of the state could alter the course of economic affairs.

While neo-classical analysts shunned the fatalistic overtones of earlier traditions (and of Marxism in particular) they continued to look to the natural scientists for inspiration. The images and vocabulary of the natural sciences emerged most clearly in the propensity of neo-classical economists to construct much of their argument around ‘pure' cases. Economic investigation, they maintained, should proceed in a manner analogous to research in a scientific laboratory. Some allowance had to be made for the fact that economic events could not be studied under controlled experimental conditions. The ideal situation could be simulated, however, through the formulation of abstract models of the economy's behaviour in which the frictions and untidiness of the real world were neglected. Admittedly, such formal systems could claim to be no more than approximations. Nevertheless, they were defended on two principal grounds: first, they isolated for inspection the central nerves of the economic process; and secondly, they provided a benchmark against which the performance of the flesh-and-blood economy could be measured.

This modus operandi lent itself readily to the use of mathematics in economic analysis and particularly to the application of the differential calculus. Even so, the widespread adoption of mathematical notation in economic debate did not altogether satisfy Malthus's appeal in the early decades of the century for a standardized set of definitions in the discipline. Each theorist exercised his prerogative to define symbols in a manner of his own choosing. Nevertheless, findings that could be reported in mathematical notation did lend an aura of universality to the subject. Moreover, this manner of argument both elevated the rigour of economic discussion and placed a premium on logically tight and consistent argument - even if, at times, the price of consistency was detachment from close contact with real problems.

The era of neo-classical economics differed from that of its predecessors in yet another respect. For the first time, economic theorizing at a high level became a thoroughly international activity. By contrast with classicism - the overwhelming bulk of the contributors to which were British - insights of fundamental significance to the formal treatment of neo-classical problems were generated by nationals of many countries. While the fertility of the English tradition was undiminished, important schools of neo-classicism emerged in Vienna, Lausanne, Sweden, and in the United States. Each played its own variations on the common neo-classical theme: the analysis of the allocative properties of a market system.

In the world of neo-classicism, economics became more universal and more scientific in its claims - and less dismal in its conclusions.