The period between the two world wars was characterized by unprecedented rise in unemployment, the great depression, and housing crisis. This prompted the economists to question the tenets of capitalism and started reexamining the principles of Marxism. There was an increasing general feeling that Karl Marx view on the future of capitalism might not have been misplaced after all (Wesleyan, n.d: 9). Demonstrations and go slows were souring especially with the march by American war veterans to the capital which brought out the Karl Marx scenario in the open. Previous economic theories did not offer any amicable solutions to the economic distress that was facing the world (Adaman & Devine, 1994: 64). It was against this background that the post Keynesian and Austrian theorists challenged the argument behind the neoclassical theory.
The neoclassical theory was founded on the basis that full employment was the economies optimal level beyond which the economy would readjust itself. This notion was however watered down by the reality of the great depression especially in 1930’s. There was high idleness of the labor force and plant capacity with economy showing no signs of recovery on sight. This was enough proof that the neoclassical theory assumptions were deeply flawed. The explanation given by the proponents of the theory was that the rigidity in the wages as a result of the influence by the trade unions was largely to blame for the failure of automatic adjustment.
In addition, they added that the market consolidations witnessed during the war period gave rise to monopolies hence becoming price makers (Murrell, 1991: 62). This impaired pricing making it inflexible to the sellers which in the long run hampered self adjustment to full employment. The neoclassical assumptions and their view of competition have come under sharp criticism from many economic theorists. In this paper I seek to argue out that the post Keynesian and the Austrian economists’ criticisms stand out as a powerful argument against the standard neo classical view.
The critique of standard neoclassical view of consumption
One of the major departures by the Austrian group from the neoclassical theorists was the opposition to the mathematical equilibrium approach. They contended that the approach only sought to simplify the behavior of the economic variables rather than to represent the actual reality in the market (Chamberlain, 1998. 1). The Austrians argued that the restrictions imposed in the assumption of the model confined them to the activities within the assumptions while leading to a biased interpretation of the events occurring outside those assumptions. Their source of contention was the methodology employed by the neoclassical theorists who believed that economics was empirical and entirely depended on observation (Lavoie, 1981: 72). This implies that the theory is valid if the assumptions are valid whether the variables are observable in the real world or not (boogie online, n.d). This according to the Austrians caused a gap between theory and the reality in the market.
The Austrian economists see the market as being characterized by imperfect rather than the perfect information advocated by the neoclassical economist’s equilibrium model. The imperfect information indeed acts as a constraint for attainment of equilibrium in the market. This element which they called sheer ignorance manifested in the imperfect information could not be accommodated in the neoclassical model (Kirzner, 1997: 62). This element of sheer ignorance is broken by entrepreneurial discovery which broadens awareness among the market actors. This in turn takes the inputs, outputs, and prices back to the equilibrium levels. They also oppose the assumption that the market is always in equilibrium and presuming that equilibrium will always prevail in the market that gives little room for emerging equilibrium in the market.
The criticism by the Austrian economists is geared towards discouraging the dominance of perfect competition model and replacing it with their dynamic model. The market actors in this model become price takers instead of price makers and competitive quality makers as opposed to the former. The Austrians also take leave from the neoclassical highly mechanical mode of constrained maximization which ignores the role of human choice in decision making (Mises, 1920: 3). The human choice neoclassical model appears rigid blocking the possibility of the consumer being open ended, imaginative, and bold as is often the case in decision making.
As a result of the above argument, the Austrians claimed that economics was a logical rather than an empirical science. They further supported this argument by observing that economic data is not observable in the actual world and only exists in the minds of the economic actors (boogie online, n.d.). As argued by scientists, a theory can only be valid only when its assumptions are valid irrespective of whether the assumptions are observable or not.
The Austrian school of thought also challenges the assumption that consumers in perfect competition are always seeking to maximize their utility (Rowthorn, 1973: 28). This assumption assumes that a maximizing consumer makes use of known procedures toward a known course and the firms know their costs and revenue curves. The notion of the perfect knowledge is implied by the data hence making economics more logical than empirical. This school of thought thus argues that maximizing behavior based theory has very limited potential of searching and studying new data (boogie online, n.d: 1).
The Austrians also criticize the equilibrium analyses which measures efficiency of the market using output while picking out perfect competition as the standard model. The equilibrium model fails to factor in value quality which is highly valued by the consumers. The perfect competition model according to them offers a misleading interpretation of competition while on the other hand; the product differentiation and selling costs are given a distorted meaning in the imperfect competition model. Pure monopoly model in addition gives the wrong impression of competition and restriction. The neoclassical model gives no room for entrepreneurship due to the fact that opportunities for profits are diminished and individual decision making inhibited (Carlton & Perloff, 2005: 70).
To the Austrians, innovation is not compatible with perfect competition. The idea of perfect knowledge for all products and the methods of production ignore the role of innovation on the equilibrium models. Bringing in innovation takes away the market from equilibrium. Neoclassical theorists argue that differentiation of the products results in monopolies in an imperfect competition market model (boogie online, n.d: 1). The Austrians argue that product differentiation originate from the nature of the goods rather than arbitrary grouping of goods.
By assuming perfect information in the market, neoclassical economists are criticized by the Austrians for displaying a misinterpreted notion of the selling costs. The aim of the selling costs is to influence the demand of the commodity while production cost is incurred in the conversion of the product from its raw form to the finished form and so in effect changes supply. The pure monopoly envisaged by the neoclassical theorists follows a misplaced notion of competition. They view competition as a situation rather than an ongoing process. In reality monopoly can exist even in the presence of competitive environment. A seller who has no legal limitation or monopolistic access to resources still faces a competitive pressure to improve his services and products from consumers.
The post Keynesian theorists argue that the perfect competition model portrays all the players as being passive. They thus are unable to raise their welfare and profits by manipulation of prices, product promotions, product designs, branding, and innovations. These are said to be characteristic of most markets and businesses. This is informed by the assumption of product homogeneity and the subsequent inability to differentiate them (Wohlgemuch, 1995: 38). Another criticism is directed on the notion that in the short run, changes in supply and demand causes shifts in prices (absolute astronomy, 2009: 2). In real sense, in the manufacturing sector the industry alters their production output without changing their prices. The post Keynesians concentrate on supply and distribution rather than the working of the perfect competition.
The post Keynesian economist also challenged the argument that full flexibility of wages in the market would cause full employment of labor in the economy. The Sraffian School of thought for example argues that it is impossible to obtain the labor demand curve and therefore there exist no level of wage that balances the supply and demand for labor (absolute astronomy, 2009: 3). These advocates for the revisit of the classical theory where competition in the labor market can not translate to flexibility of price as long as supply and demand are not equal. They further claim that the level of wages are determined by the factors outside the model which include the employees allegiance to a class, customs, and the influence of the trade unions which act as a bottleneck to the smooth running of the labor market.
Other post Keynesian economists like the heterodox economist challenge the little attention accorded to the human welfare. They observe that there is a strong correlation between the national output of the country and its human welfare which neoclassical theorist tends to have been ignored in their models (Cohn, 2003: 4). These tend to give emphasis on the empirical findings about the human welfare and the effect of economic variables on non-economic elements such as democracy and peoples customs which are of significant importance in the market.
The neoclassical economists also advocate for the government control in the market. They argue for nationalization of those firms that fail to meet the perfect competition criteria. They say by doing so the firm owners would be directed to price their products at marginal cost hence allowing for optimal allocation of resources. This notion has been strongly challenged by the post Keynesian theorists who insist on the free hand in the market to avoid distortions in the market which are characteristic of planned economies. They argue that as long as technical innovations are sustained, important characteristics of competition can be maintained (Wesleyan, n.d:1). These economists advocate for the easing of the government controls on the market.
Thornstien Veblen and J.B. Clark criticized the concept behind the neoclassical theory by arguing out that the neoclassical theory was too formal, deductive, and too static to solve the emerging economic issues. It lacked enough clout to analyze economic dynamics and changes in the society. They argued that the neoclassical concept tended to rely heavily on single assumed changes by holding all other factors constant from which attempts were made to trace back the equilibrium level. Veblen argued that although the neoclassical theory relied on rational tabulation of human behavior, it assumed that human actions were instinctive rather than reflective (Wesleyan, n.d: 1). He observed that human beings are naturally motivated to produce, innovate, and to create which if unrestrained would lead to economic sufficiency. To him, human efforts are suppressed by other factors surrounding him.
Veblen also even opposed the basic tenets of neoclassical theory which implied that with proper knowledge of the market, consumers would buy more commodities at lesser prices than at higher market prices. He cited Veblen goods that have an abnormal demand curve in this argument to prove that conspicuous consumption would produce the opposite results of the assumptions. This he illustrated by indicating that luxurious goods that are often treated as status symbols will have a lesser demand as their prices fall (Wesleyan, n.d: 1). on the perceived disutility of labor by neoclassical economists, he observed that man by instincts derives satisfaction from his productive efforts.
The post Keynesian and the Austrian criticisms stand out as a powerful argument against the standard neo classical view. The erroneous assumption of the neoclassical model relied heavily on equilibrium model though it offered the first major attempt of analyzing human behavior using rational mathematical calculations which failed to connect reality with its logical assumptions (Chaloupek, 1990: 70). Thus, the criticism labeled against them had a strong basis especially against the rigid competitive model assumptions which assumed perfect information.
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