What can economics explain?

The death of Gary Becker, the father of the "economics of everything" set me wondering: could it be that basic neoclassical economics does a better job of explaining "non-economic" behaviour than it does of economic phenomena?

Take three examples where basic neoclassical is, at best, questionable:

 - A theory of distribution. The idea that wages are equal to workers' marginal product is deeply questionable. It seems instead that power, rent-seeking and institutional frameworks also matter enormously; the fact that there's no correlation between patterns of income inequality and of human capital inequality should be awkward for neoclassicals. And the idea of a marginal product of capital is just close to meaningless, which gives neoclassical economics little idea of where profits come from.

 - The Solow-Swan growth model found that most economic growth was due to exogenous technical progress, which is pretty much no explanation of growth at all. The difficulty (pdf) of relating growth to human capital suggests that augmented theories do little better. And the fact that governments in developed economies can do little to change long-term growth rates suggests that growth theory hasn't (yet?) had a useful policy influence.

 - The neoclassical explanation of unemployment stresses wage inflexibility and "rigidities". But this fails to account for why unemployment was high in the 19th century.

By contrast, Beckerian economics has given us some useful insights into crime, family life (pdf) and racial discrimination.

There might be good reasons for this difference. Matters of individual choice are often more tractable in the "non-economic" than economic arena. The man thinking of committing a crime, for example, doesn't face such severely bounded rationality and knowledge as the company boss making investment decisions. Problems of aggregating different goods are less relevant. And whereas financial capital is now abundant, time is not - and so the neoclassical presumption of scarcity remains relevant to our life choices.      

Now, I'm not saying here that neoclassical economics of everything is a complete theory. The assumption of an atomic rational maximizer is challenged by cognitive biases and peer pressures - though Becker was well aware (pdf) of the latter. And it's an open question how far the Beckerian approach can explain the collapse in crime rates recently. It might be, though, that neoclassicals' limitations in these areas are more resolvable than in others.

What I'm saying here might earn me the wrath of both heterodox and orthodox economists, but it is in a sense trivial.Different theories can explain different things. The idea that one theory fits all owes more to fanaticism and tribalism than to the data.

Comments

[Luis Enrique]

this is a bit of a funny one. some people take neoclassical theories of income distribution seriously, but nobody thinks the Solow model is a useful model in any other sense than 1. the result you mention and 2. pedagogic. Similarly I doubt anybody claims a basic neoclassical model says much about unemployment.

Generally, simple models may have one or two simple lessons or point towards things that may matter in reality (for example, the idea of how much a factor contributes towards revenues or profits, however defined, probably has something to do with how much that factor gets paid in many cases).

I'd have guessed the same goes for Becker - he liked simple abstractions that would say something, but would still have unlearningeconomics giving us insights about how reality is more complicated

[Boffy]

"The idea that wages are equal to workers' marginal product is deeply questionable."

Its not just questionable, its just plain wrong! Even Adam Smith recognised it was wrong. Workers wages are determined by the Value of their Labour-Power as a commodity, and is determined as with any other commodity, price of production (here the cost of reproducing that particular type of labour-power). It has nothing to do with the value produced by that labour-power.

If it was then there could be no surplus value, i.e. no profit. Unfortunately Adam Smith couldn't get his head round that bit, and ended up going round in circles, as did his followers like Ricardo.

Its one reason that very highly paid people can actually be more exploited than people on low wages. If you are paid £1,000 a day, but create £10,000 of new value in a day, you are more exploited than someone paid just £10 a day, who only produces £50 of new value per day.

[Boffy]

Also, there's no such thing as a marginal product of labour in respect of individual workers because labour is a social and co-operative activity.

[Ralph Musgrave]

Chris,

That chart you link to allegedly showing that “unemployment was high in the 19th century” doesn’t actually show that. It shows more than usual volatility around 1880, but that’s it.

[Gerhard Klaus]

I am not sure what exactly you mean by "neoclassical economics" but suppose we interpret it as "mainstream economics".

Well...

Your Example #1: Mainstream economics has long known that Wages don't usually equal Marginal Product, nor do they HAVE to.

The theory that MP = Wages stems from the larger theory of firm profit maximization.

But firm profit maximization can be attained without MP = Wages.

The work by Ed Lazaer and many others shows the importance of rank-order tournaments, imperfect monitoring, and other factors in determining wages.

In fact, MP = Wages is just a special case, in which there are no monitoring costs, etc.

So the neoclassical/mainstream framework of profit optimization can stay in place and still account for a lot of the real-world behavior of wages.

You seem to be taking it as some kind of fundamental law or rules.

It's not.

Your Example #2: The neoclassical framework shows that growth depends on capital accumulation, labor accumulation, and productivity.

Productivity and investments in capital in turn depend on institutions, laws, norms, technology, agglomeration and network effects, etc.

The framework is still in place.

It's just that their components are being steadily decomposed by modern economics into finer and finer details.

Lots of modern economics is concerned with precisely this process of understanding physical and human capital accumulation and productivity, but there is no need to reject the broader thesis that physical and human capital and productivity are what matter to growth.

So again this is not a failure of the framework.

Your Example #3: Yes, rigidities.

The theory is that full employment will obtain if wages were perfectly flexible and there were no information and coordination problems.

These days economists are understanding the information and coordination problems.

For example, work has been done showing that it is optimal for employers to set wages above market-clearing levels when monitoring costs exist.

Yet again, the framework is still in place. It is just being filled out from within.

[ezra abrams]

I read the first few words in teh crime paper from italy
I find it hard to imagine that Becker added anything that wasn't already known to others

[Kaleberg]

I used to fly a lot on business, and in every in flight magazine there was an ad for Karass negotiating seminars. Their motto was: "In business as in life, you don't get what you deserve you get what you negotiate." Despite being a techie, I was often involved in contract negotiations, so this statement always rang true. I was always surprised it never seemed to appear in any economic theories or arguments.

(Karass seemed to be fairly successful as their ads got larger over the years and they switched from black and white to color. Magazine ads were a great way to follow businesses. There was that weird guy with the Scientific American ads telling you that you could "do real math on your calculator", and there were the little Natural History ads for Victoria's Secret back when they were just a mail order outfit offering the discreet purchase of sexy lingerie. Internet ads just don't seem to offer as much of a sense of business, probably because they are sparser, gaudier and automatically and adaptively placed.)