RH351 Rhetoric of Economic Thought Transparencies Set 5 Marshal, Marginalism, & Alternative Voices: Economics Comes of Age

Economic Analysis – Key Contributors, 19 th century Karl Marx (1818 – 1883) Adam Smith (1723 – 1790) David Ricardo (1772 – 1823) August Cournot (1807 – 1877) Johann von Thünen (1793 – 1850) Hermann Gossen (1810 – 1858) John Stuart Mill (1806 – 1873) Stanley Jevons (1835 – 1882) Leon Walras (1834 – 1910) Carl Menger (1840 – 1921) Alfred Marshall (1842 – 1924) Walras Cournot Marshall Jevons Mill

Marshall’s Inaugural Lecture, Cambridge, February 1885 “… that part of economic doctrine, which alone can claim universality, has no dogmas. It is not a body of concrete truth, but an engine for the discovery of concrete truth, similar to, say, the theory of mechanics. “… why are so many lives draggled on through dirt and squalor and misery? Why are there so many haggard faces and stunted minds? Chiefly because there is not wealth enough; and what there is, is not well distributed, and well used … “Never was there an age so full of great social problems as ours; surely they are not unworthy of the best efforts of the best minds among us. … “It will be my most cherished ambition, my highest endeavor, to do what with my poor ability and my limited strength I may, to increase the numbers of those, whom Cambridge, the great mother of strong men, sends out into the world with cool heads but warm hearts …” “It is vain to speak of the higher authority of a unified social science. No doubt if that existed Economics would gladly find shelter under its wing. But it does not exist; it shows no signs of coming into existence. There is no use in waiting idly for it; we must do what we can with our present resources. “There is wanted wider and more scientific knowledge of facts: an organon stronger and more complete, more able to analyze and help in the solution of the economic problems of the age. To develop and apply the organon rightly is our most urgent need: and this requires all the faculties of a trained scientific mind. Eloquence and erudition have been lavishly spent in the service of Economics. They are good in their way; but what is most wanted now is the power of keeping the head cool and clear in tracing and analyzing the combined action of many combined causes. Alfred Marshall

Precursors to marginalism: Cournot E conomists understand by the term Market, not any particular market place in which things are bought and sold, but the whole of any region in which buyers and sellers are in such free intercourse with one another that the prices of the same goods tend to equality easily and quickly August Cournot Competitive Outcome Cournot Outcome

Precursors to marginalism: Gossen’s 1 st & 2 nd “laws” First Law "... the magnitude of a given pleasure decreases continuously if we continue to satisfy this pleasure without interruption until satiety is ultimately reached." Second Law "The magnitude of each single pleasure at the moment when its enjoyment is broken off shall be the same for all pleasures." Hermann Gossen, The Development of the Laws of Exchange among Men and of the Consequent Rules of Human Action (1854)

The marginalist “revolution”: Jevons W e may state as a general law that the degree of utility varies with the quantity of commodity, and ultimately decreases as that quantity increases. Stanley Jevons 1832 – 1882 "Brief Account of a General Mathematical Theory of Political Economy", 1866 The Theory of Political Economy, 1871.

The marginalist “revolution”: Menger Carl Menger Grundsätze (Principles of Economics, 1871) N ever was there an age that placed economic interests higher than does our own. Never was the need of a scientific foundation for economic affairs felt more generally or more acutely. And never was the ability of practical men to utilize the achievements of science, in all fields of human activity, greater than in our day. If practical men, therefore, rely wholly on their own experience, and disregard our science in its present state of development, it cannot be due to a lack of serious interest or ability on their part. Nor can their disregard be the result of a haughty rejection of the deeper insight a true science would give into the circumstances and relationships determining the outcome of their activity. The cause of such remarkable indifference must not be sought elsewhere than in the present state of our science itself, in the sterility of all past endeavors to find its empirical foundations.

The marginalist “revolution”: Walras “Facts of the Universe” Natural Phenomena: Those which result from the blind forces of nature Human Phenomena: Those which result from the exercise of the human will (a force that is free and cognitive) Pure Natural SciencePure Moral ScienceArt or Ethics Science “observes, describes, and explains” Art “advises, prescribes and directs” Leon Walras Elements of Pure Economics (1874)

The marginalist “revolution”: Walras General Equilibrium

Marshall on method I never read mathematics now; in fact I have forgotten how to integrate a good many things… But I know I had a growing feeling in the later years of my work at the subject that a good mathematical theorem dealing with economic hypotheses was very unlikely to be good economics: and I went more and more on the rules – (1) Use mathematics as a shorthand language, rather than as an engine of inquiry. (2) Keep to them until you have done. (3) Translate into English. (4) Then illustrate by examples that are important to real life. (5) Burn the mathematics. (6) If you can’t succeed in (4), burn (3). Alfred Marshall

“Second Generation” Marginalists / Neoclassical Economics …N ow, it is remarkable that the principal inquiries in Social Science may be viewed as maximum-problems… Since, then, Social Science, as compared with the Calculus of Variations, starts from similar data – loose quantitative relations – and travels to a similar conclusion – determination of maximum – why should it not pursue the same method, Mathematics? Mathematical Psychics, (1881) Francis Edgeworth (1845 – 1926)  Contemporary of Marshall’s; Oxford chair  Utility theory, indifference curves, “Edgeworth box”

“Second Generation” Marginalists / Neoclassical Economics Vilfredo Pareto (1848 – 1923)  Successor to Walras at Lausaunne  Pioneer in the area of welfare economics  Manual of Political Economy (1906)  Pareto optimality

“Second Generation” Marginalists / Neoclassical Economics John Bates Clark …T he distribution of income to society is controlled by a natural law, and this law, if it worked without friction, would give to every agent of production the amount of wealth which that agent creates. Distribution of Wealth (1889) John Bates Clark (1847 – 1938)  Teacher at Columbia University  Marginal productivity theory of distribution

“Second Generation” Marginalists / Neoclassical Economics Irving Fisher (1868 – 1947)  Professor of Economics at Yale  Proponent of the Quantity Theory of Money  The Theory of Interest (1907) “Stock prices have reached what looks like permanently high plateau.” October 17, 1929

“Second Generation” Marginalists / Neoclassical Economics Arthur Cecil Pigou (1877 – 1959)  Successor to Marshall at Cambridge  Pioneer in the area of welfare economics  Keynes’s foil in The General Theory

Wilhelm Roscher (1817 – 1894) Friedrich List (1789 – 1846) Karl Knies (1821 – 1898) Early German Historical School Gustov Schmoller (1838 – 1917) Werner Sombart (1863 – 1941) Later German Historical School Richard Ely (1854 – 1943) John Bates Clark (1847 – 1938) Early American Economists Austrian School Carl Menger (1840 – 1921) Friedrich von Wieser, ( ), Eugen von Böhm-Bawerk ( ) Ludwig von Mises (1881 – 1973) Joseph Schumpeter (1883 – 1950) Friedrich von Hayek (1889 – 1992) Oscar Morgenstern (1902 – 1976) Richard Ely (1854 – 1943) John Bates Clark (1847 – 1938) Early American Institutionalism Adam Muller (1779 – 1829) German Romanticism Ronald Coase Oliver Williamson New Institutionalism Wesley Mitchell (1874 – 1948) John Kenneth Galbraith (1908 – 2006) Old Institutionalism Methodenstreit (“Debate over Method”) Alternative voices in the history of economic thought

Institutionalism in Economic Thought A complex organism cannot be understood if each segment is treated as if it were unrelated to the larger entity. Economic activity is not merely the sum of the activities of persons motivated individually and mechanically by the desire for maximum monetary gain. In economics there are also patterns of collective action that are greater than the sum of the parts. An institution is not merely an organization or establishment for the promotion of a particular objective, like a school, a prison, a union, or a federal reserve bank. It is also an organized pattern of group behavior, well-established and accepted as a fundamental part of the culture. It includes customs, social habits, laws, modes of thinking, and ways of living … Economic life, said the institutionalists, is regulated by economic institutions, not by economic laws. Thorestein Veblen Stanley Brue, The Evolution of Economic Thought John Commons 1862 – 1945 Wesley Mitchell 1874 – 1948

Veblen and neoclassical analysis I n all the received formulations of economic theory, whether at the hands of English economists or those of the Continent, the human material with which the inquiry is concerned is conceived in hedonistic terms; that is to say, in terms of a passive and substantially inert and immutably given human nature … The hedonistic conception of man is that of a lightning calculator of pleasures and pains who oscillates like a homogeneous globule of desire of happiness under the impulse of stimuli that shift him about the area, but leave him intact. He has neither antecedent nor consequent. He is an isolated definitive human datum, in stable equilibrium except for the buffets of the impinging forces that displace him in one direction or another. Self-imposed in elemental space, he spins symmetrically about his own spiritual axis until the parallelogram of forces bears down upon him, whereupon he follows the line of the resultant. When the force of the impact is spent, he comes to rest, a self-contained globule of desire as before. Spiritually, the hedonistic man is not a prime mover. Thorestein Veblen Why is Economics not an Evolutionary Science? (1898)

Veblen’s Style: Theory of the Leisure Class G enerally, as industrial activity further displaces predatory activity in the community’s everyday life and in men’s habits of thought, accumulated property more and more replaces trophies of predatory exploit as the conventional exponent of prepotence and success. Conspicuous consumption of valuable goods is a means of reputability to the gentleman of leisure. Throughout the entire evolution of conspicuous expenditure, whether of goods or of services or human life, runs the obvious implication that in order to effectually mend the consumer’s good fame it must be an expenditure of superfluities. In order to be reputable, it must be wasteful.. Thorestein Veblen The Theory of the Leisure Class (1899)

Veblen’s Critique of Modern Capitalism I n more than one respect the industrial system of today is notably different from anything that has gone before. It is eminently a system, self-balanced and comprehensive; and it is a system of interlocking mechanical processes … it lends itself to systematic control under the direction of industrial experts, skilled technologists, who may be called “production engineers,” for want of a better term … technological specialists whose constant supervision is indispensable to the general staff of industry … The captains [of industry] have per force continued to employ the technologists, to make money for them, but they have done so only reluctantly, tardily, sparingly, and with a shrewd circumspection; only because and so far as they have been persuaded that the use of these technologists was indispensable to the making of money. By settled habit, the technicians, the engineers and industrial experts, are a harmless and docile sort, well fed on the whole, and somewhat placidly content with the “full dinner-pail” which the lieutenants of the Vested Interests habitually allow them. Thorestein Veblen The Engineers and the Price System (1921)

Institutionalists and Business Cycle Studies Kuznets's life work was the collection and organization of the national income accounts of the United States Wesley Mitchell 1874 – 1948 Simon Kuznets 1901 – 1985 Mitchell's life work was the documentation of the U.S. business cycle.

The Affluent Society (1958) The New Industrial State (1967) From The New Industrial State, chapter 31: “Viewing the whole economy in purely technical terms, no natural superiority can be assumed either for the market or for planning. In some places market responses still serve. Over a very large area such responses cannot be relied upon; the market must give way to more or less comprehensive planning of demand and supply. Here, if the industrial system does not plan, performance will be poor and perhaps appalling … The error is in basing action on generalization. There is no natural presumption in favor of the market; given the growth of the industrial system the presumption is, if anything, the reverse. And to rely on the market where planning is required is to invite a nasty mess.” Galbraith’s “New Industrial State” John Kenneth Galbraith 1898 – 2006

Joseph Schumpeter 1883 – 1950 S chumpeter turned Karl Marx on his head … Hateful gangs of parasitic capitalists become, in Schumpeter’s hands, innovative and beneficent entrepreneurs.” Thomas K. McCraw, Prophet of Innovation: Joseph Schumpeter and Creative Destruction Major Publications: The Theory of Economic Development (1911) Capitalism, Socialism and Democracy (1942) History of Economic Analysis (1954) Schumpeter’s contradictory views

Capitalism, Socialism and Democracy (1942): C an capitalism survive? No. I do not think it can. But this opinion of mine, like that of every other economist who has pronounced upon the subject, is in itself completely uninteresting. What counts in any attempt at social prognosis is not the Yes or No that sums up the facts and arguments which lead up to it but those facts and arguments themselves. They contain all that is scientific in the final result. Everything else is not science but prophecy … The thesis I shall endeavor to establish is that the actual and prospective performance of the capitalist system is such at to negative the idea of its breaking down under the weight of economic failure, but that its very success undermines the social institutions which protect it, and “inevitably” creates conditions in which it will not be able to live and which strongly point to socialism as the heir apparent. Schumpeter’s contradictory views

The opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory to such concerns as U.S. Steel illustrate the same process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.” Schumpeter’s “Creative Destruction” Joseph Schumpeter Capitalism, Socialism and Democracy

The Austrian School of Economics “First” Generation: Friedrich von Wieser ( ), Eugen von Böhm-Bawerk ( ) “Second” Generation: Ludwig von Mises (1881 – 1973) Joseph Schumpeter (1883 – 1950) “Third” Generation: Friedrich von Hayek (1889 – 1992) Oscar Morgenstern (1902 – 1976)  Radically "subjectivist" strain of marginalism  Dedication to a priorism and an emphasis on methodological individualism  Time-theoretic approach to capital theory  Monetary overinvestment business cycle theory  Analysis of markets in terms of disequilibrium  Stress on uncertainty and information in the economy