Thoughts on Standard Economics

I’ve been looking through Paul Krugman’s textbook Macroeconomics (Krugman and Wells, 4th edition, 2015) and came on Principle #2 – “The opportunity cost of an item—what you must give up in order to get it—is its true cost….The concept of opportunity cost is crucial to understanding individual choice because, in the end, all costs are opportunity costs. That’s because every choice you make means forgoing some other alternative.”

In this standard economics model, a central feature of capitalism gets swept under the rug or simply not mentioned, external costs. Many of the total costs of capitalist products are hidden from the pricing system, yet we all live with the consequences of the fact that capitalist markets require producers to socialize (externalize) as many costs as possible. Much of the history of the capitalist era is a struggle over who pays for these external costs. The capitalists wanted to continue to have someone else pay. Others began to push back.

Smog over Manhattan – 1966

As we will be reminded if Trump’s efforts to disable the EPA come to fruition, capitalist producers will rapidly return to polluting the air and water. Currently we substantially require them to bear many of these costs.

Another example of external costs are the human costs of US food production. Farm workers continue to be substantially outside Federal wage laws and other labor laws. The work and living conditions are deplorable but they invisibly subsidize the cost of our food. So when you are considering the opportunity costs of choices between various foods, the prices don’t reflect the lost opportunities of these workers’ lives.

When you expand the view to the claims about the “wisdom of the markets” which allegedly expresses the intelligence of countless consumers as the ultimate valuation machine this critique hardly becomes less cogent. After all Milton Friedman once took the position that the government did not need to enforce laws against fraud because the market would drive out fraudsters. Ask investors in Bernie Madoff’s company about how effective that was.

If we turn to the financial sector there is a further example of the failure of the opportunity cost valuation model. When a trader in the multi-trillion dollar per day gambling casino (a description without much rhetorical overreach) of international finance makes a buy/sell decision she has no way of evaluating the systemic risks at hand. Might her trade that day be the tipping point that creates a torrent of calls on the assets of the companies involved and intertwined? Might this lead to the next global meltdown?

You can read more about these kinds of information imperfections (this is the polite obfuscating language of standard economics) language and many others in Stiglitz’s 2001 Nobel Prize lecture. At the end of which he pauses to wonder why this system of thinking has remained dominant for so long?

“Partly, it must be because, in spite of its deficiencies, it did provide insights into many economic phenomena. There are some markets in which the phenomena which we have discussed are not important – the market for wheat or corn – though even here, pervasive government interventions make the reining competitive paradigm of limited relevance. The underlying forces of demand and supply are still important, though in the new paradigm, they become only part of the analysis; they are not the whole analysis. But one cannot ignore the possibility that the survival of the paradigm was partly because the belief in that paradigm, and the policy prescriptions, has served certain interests.”

One cannot help but think that he is being very tongue in cheek by citing “wheat or corn” as markets where the standard model applies well. And the closing comment about the possibility that “certain interests” are being served by these ideas is of course a hint at another large topic, the use of these ideas to justify all sorts of activities that end up padding the wallets of the rich and corporations.

These are examples of why I have felt nothing but intellectual disdain for standard economics since my first exposure in 1965 in Econ 101. It has the false attraction of a pseudo science because you can indulge in mathematical games that provide some insights into the movements of stock and bond prices. Even there these false models cannot explain the many depressions, recessions, bubbles and busts that characterize capitalism. Worse standard economics and its neoliberal variant is used to justify and shield the effects of the more than 40 years of class warfare so successfully carried out by the rich (now super-rich) and corporations.