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The Rediscovery of Classical Economics Adaptation, Complexity and Growth
David Simpson
New Thinking in Political Economy Series, Vol. 8 Published in Association with the Institute of Economic Affairs Cheltenham: Edward Elgar, 2013 Hardcover. vi + 215 p. ISBN 978-1781951965. £70.00
Reviewed by Gavin Kennedy Heriot-Watt University (Edinburgh)
David Simpson’s book is a timely contribution to debates among economists about the core interpretations of how market economies have functioned since Adam Smith’s Inquiry into the Nature and Causes of the Wealth of Nations appeared in 1776. Smith was not the first to address questions about the generation of a nation’s wealth – scores of essays and a few books circulated, including Sir James Stewart’s, Inquiry into the Principles of Political Economy, in 1767 – before Smith’s famous work, but none of them attracted the lasting attention accorded to Smith’s works during his lifetime. Prominent, though not uncritical, authors came after Adam Smith, such as Thomas Malthus, David Ricardo, Frederic Bastiat, J.B. Say, John and James Mill, Karl Marx, and Marshall. Despite their many differences, they are known collectively as the Classical Economists. Not surprisingly economics as an academic subject did not stand still and new authors began after the 1870s to develop increasingly distinct different ideas to the classical scholars. Since the 1950s, this economics is known collectively as the neoclassical school. However, the labels accorded to each school of thought cover a broad range of topics with and some overlaps and distinctly different solutions. David Simpson attempts to clearly disentangle the two schools and see what remains relevant in classical economics that was lost to the neoclassical ascendancy with its claims to mathematical precision. He reports on modern developments in the classical approach, including its new mathematical components, and compares how the two schools address their subject matter when applying their economic theories to the political choices in the real world. In a count today of the number of practitioners in the two schools the neoclassical school would win hands down. Those who prove their scholarly and expository excellence in the neoclassical paradigm, and are comfortable with its claimed mathematical precision, dominate the top posts in universities, consultancies and government institutions. David Simpson offers an alternative view from recent developments in classical economics. After the 1870s, new marginal utility theories came from Carl Menger and W.S. Jevons, 1871; and Leon Walras, 1874, which melded into a neoclassical school driven, by mathematical treatments of economic ideas by F.Y. Edgeworth, V. Pareto, P.A. Samuelson, J. Hicks and others. Linear calculus and General Equilibrium theory (G. Debreu and K.A. Arrow) dominated economics for decades. Mathematics, allied to behavioural theories of the rationality of human behaviour, led to claims that modern economics was the “hardest” of the social sciences, similar to the way physics dominated the natural sciences. Neoclassical economists dismiss the modern relevance of the pioneering descriptive origins of political economy, typified by Adam Smith’s solely discursive Wealth of Nations (1776), in which mathematics is absent, though Adam Smith was competent in the algebra and geometry of his times. Mathematics appeared in Alfred Marshall’s popular Principles of Political Economy (1890), though confined to footnotes and appendices, reflecting his competence as Wrangler in maths at Cambridge. Marshall, famously, remained reluctant to use maths at the cost of ordinary readers’ understanding of economic principles. He advised A.L. Bowley, a former student and distinguished pioneer of mathematical economics and statistics in the 1920s, to: “(1) Use mathematics as shorthand language, rather than as an engine of inquiry. (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important in real life (5) Burn the mathematics. (6) If you can’t succeed in 4, burn 3. This I do often”. Too late! The genie, once out of the bottle, inexorably took over the entire discipline, despite the fatal flaw that what explained was not how real people behaved in real world economies. From 1948 onwards (Samuelson), algebraic linear relationships of two variables proliferated in textbooks and were widely used in examinations to test students’ understanding, accompanied by requirements that they demonstrated their abilities using basic mathematical tools. Higher degrees from the 1980s required students to prove their abilities in advanced mathematical and statistical techniques. Applicants for junior teaching posts required high minimum mathematical and statistical competences and, later, authorship of papers published in the leading professional journals on which senior professorial appointments depended. Now nothing here disqualifies the relevance of mathematics as an insightful set of tools. Simpson recommends the use of modern mathematics suitable to model complex adaptive systems and agent-based subjective reasoning in conditions of bounded rationality. He suggests that much can also be learned from appreciating aspects of “Austrian” subjectivism in economic theory (L. Mises) and the later work of F. Hayek on “spontaneous orders” and “unintended consequences” linked by complexity theory to “evolutionary processes”. The problem addressed by his book is that because the real world continues to evolve socially and works differently from an imagined neoclassical world, populated by perfectly rational Homo economicus, it leads to surprises and disappointments, with occasional destructive lapses, such as experienced worldwide from 2008. Neoclassical economists held the floor throughout the post-war period, their dominance replicated in the career progressions of like-minded student clones who believe their advice on economic policy is the gold standard of a settled science. Recent events suggest a need for them to undergo a period of contemplative hubris. Simpson’s Rediscovery of Classical Economics summarises why the essential ideas dominating neoclassical thinking are not fit for purpose. He writes as a proven and competent exponent of mathematical neoclassical economics. His General Equilibrium : An Introduction (1975) confidently explained the mathematics driving the dominant orthodox neoclassical paradigm as taught and researched in most universities from which its precepts influenced government (Treasury) and inter-government (World Bank, IMF) policies. Economists continue to dispute their remedies for the unresolved problems faced by governments reliant upon competing “left” and “right” shades of electoral politics. Simpson’s background is working and practising for over three decades in the prevailing orthodox neoclassical paradigm in academe and in the real world of senior analysis from which he advises a rediscovery of the roots of classical economics, first associated with Adam Smith and later developed by a dwindling number of prominent economists in the 20th century (L. Mises, F. Hayek, J. Schumpeter). Faculty tenure panels “squeezed” out individuals remaining or surfacing as classical economists in mainstream departments, from which some sought refuge as historians of economic theory. Kenneth Galbraith once remarked: “I’ve just reread [Adam Smith] – a rather wonderful experience which persuades me that he could not now get tenure.” Simpson presents the classical tradition as broad propositions, upon which its modern revival is built, supported by modern mathematics more appropriate to the real world, summarised as addressing adaptation, complexity and growth. Adam Smith asserted that consumption was the sole purpose of production and he regarded economic growth as essential for any prospects of relative opulence among the majority of people, which, he suggested, “was only equity besides”. Economic growth is the corner stone of classical economics. It celebrates the historic achievements of real world economies without any prior intervention from economic theorists guiding the transition from the general material poverty of the vast majority where today the majority shares in rising “opulence” from growth. In contrast, the principal focus of neoclassical economics is on the theoretical derivation of relative prices in static equilibrium models to which people supposedly behave predictably. Classical economics treats market economies primarily as complex processes driving continuous dynamic changes that are evolutionary, self-organising and produce economic growth. It is much more attentive to studying the key roles of individual entrepreneurs and innovators rather than to celebrating passive, neoclassical automatons, supposedly rationally self-interested, with imaginary perfect information about the present and the future. Neoclassical economics fails to explain the real world. Its claims to predictability are risible. The focus of neoclassical economics remains firmly focused on the efficient “allocation of fixed resources from scarce means” (Lionel Robbins, 1932). We are reminded by Roger Sandilands that four years earlier, Allyn Young (1928) reintroduced Adam Smith’s theme of the economics of specialisation both within firms and, increasingly visible in the 20th century, by new firms, large and small, where growth is an endogenous cumulative process in which the division of labour depends upon the division of labour in the supply chains. The rate of growth is not exogenous and tends to be self-sustaining rather than self-exhausting, absent occasional policy shocks. Allyn Young demonstrates how printing technology had proliferated into scores of specialist individual firms for type faces, machine parts, inks and papers, etc., to supply the multiple inputs required for modern (post-1920s) printing as a rapidly developing industry in expanding markets. Adam Smith asserted that the “division of labour is limited by the extent of the market” and that the human capacity for its “propensity to exchange” originated from the “necessary consequences of the human faculties of reason and speech”. Growth in market economies, even by small margins of less that 3%, leads to hundreds of millions of people becoming cumulatively better off per capita compared to the fragile life experiences of countless past generations. Today, after only two centuries of market economies, Smith’s moral goal of social equity for the labouring poor continues as their per capita real incomes and consumption makes them and their descendants immeasurably better off than the very richest of kings, princes and tribal chieftains of all previous millennia. Yet growth did not feature in static neoclassical equilibrium theory overburdened with the influence of the limiting “law” of diminishing returns (David Ricardo, 1818). Theorising about manufacturing as if it were subject to diminishing returns ignores the growing influence of successive productivity improvements from increasing rounds of the division of labour, especially from expanded power-driven mechanisation promoted by the Industrial Revolution, feeding small process changes in long product supply chains. Lower costs and prices, creating larger markets for increasing numbers of consumers, improve the qualities of lower-priced products and services from increasing divisions of labour. It took fifty years to incorporate growth (unsuccessfully) into neoclassical mathematical models, from early crude attempts by R.F. Harrod (1939), E. Domar (1946), then R.W. Solow (1956), through to endogenous growth by P. Romer (1986). Textbook examples of David Ricardo’s diminishing returns per acre in farming became less significant as powered manufacturing and service activities spread, illustrated in Smith’s 1776 example of the division of labour in the supply chains that contributed to the manufacture of a common labourer’s woollen coat. Individual entrepreneurs focus on improving their own contributions and lowering their unit costs. They do not, and need not, know anything much about all the stages in the processes that use their products. But each small improvement, by changing their contributions to their customers, and their customer’s customers in larger processes, reduces total costs and unit prices along all subsequent agents in the supply chains, enhancing overall productivity, and contributing endogenously to overall increasing, not decreasing, returns. No matter how minor the entrepreneur’s changes in a complex market economy, they contribute to economic growth and are signalled in markets by visible lower prices. The entrepreneur’s role does not feature in determinate, partial equilibrium models, which leads to an economics science that ignores the real world by assigning growth to an unexplained exogenous variable existing nowhere and, by default, places policy prescriptions for governments and firms based on them in jeopardy of not just being wrong, but also harmful. Classical economics, in contrast, is about constant change and growth within open, dynamic non-linear systems that do not experience anything resembling equilibrium conditions. It recognises that social evolutionary processes from myriad changes are better modelled by complexity theories. Neoclassical economics depends on homogeneous human behaviours because individuals are assumed and required to make predictable, rationally deductive conclusions on the basis of perfect information about the present and the future, while in the real world billions of individuals believe different things about the future and have changing and different aspirations and motives. Real people in real markets learn to adapt their behaviour to the changes promoted by other adapting individuals, which simultaneously creates new changes and responses all along the complex supply chains that make up a modern market economy. The market never sleeps. Markets viewed in the classical manner experience constant unpredictable change as self-organising systems, well beyond the knowledge capabilities of any single participant, or even any group, because no participant is able to have more than a fraction of the knowledge required to model an economy. Hence, no group of planners, even with the world’s most powerful computers, can manage an economy (Smith was sceptical of the ability of absolute rulers to direct anybody to run an economy). Such thoughts echo Hayek’s claim that no centralised Socialist system nor any talented group of State officials could ever know, or grasp, or even calculate enough information about a modern economy to direct its performance. All market economies are too complex to model using equilibrium ideas. Consider such major conurbations as Paris, New York, London, Beijing or Delhi, which have billions of goods and services on sale each day, and many more in their supply chains about to compete with existing products and services, driving some into obsolescence. Classical ideas have moved considerably further on from Adam Smith and his early successors. From incessant, often spontaneous, changes comes economic growth, subject to the “perennial gale of creative destruction” (J. Schumpeter). David Simpson sees the need for the “rediscovery of classical economics”, prompting the challenging question: how can going back to imprecise descriptive economics be productive for modern economists? That is not what Simpson’s recommends. He suggests that economists rely on a more complex understanding of economics based on the behaviour of individual human agents, supported by modern dynamic, non-linear complexity theories and ideas of evolutionary social forms, including the use of modern mathematical techniques where appropriate to “illustrate examples that are important in real life”. Market economies are evolutionary by their nature and take many variations of form to reflect their disparate social natures in their different geographical locations and histories. David Simpson makes a compelling case for rediscovering the classical evolution of economics that begun in the 18th century and is the basis for it to be reconstituted in the 21st century.
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