As the title suggests, this blog post examines a couple of policy recommendations made in Chapter 2 (Micro-foundations of Macroeconomic Policy) of the Economic Survey 2011-12. This examination is carried out in conjunction with Kaushik Basu’s economic methodology which is scattered across the Economic Survey and very visible in his 2011 book Beyond the Invisible Hand: Groundwork for a New Economics (Princeton and Oxford: Princeton University Press). Note that we are making an assumption, albeit very plausible, that Basu authored and/or significantly influenced the contents of Chapter 2 of the Economic Survey. On the basis of these two texts – Chapter 2 and his 2011 book, this blog post evaluates (1) Basu’s method of doing economics, (2) his affinities towards the micro-foundations approach and (3) his (select) macroeconomic recommendations. The blog post concludes with a critical look at the role of economics as espoused by Basu.

Basu writes in the Economic Survey that ‘monetary and fiscal policies are part science and part intuition and common sense’ (p. 24). This statement reflects the openness to knowledge possessed by the author. However, owing to his role as the Chief Economic Advisor of India, he is an economic architect. Therefore, at a deeper level, one wonders whether he is talking about the ‘intuition and common sense’ of a particular individual (himself?) or a certain group of individuals. We get to read more of his thought on ‘intuition’ in his 2011 book. Some priceless extracts are reproduced below:

‘My view is that in economics, the need for intuitive understanding is much greater than most economists would have you believe. Good economic policy requires a “feel” for things over and above the knowledge of theorems and regression coefficients’ (p. 14).

‘Both interventions and noninterventions have too often been left to the ideological whims of believers. They need to be founded on analysis and reason, not faith’ (p. 23).

‘What we so often take to be features of the world are actually propensities of the mind’ (p. 51).

‘My belief about the puzzle of knowledge lies somewhere between the skeptical and evolutionary claims. I have faith in our intuition’ (p. 53).

‘Causality lies in the eyes of the beholder’ (p. 54).

‘To sum up, scientific knowledge has to be combined with intuition and a shot of skepticism for it to be useful’ (p. 54).

On p. 23, he argues that policy interventions should be based on reason and not faith. However, on p. 53, he asserts that he has faith in (his?) intuition. Most of his comments seem to indicate a certain sense of confusion on what the scientific method entails and the role of economic theory in particular. This is quite unfortunate, since it comes from the pen of the current Chief Economic Advisor of India. If it is not confusion then it seems to be a proposal that ‘any idea goes’ wherein obviously the ‘idea’ is decided by those in power. Whatever happened to reason? At the risk of repetition, let me state that this is an extremely dangerous outlook to possess because bad economic policies have devastating implications for majority of the population.

Basu rightly points out in his 2011 book that ‘the economy must be viewed as embedded in society and politics’ (p. xi). No one disputes this fact of reality. A worthwhile digression follows. Classical economists such as William Petty, Adam Smith, David Ricardo and Karl Marx in their contributions to political economy, as it was called then, never said otherwise. They stressed the need for proper social and political institutions. Coming back to Basu, he further writes: ‘Minimally, a proper understanding of economics requires recognizing that our economic relations are a part of a larger sphere of social and cultural interactions and institutions’ (p. 104). Based on this premise, he criticises neoclassical microeconomics for restricting individual choice to their budget sets for, in reality, they make choices outside their budget sets. In other words, there is a wide range of behavioural options which cannot be captured by the budget set and therefore Basu arrives at the conclusion that traditional microeconomic theory is very unqualified to deal with human behaviour. But, isn’t the aim of microeconomics to explain (economic) prices and quantities? Or, should we consider microeconomics as the study of human behaviour? Basu seems to think of the latter when he discusses economics. For him, economics is primarily the study of human behaviour and actions and not primarily a study of incomes and prices (on this, see Economics: The Study of Commodities). It also must be kept in mind that Basu’s scientific strengths lie in game theory, behavioural economics and related fields. In his 2011 book, he himself states that his analysis ‘belongs predominantly to positive social science’ (p. 98).

Since his objective is to study human behaviour, he proposes that we expand the scope of economics. This proposal, as we all know, has important repercussions on economic theory and eventually on economic policy. As Malthus pointed out, to study wealth and its distribution, one needs depth and not breadth; in short, the boundaries or scope of economics must be clearly outlined, however limited they might seem. Introducing several aspects of culture as Basu suggests will only make the explanatory and causal content of economic theory very weak. In fact, it might make economic theory too open that it can be used to explain everything. This must be resisted at all costs for it is knowledge that is at stake here (see also Malthus: The Scope of Political Economy). Basu therefore hopes to expand the scope of economics by altering and widening its foundations in order to usher in the micro-foundations approach in macroeconomic theory as well as in policy making. One glance at the title of Chapter 2 of the previous three Economic Surveys is sufficient for this purpose – 2009-10: Micro-Foundations of Inclusive Growth; 2010-11: Micro-foundations of Macroeconomic Development and 2011-12: Micro-foundations of Macroeconomic Policy. The mark of Kaushik Basu is indelible.

Basu seems to be doing exactly what Gary Becker did when he applied microeconomic tools to a variety of human behaviour around the 1970s. Although, things have improved since then and research in game theory and behavioural economics have been reasonably successful in dispelling the very nice-to-hear qualities of the individual/agent in the economy. Cooperation, reciprocity, trust, etc have once again (Adam Smith talked about a lot of this in his Theory of Moral Sentiments; although he believed that it was necessary to assume certain behavioural propensities when studying the generation and distribution of wealth) begun to play an important role in economics. Basu does provide the reader with many such insights in his 2011 book by drawing upon his earlier research. As a consequence, he criticises the manner in which mainstream neoclassical/marginalist economics employs methodological individualism, especially the textbook version of it. Basu is unhappy because the agent in mainstream economics still does not carry out identity-based behaviour (p. 49). He demands an agent who is more social which does not imply a complete rejection of methodological individualism. Basu is candid about this: ‘It is not within my ability to break away from methodological individualism to the extent that we will eventually need to in order to have a more powerful social science and at the same time retain rigor’ (p. 101). He wants an increased role for identities in economic theory – caste, gender, race, language, etc. As pointed out earlier, bringing too many variables when studying a specific problem often muddies and obfuscates the phenomenon under study. Moreover, the cognizance of such identity-based behaviour can easily be taken into account while formulating policies without having to call for an overhaul of economic theory. Therefore, Basu calls for widening the scope of economics:

‘A fundamental step in broadening the scope of economics is to recognise that the feasible set of actions open to individuals is much larger than our models make it out to be’ (p. 27).

‘Minimally, a proper understanding of economics requires recognizing that our economic relations are a part of a larger sphere of social and cultural interactions and institutions’ (p. 104).

‘How a nation functions at the level of macroeconomic aggregates depends a lot on the nuts and bolts of the economy. In our concern with managing the large and attention-catching variables, it is easy to let attention slip on the small, which may be vital’ (p. 39, Economic Survey 2011-12 ).

Given Basu’s view about the scope of economics, it is easy to understand why he promotes the micro-foundations approach in macroeconomics. This is undertaken in a manner which shows complete disregard for alternative/heterodox macroeconomic schools such as the Post-Keynesians, the Sraffa inspired Classical/Keynesians, the Marxians or the Kaleckians. These schools of thought are built on the belief that the economy is a system which has a logic and working distinct to itself. They criticise the neoclassical/mainstream economists of committing the fallacy of composition when they conceptualise the economy as an aggregation of individuals (see Some Logical Fallacies in Economics). Basu strongly advocates using the micro-foundations approach to macroeconomic issues in the Economic Survey. He writes:

‘The error has usually been in misreading the incentives and behavioural traits of the individuals who are to benefit from the policies and those who are supposed to carry out their day-to-day functioning. Fortunately, this is beginning to change both in the discipline of economics as well as in the design of policies in India. There is increasing recognition that flawed micro-foundations can devastate the best of macro intentions’ (p. 24).

‘Macroeconomic policymaking entails a mix of science and intuition. To ignore either of these would be a mistake. We need to marshal the best scientific knowledge available and study the microeconomic foundations of these macroeconomic concerns and then blend them with intuition and commonsense to craft policy’ (p. 25).

In short, according to Basu, micro-foundations is THE way forward both of economic theory and for policy.

His macroeconomic policy recommendations are problematic because of two reasons. First, his method of doing economics seems to lack focus on the issues at hand – unemployment, poverty, inflation, agricultural growth and so on; instead, his entire focus is on human behaviour and micro-foundations. Second, he appears to lack a solid understanding of macroeconomics, especially its alternative schools. In any case, let us take a look at two of his major macroeconomic proposals – on fiscal deficit and Government as an enabler.

‘In the interest of medium- to long-term growth, it is important for us to bring the fiscal deficit down. While an expanded deficit can boost consumption and economic growth, this is medicine akin to antibiotics. It is very effective if properly used and in limited doses, but can cause harm if used over a prolonged period. Hence, government’s aim must be to effect rapid fiscal consolidation. A large deficit over a long period tends to squeeze out the private sector from the credit space. This dampens private investment and productivity and, more significantly, worsens the options of the inflation-growth mix available to government’ (p. 27).

‘This is what is meant by the enabling role of government. It should create a setting where it is in the interest of private agents to deliver on what needs to be delivered’ (p. 28).

As long as the economy is not at the full-employment level of output, crowding-out can never happen. Moreover, Basu forgets that the economy is not a stagnant organism; instead it is a growing one. The idea that government investment crowds-out private investment precariously hinges on the notion of scarcity in the economy. In a setting where the Central Bank controls interest rates so as to maintain price stability, it is difficult to see how crowding-out occurs as a result of government expenditure. [Given the length of this post, I chose not to elaborate on crowding-out. I hope to do that soon, in a future post.] As for the enabling government, Basu seems to forget that India requires significant government expenditure/intervention in the form of Right to Food, Right to Education, Right to Employment, Right to Information, etc so that a dignified ‘setting’ can be constructed for everyone.

To conclude, it appears that as a game theorist who has important socially relevant insights, Basu is well on the mark. However, his macroeconomics, unfortunately, is grounded on extremely weak foundations and therefore is well off the mark.

In these difficult times we live in, what economics needs is perhaps, depth and not breadth. Unemployment, poverty, inflation, food insecurity, financial fragility, debt crisis, etc can be better understood and tackled by diverting increased resources (time and financial) in understanding the production, distribution, exchange and consumption of wealth. This blog post very briefly examines Thomas Malthus’s (1766-1834) view of political economy – its method, scope, uses and limitations.  For this purpose, I have used John Pullen’s definitive variorum edition of Malthus’s Principles of Political Economy published as 2 volumes by Cambridge University Press in 1990.

According to the Cambridge Advanced Learners Dictionary, ‘scope’ is defined as the ‘range of subjects covered’. In the context of political economy, scope refers to the range of subjects it covers. That is, the scope of political economy informs us about the sphere of analysis, the boundaries or limits, the kind of situations it describes and its applicability in the real world or, its relevance. Keeping in mind that mathematics played only a small role in political economy during Malthus’s time, let us see what his view of political economy is: ‘the science of political economy bears a nearer resemblance to the science of morals and politics than to that of mathematics’ (p. 2). Undoubtedly, morals played and still play an important role for interventions in the economy based on what we consider to be a ‘good society or economy’. And politics, distributional conflicts over income, land, natural resources and employment are integral part of any economy. Thus, it is important that political economy (and economics) takes into account these distributional conflicts when theorising or modelling an economy. However, for purposes of theory, these conflicts can be taken as given from outside economics (exogenous) or can be determined within economics, in the manner of behavioural economics.

It would not have mattered if political economy was/is not a very important branch of knowledge. Reminiscent of Keynes’s words, Malthus writes: ‘The science of political economy is essentially practical and applicable to the common business of human life. There are few branches of human knowledge where false views may do more harm, or just views more good’ (p. 12). But, Malthus wrote it more than a century earlier. (See also Sismondi’s words of a similar nature). Since Malthus viewed political economy to have significant practical applications, the complete title of his book reads ‘Principles of Political Economy Considered with a View to their Practical Application’. The editor, Pullen, gives us a bit more information on this matter. ‘This was apparently a lifelong concern. As a student at Cambridge in 1786 Malthus wrote to his father: ‘I am by no means, however, inclined to get forward without wishing to see the use and application of what I read. On the contrary I am rather remarked in college for talking of what actually exists in nature, or may be put to real practical use’’ (p. 291, Vol II; all other page numbers excepting this refer to Vol I).

Malthus understands that ‘To trace distinctly the operations of that circle of causes and effects in political economy which are acting and re-acting on each other, so as to foresee their results, and lay down general rules accordingly, is, in many cases, a task of very great difficulty’ (p. 12). Economic processes are caused by a multiplicity of causes and often not by a single one. Owing to this and because of his view of economics as a practical science, he maintained that ‘[t]o know what can be done, and how to do it, is, beyond a doubt, the most valuable species of information. The next to it is, to know what cannot be done, and why we cannot do it’ (p. 17). In other words, we must be very aware of the ‘scope’ of our knowledge.

Furthermore, if our objective is to understand the problems of unemployment and poverty, we must perhaps, as mentioned in the introduction, study in-depth the process of generation and distribution of wealth. I conclude with a statement by Malthus: ‘If we wish to attain anything like precision in our inquiries, when we treat of wealth, we must narrow the field of inquiry, and draw some line, which will leave us only those objects, the increase or decrease of which is capable of being estimated with more accuracy’ (pp. 27-8).

The recent global financial crisis has led to a renewed interest in the works of John Maynard Keynes. In part, this is motivated by the intellectual failure of contemporary economics and the search for important insights into the working of the real and financial sectors. Another part owes to the dissatisfaction with conventional economics and restoring the research programme of Keynes seems to point at a better alternative. Together, revisiting the works of Keynes does assume great importance in the current economic and political climate. Two books stand out in this regard: Robert Skidelsky’s Keynes: The Return of the Master and Peter Clarke’s Keynes: The Rise, Fall, and Return of the 20^th Century’s Most Influential Economist. Both of them were published in 2009. This blog post is a critical examination of these two books.

Skidelsky

According to Skidelsky, ‘the root cause of the present crisis lies in the intellectual failure of economics’ (p. xiv). To avoid such crises in the future, Skidelsky encourages economists to think of economics ‘as a moral, not natural, science’ (p. xvi). We are quite aware of the affinities between Malthus and Keynes, on the role of consumption. Besides this, Malthus had a similar vision of economics (political economy as it was known then) as Keynes. That is, Malthus also views economics as a ‘science of moral and politics’; For Keynes, economics is a ‘moral science . . . it deals with introspection and with values . . . it deals with motives, expectations, psychological uncertainties’ (p. 81). Keynes’s economics and broader ideas, argues Skidelsky, aids in contemporary economic thinking and policy making. In particular, the role of uncertainty is emphasised.

The intellectual stature of Keynes is something that is well-established. Skidelsky provides the readers with a statement from the philosopher, Bertrand Russell: ‘Keynes’s intellect was the sharpest and clearest I have ever known. When I argued with him, I felt that I took my life in my hands, and I seldom emerged without feeling something of a fool’ (p. 57). In any case, Keynes was extremely active in academic and policy discussions.

Keynes argues that investment is determined by expectations and depending on the state of confidence, investment would increase or decrease. This renders investment unstable, as a policy variable. In addition, if savings are greater than investment, it diverts resources ‘from the wider economy into financial speculation and conspicuous consumption’ (p. 69). Consumption is seen as the stable component of demand. Keynes also clarified the very important distinction between decisions to save and actual saving. Firstly, ‘If everyone wants to save more, firms will sell less and therefore output will fall, unless the inducement to invest is increasing at the same time (p. 91). This is the paradox of thrift, a simple enough idea but very powerful which had not been presented clearly so far. Therefore, if increases in saving are not matched by increases in investment, it will cause a fall in output and employment. In short, ‘It is spending, not saving, which creates output and employment; and when spending falls short of earnings, unemployment results’ (p. 91). Skidelsky captures the most important conclusion of Keynes’s General Theory which is ‘that a decentralized market economy lacks any gravitational pull towards full employment’ (p. 97).

So far, so good. However, when it comes to Keynes’s views on classical economics, Skidelsky falls prey to the conventional view. The conventional view being that Keynes attempted to disprove the economic theories of classical economissts such as Smith, Ricardo and Malthus. This view is far from the reality. (For a concise account of this, see my short article in the DSE Journal.) In fact, Skidelsky, being very faithful to Keynes’s words calls Arthur Pigou a classical economist (see p. 104). Suffice it to say here that classical economists such as Smith, Ricardo and Malthus maintained that unemployment could be a permanent feature of capitalistic economies. By classical economists, Keynes actually meant the (neoclassical) economics of Marshall and Pigou. In the following paragraphs, we will see that Clarke deals with this issue in a more satisfying way.

Clarke

We need to read Keynes today, says Clarke, because of his ‘lifelong commitment to the strategy of institutional reform through reasoned argument’ (p. 23). This means that we need to understand the historic and political context in which he lived. Also, reading ‘Keynesian economics’ is no substitute for understanding Keynes. In fact, as Clarke informs us: ‘After dining with a group of American Keynesian economists in Washington, DC, in 1944, Keynes said at breakfast the next morning: ‘I was the only non-Keynesian there’’ (p. 168).

Similar in spirit to Brtrand Russells’ comment, Clarke shares with us that ‘Friedrich von Hayek, Keynes’s most formidable academic opponent, wrote that ‘he was the one really great man I ever knew, and for whom I felt admiration’’ (p. 10). Clarke sheds light on the not often discussed aspect of Keynes’s life – his training in economics. Alfred Marshall, Keynes’s family friend, taught economics to Keynes. ‘It was the usual Cambridge system of individual supervision, one hour a week for the eight weeks of the teaching term – the only formal instruction in economics that Keynes ever received’ (pp. 24-25). In any case, this doesn’t matter and clearly, it didn’t matter. For him, economic theory was not an end in itself (like the classical economists). ‘The whole point lies in applying them to the interpretation of current economic life’ (p. 49). In this quest, there are no roles for dogmas. Hence, he expressed his dissatisfaction with both anti-capitalist as well as free trade dogmas. However, the latter emerged as his primary target (p. 68). On the free trade system, Keynes writes the following: ‘It is not intelligent, it is not beautiful, it is not just, it is not virtuous – and it doesn’t deliver the goods’ (p. 72). To this end, by writing the General Theory, Keynes wanted to change the thinking of economists first and foremost. This is why the General Theory is ‘a concentrated assault on inside opinion as the necessary prelude to converting outside opinion’ (p. 77). Given those difficult times, the theoretical and policy oriented intervention of Keynes was essential. For, ‘Many people [were] trying to solve the problem of unemployment with a theory which is based on the assumption that there is no unemployment’ (p. 148).

We have already pointed the crucial distinction between saving and investment. Clarke puts forth the importance more clearly. ‘At the time, saving remained prized and honoured as the key to economic recovery. Keynes’s serious point is to distinguish saving (or thrift), which is essentially negative, from the real motor of economic growth, investment (or enterprise)’ (p. 106). Furthermore, Keynes is correct when he states: ‘I think it makes a revolution in the mind when you think clearly of the distinction between saving and investment’ (p. 107). Too much saving diminishes income. ‘It is a paradox because it seems natural to suppose that if individual saving enriches the individual concerned, it must also enrich the community’ (p. 152). Despite these crucial differences between saving and investment, much of the modern theories of economic growth seems to take the equality for granted; thanks to the single-good models and continuous production functions.

The commentary by Clarke on Keynes’s view of classical economics is historically accurate and therefore more satisfying than that of Skidelsky. The following extracts bear testimony to this. ‘Keynes later took him [Pigou] as representative of the ‘classical school’, devoting seven pages of the General Theory to a demolition of Pigou’s The Theory of Unemployment (1933)’ (p. 108). ‘Orthodox economics assumed that the system reached its own equilibrium through the effect of interest rates in reconciling the level of investment to the amount of saving available – through flexible prices, of course’ (p. 131). ‘‘Classical’ economics – really Marshallian orthodoxy – said an infinitely adjustable price mechanism will deliver equilibrium via interest rates’ (p. 134). Finally, Keynes’ friend and a reviver of classical economics, Piero Sraffa, is said to have brought the terms ‘effective demand’ to the attention of Keynes. ‘Keynes decided to salute Malthus as yet another brave Cambridge pioneer by purloining his term ‘effective demand’ to describe his own theory of output as a whole’ (pp. 143-4).

Concluding thoughts

The two introductory books on Keynes by Clarke and Skidelsky attest to the intellectual and practical relevance of his work. A few points are in order. First, a perfectly competitive economy does not have intrinsic forces that result in full employment. Secondly, saving and investment are conceptually distinct variables. Finally, economic theory is a means to understanding contemporary society and not an end in itself. I let Clarke have the last word: ‘Keynes’s name is thus rightly invoked to license fresh approaches to the novel economic difficulties of our own era – to tackle them actively rather than take refuge in inert doctrinal purity’ (p. 180).

Karl Marx (1818-1883) is an important figure in most social sciences. His works have been translated into several languages. One might not agree with his views, but he cannot be ignored. Some love him. A lot more hate him. Note that the like and dislike are not targeted at his works, which are seldom read, like most ‘classics’. Having recently read the first part of Theories of Surplus-Value, 3 volumes of Capital and a discussion with a friend who works closely with Indian realities has resulted in the following blog post.

Classical political economy, according to Marx, begins with William Petty in Britain and Boisguilbert in France and ends with Ricardo in Britain and Sismondi in France. In the Theories of Surplus-Value, Marx mainly scrutinises the works of these classical political economists. However, Marx does not provide an overall summary of their entire work but focusses on his central question: how did these authors conceptualise and comprehend value? Particularly, he discusses the why and how of classical political economists theorising of ‘appearances’ while forgetting the ‘essence’. In any case, Marx does not have the last word on the theoretical framework on the classical political economists. Hence, reading Marx motivates one to go forward and read the works of the classical political economists.

But, why read Marx or the classical political economists? They did not write in the 20^th century. The world is different today. Facts have changed. Are their works relevant anymore? Firstly, ‘progress’ or growth of scientific theories does not follow a linear path; the path could be non-linear. The implication is that what was considered unscientific in the past can resurface (with adjustments) with a greater explanatory strength and challenge the contemporary ‘scientific’ theories, at least in principle. For institutional reasons, this might never happen; mainstream journals, scientific associations, university teaching and textbooks are, what I label, institutions in this context. Thus, a priori, there exists no scientific basis for not reading the works of classical political economists, Marx and other economists. Secondly, a distinction needs to be made between theory and fact. A theory is not (necessarily) a fact. A fact is never a theory. A theory is general while a fact is specific. Theory tells us a way of thinking about facts – in identifying them, classifying them and ascribing relations to them. The classical political economists as well as Marx theorised a capitalistic economy; in this regard, the rate of profit was taken to be uniform across industries through the process of competition. It is obvious and very clear that in a country like India, which cannot be classified as capitalist or non-capitalist (perhaps, 10% capitalist), using Marx’s theoretical apparatus blindly is going to result in perverse outcomes. The reason for choosing 10% and not 20% is because the share of the organised sector in the GDP is 10%. Maybe, Marx’s theory has certain insights to offer to the 10% of India. The remaining has been visualised as pre-capitalist. (Remember the mode of production debates.) But, one wonders whether this is the desirable (or even scientific) way of characterising the remaining 90%. When reading an author’s work, it is not solely for the theory. Often, it is for the method too. There has been and will be many books and articles on Marx’s method. But, whatever the agreements and disagreements are, there are always fresh possibilities. Given this, not reading Marx seems unscientific!

Often, the works of classical political economists and Marx are confined to the class rooms of history of economic thought (HET). Teaching their works in HET classes is not considered irrelevant. One reason for this thought arises from the linear view of scientific progress. The other, perhaps, has to do with the pride every generation possesses over their ancestors in terms of knowledge. Although, this ‘pride’ is not solely our own creation but it has been passed on to us. It is perhaps our responsibility to check whether we have been taught the ‘correct’ theories and facts about our world. This is all the more reason to assess the foundations of our current beliefs and theories. HET is one way to do this, in economics.

Marx has interesting insights to offer contemporary economics on property rights, labour conditions, economic crises, concentration of markets (inter-linked markets?) and so on. To conclude, reading Marx is important to an economist. Secondly, his observations regarding the ‘evil’ nature of capitalism can be addressed so as to improve the existing laws, institutions, markets, morals and values. After all, the objective and aspirations of scientific knowledge is to better the lives of all.

Alfred Marshall made lasting contributions to economics. No economist will question that. However, his precise contributions to economics are often forgotten. In a way, the microeconomics that we learn and apply today has strong Marshallian foundations. This post draws on Peter Groenewegen’s excellent (concise) biography of Alfred Marshall (2007) which has been published as part of the Great Thinkers in Economics Series published by Palgrave Macmillan.

Marshall is most famous for his Principles of Economics first published in 1890; the definitive eighth edition was published in 1920. In addition, he wrote Industry and Trade (1919), Money, Credit and Commerce (1923) and Economics of Industry (1879) which he wrote along with his wife, Mary Paley Marshall. Besides these, he also printed and privately circulated his work entitled The Pure Theory of Foreign Trade. The Pure Theory of Domestic Values (1879). Overall, he taught for more than forty years in Bristol, Oxford and Cambridge. The most notable among his students are John Maynard Keynes and Arthur Cecil Pigou.

He took German lessons in order to read Kant in the original. Hegel’s Philosophy of History had a strong influence on his thought. Marshall commenced his study about economics with a close reading of John Stuart Mill’s Principles of Political Economy. He also read the methodological works of Mill on logic and particularly criticised Mill’s conception of the individual as a ‘self-seeking, wealth-maximising homo economicus’. His other economics readings included Smith’s Wealth of Nations, Ricardo’s Principles and Marx’s Capital. Other important influences were Cournot’s Mathematical Investigations in the Theory of Wealth and von Thunen’s The Isolated State; they motivated Marshall’s use of diagrams.

For Marshall, ‘the proper work of economic science…was solving economic problems’. ‘The necessity of economic theory, the importance of facts and continual striving to keep economic analysis relevant and practical were all crucial parts of Marshall’s promise to devote his professional life to the improvement of economic science’ (p. 74). It is also quite well known now that, for Marshall, the ‘mecca of the Economist lies in Economic Biology rather than in Economic Dynamics’ (p. 106).

Groenewegen informs us that Marshall had a personal dislike of the use of textbooks in university teaching (p. 77). Not surprisingly, ‘[t]he Principles of Economics remained a leading textbook on the foundations of economics not only during the life of its author, that is, from 1890 to 1924, but for the next quarter century as well, that is, until the early 1950s’ (p. 111).

The use of mathematics in the Principles has garnered lot of attention since he ‘banished’ all equations to the appendix. In any case, Marshall considered economics as ‘form of reasoning’. Perhaps, given the use of mathematics during his time, his relegation of equations to the appendix might have been appropriate. I quote an interesting letter Marshall wrote to his student Bowley: ‘(1) Use mathematics as a 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 which are important in real life. (5) Burn the mathematics. (6) If you can’t succeed in 4, burn 3. This last I did often’ (p. 114).

Marshall identified time to play an important role in the theory of value. He developed the concepts of the short and long period. He paid particular attention to ‘elasticity’. Besides these, he laid the foundations for the theory of the firm, use of offer curves or reciprocal demand curves in international trade and distinguished internal and external economies.

This post has only very briefly touched upon the way Marshall viewed economics, especially his use of mathematics and his evolutionary notion. We have not detailed his precise contributions to economics. This post serves the purpose of being a very short introduction to Marshall. As students of (micro)economics, it will be fascinating to read Marshall’s works, especially his Principles.

Economic theory of various kinds are often employed to formulate policies in the real world. Often, certain conclusions of a particular economic theory are utilised in policy making. For instance, some of the insights/conclusions arising from mainstream economics are: fiscal deficits are inefficient and inflationary; a perfectly competitive economy is desirable because it is efficient; increase in money supply causes inflation and increase in investment (domestic and foreign) will create employment. Hence, we are regularly advised to lower fiscal deficits, encourage ‘efficiency’, etc.

Broadly, two kinds of logical fallacies are committed by economists and policy makers. Firstly, there are logical fallacies in the domain of economic theory. Secondly, a logical fallacy is committed when real-world policy decisions are derivatives of conclusions from a particular economic theory. This blog post makes use of Stephen F Barker’s book The Elements of Logic (1965) to illustrate some of the logical fallacies in economics.

According to Barker, a “fallacy is a logical mistake in reasoning.” He identifies three broad categories of logical fallacies: (1) non sequitur, (2) petition principia and (3) inconsistency. Fallacies of non sequitur (Latin: “it does not follow”) occur when there is an insufficient link between premises and conclusion. “If the premises are related to the conclusion in such an intimate way that the speaker and his hearers could not have less reason to doubt the premises than they have to doubt the conclusion, then the argument is worthless as a proof, even though the link between premises and conclusion may have the most cast-iron rigor,” logical fallacy of petition principia (Latin: “begging the question”) occurs. Lastly, fallacies of inconsistency occur “when someone reasons from a set of premises that necessarily could not all be true.”

Logical fallacies in economic theory

An economic theory like any scientific theory begins from a set of premises. These premises can be based on observation, fact, other theories, (reasonable) assumptions, etc. Obviously, these premises have to be sufficiently general for it to be a ‘theory.’ From these premises, through the process of (deductive) reasoning, we arrive at certain conclusions. Note that unrealistic assumptions do not render an economic theory fallacious. However, their utility in real-world policy making is contingent on how ‘approximate’ the assumptions are to the particular context.

Hence, given the premises, if the conclusions do not follow, the economic theory under consideration is said to be logically fallacious. This, in fact, happened to the marginalist theory of value and distribution. In the 1960s, it was demonstrated bySraffa, Garegnani and others that marginalist theory of value and distribution is logically fallacious. This was shown so clearly that defenders of the theory, notably, Paul Samuelson, admitted this defect. The main reason for this logical fallacy was/is that prices (value) and distribution are interdependent and hence are simultaneously determined. Therefore, the distribution theory in neoclassical economics (marginal productivity theory) cannot be logically prior and independent of the theory of prices (value). In other words, capital cannot be treated as a distinct factor of production, independent of prices. This is because, at an aggregate level, capital is comprehensible only as a value magnitude. Therefore, the construct of the aggregate production function breaks down and with it the whole neoclassical edifice of value and distribution crumbles. In any case, to circumvent such logical critiques, the concept of inter-temporal equilibrium was constructed. So far, it seems to have been ‘successful’ in warding off capital-theoretic critiques. But, this shift towards inter-temporal equilibrium from long period equilibrium has seriously compromised the relevance of such economic theory. For, ‘anything goes’ in temporary equilibrium. The capital theoretic fallacy is of the non sequitur type as there is an insufficient link between the premises and conclusion.

Marginalist economics studies human behaviour. It is a science of choice thanks to Lionel Robbins who presented a clear definition of neoclassical economics (which originated in the works of Jevons, Walras and Menger in 1870s). Hence, the theory assumes scarcity of both factors and commodities. The central problem in economics becomes that of – allocation. The theory starts with specifying endowments to agents and concludes  that there is full employment of resources. After all, if the issue is that of allocation, there will necessarily be a full-employment of resources both before and after the process of allocation (carried out by the market forces of demand and supply). In this case, the premises and the conclusion are connected in such an intimate manner that it seems to commit the fallacy of petition principia.

Consumers maximize utility. Producers maximize profits. This gives us equilibrium. However, is there a clear line of demarcation between a producer and a consumer? What if an agent is both a consumer and a producer? In the language of set theory, what if the intersection between consumers and producers in an economy is not a null set? If so, is it logically consistent to have a strict demarcation between producers and consumers?

Logical fallacies in economic policy

Economists, policy makers and journalists argue for a particular economic policy based on certain premises. These premises are nothing but an admixture of various economic theories. Note the emphasis on ‘theories’, for there is not just one economic theory but multiple economic theories. Most of them are competing paradigms, i.e., they ask similar questions but provide dissimilar answers. Examples include Austrian economics, Marxian economics, Classical economics and Keynesian economics. The dominant paradigm, of course, is the marginalist one; variants of this include New Classical Macroeconomics, Monetarism, New Keynesian Macroeconomics, Microeconomics, etc.

The question we are interested in asking is: what is the basis on which a particular economic policy is favoured. A few examples are provided below.

I

Premise: Increase in money supply causes inflation.

Conclusion: Therefore, increase interest rates to reduce inflation.

II

Premise: Inflation is determined by inflation expectations.

Conclusion: Therefore, the Central Bank should target inflation expectations.

III

Premise: Given full-employment of all resources, an increase in expenditure will raise prices.

Conclusion: Fiscal deficits are inflationary. Therefore, reduce fiscal deficits.

The premise in the first example is from a Monetarist paradigm; the premise in the second one is a New Keynesian perspective and the premise in the third example is a typical neoclassical/marginalist view. Are these kinds of policy conclusions logically correct? Do the conclusions follow from the premises? Or, are we taking a leap of faith? For, the economies which the premises talk about and describe aretheoretical worlds which (hopefully) have certain characteristics of the real-world. In any case, hasty conclusions should not be made. This is especially important for policy making in an economy like India which is very distinct from the theoretical worlds mentioned above.

Yet another commonly used argument is to favour a policy based on its success in another economy. For a long time, India followed economic doctrines which were promoted in the advanced economies of the West. Today, we see a similar trend where examples and case-studies from ‘other emerging economies’ are used to argue for a particular policy recommendation in India. But, India is structurally – socially, culturally, politically and economically different from these other economies. Hence, we again take a leap of faith. I end with such a claim which was made to argue that FDI is favourable: “in Indonesia 10 years after allowing 100 per cent FDI, 90 per cent of the retail sector is controlled by the small shopkeepers.”

To celebrate the 100th post on this blog, I am sharing my 15 best posts over the past years. Thank you all for the support, in the form of comments, likes, tweets, etc. Thanks once again.

(1) The ‘Micro-Foundations’ of Economic Survey 2009-10

(2) On Financial Markets: The Problematic Assumptions

(3) On Disguised Unemployment: Some Issues

(4) On the Unorganised Sector in India

(5) James Steuart, Strange(r) Economists and the Indian Economy

(6) The Politics of Microeconomics

(7) What Can Indian Economists Learn From Sismondi?

(8) Urbanization in India: What does it mean?

(9) For ‘Social’ Economists

(10) (Mis)understanding Inflation

(11) Employment: The Neglected Variable

(12) Economics: The Study of Commodities

(13) Economic Growth in India: Some Considerations

(14) Krishna Bharadwaj: The Ideal Economist

(15) Sraffa: Production as a Circular Process

Although J.-C.-L. Simonde de Sismondi (1773-1842) lived in Geneva and wrote on economics, history and public policy, his concerns about the role of political economy is valid even today, especially for India. Marx considered Sismondi to be the last classical economist. Sismondi engages with the economics of Adam Smith, David Ricardo and J B Say in his 1819 work New Principles of Political Economy: Of Wealth In Its Relation to Population. This work has been translated into English by Richard Hyse in 1991 (available at Google Books). According to Sismondi, the objective of Political Economy is to ensure that majority of the population live a happy life.

Indian realities

Sainath informs us that India has seen over a quarter of a million farmers’ suicides between 1995 and 2010. The total figure according to National Crime Records Bureau (NCRB) is 256,913. And, since 1998, at least 15,000 farmers have committed suicide very year. More unsettling is that fact that the total number of farmers have been declining significantly. In Andhra Pradesh, it is alleged that 90 farmers committed suicide, that too, in rain-fed areas, in the last few weeks.

The inflation of food articles has reached double digits. Food inflation doubly affects the actual cultivators. Since, the prices are fixed by the Government (minimum support prices), the price rise does not benefit the actual cultivators. Secondly, their ability to purchase their usual consumption basket also falls when price rise. It is in this context that M S Swaminathan’s reminders need to be understood. He rightly asserted: “If agriculture goes wrong, nothing else can go right for this country.”

Very recently, Dreze and Sen pointed out the nature of the asymmetrical growth that is driving India with a majority of the population living without access to basic amenities. They concluded their article in the Outlook by stating that one of the ways forward is to have a “radical broadening of public discussion in India to development-related matters—rather than keeping it confined to simple comparisons of the growth of the gnp, and naive admiration (implicit or explicit) of the high living standards of a relatively small part of the population. An exaggerated concentration on the lives of the minority of the better-off, fed strongly by media interest, gives an unreal picture of the rosiness of what is happening to Indians in general, and stifles public dialogue of other issues.” In other words, how much has the socio-economic condition of majority of the Indian populace (who happen to be farmers and weavers) improved?

Sismondi

In the hurry to build sophisticated DSGE models and while working out monetary and/or fiscal solutions to inflation and economic growth, it is often forgotten that actual human livelihood is at stake. How can Indian agriculture not be a necessary component of the curriculum in economics? Within economics, steep walls which cannot be crossed exist between agricultural economics, macroeconomics, monetary economics, labour economics, development economics, etc. The so-called specialization in these fields (to be understood as literature which is not easily accessible or comprehensible to an economist from another field) has reached alarming levels. Sismondi says the following on the nature of economic inquiry:

However, I believe I should protest against the manner, so often superficial, so often false, in which a work on the social sciences is judged in the world. The problem which they offer to resolve is tangled in quite another way than those that arise from the natural sciences; at the same time it appeals to the heart as well as to reason. The observer is called upon to recognize unjust sufferings that come from man, and of which man is the victim. We cannot consider them coldly and pass them over, without seeking some remedy (Sismondi 1819: 13).

Maybe, the idea of modern science does not allow investigators to be moved by the ‘object’ under study. Nevertheless, as Sismondi reminds us, economic problems and their solutions affect people (who are not ‘objects’) in a significant manner. The state of Indian farmers and weavers is certainly to be given attention, especially in terms of livelihood building, through providing employment and incomes in a dignified manner.

The following lines from Sismondi echoes what Dreze and Sen recently pointed out as regards Indian growth:

If they find a tremendous accumulation of riches, an improved agriculture, a prosperous business community, manufactures which multiply without end all products of human industry, and a government that disposes of almost inexhaustible coffers, as in England, they call the nation opulent that has all these things, without stopping to inquire whether all those who work with their hands, all those who create this wealth, are not reduced to mere subsistence; whether every tenth member among them must not apply each year to the public welfare; and whether three-fifths of all individuals, in a nation that is called rich, are not exposed to more privation than an equal proportion of individuals in a nation called poor (Sismondi 1819: 22).

In India, the wealth creators, the farmers, are forced to live below even ‘subsistence levels’ as Sainath’s commentary on farmer suicides indicate. Even though we have 53 agricultural universities in India, their contribution to the farming population is circumspect. Three to four decades before, working on agricultural economics and debating issues related to agriculture was fashionable and ‘important’. Today, it is even more important but, perhaps, not very attractive. In fact, the Government admits that the farm sector has been neglected.

Admitting that the government is neglecting research in the farm sector, the agriculture ministry has sought more funds in the next Five Year Plan (2012-2017) for significant jump in food grain production.

But, focussing on aggregate food grain production is clearly insufficient. One needs to look at the ‘production conditions in Indian agriculture’. As Sismondi points out very clearly

Commercial wealth is augmented and distributed by exchange; and even the produce of the ground, so soon as it is gathered in, belongs likewise to commerce. Territorial wealth, on the other hand, is created by means of permanent contracts. With regard to it, the economist’s attention should first be directed to the progress of cultivation; next to the mode in which the produce of the harvest is distributed among those who contribute to its growth; and lastly, to the nature of those rights which belong to the proprietors of land, and to the effects resulting from an alienation of their property (Sismondi 1819: 133).

In 1974, Krishna Bharadwaj published a book Production Conditions in Indian Agriculture. In the same period, economists such as Amit Bhaduri, Ashok Rudra, Amartya Sen, K N Raj, C H Hanumantha Rao, Pranab Bardhan, etc wrote extensively on various aspects of Indian agriculture. The issues Sismondi pointed out were discussed and debated. Bharadwaj points out the significance of examining property relations, technology, local patterns of power, etc. Moreover, she notes that non-economic variables such as tradition, customs, caste and religion determine the economic position of a farmer and thereby determines their income and asset levels. The rise in food inflation has prompted many commentators to hold employment guarantee schemes (NREGA) responsible. If agriculture generated adequate incomes (to maintain a decent and dignified life) employment guarantee would not be necessary. In other words, employment on and off farm cannot be treated as independent of each other. Further, in India, markets are interlocked through both price and non-price links (with the Government playing an ambiguous role). These interlocked markets are exploitative as it denies the following freedoms to the agricultural farmer, who is very much an entrepreneur.

(1)   What to produce?

(2)   How much to produce?

(3)   For whom to produce?

(4)   When to sell the produce?

Conclusion

As Sismondi reminds us, we cannot ignore the majority of the Indian population who do not have access to the basic necessaries of life. Agriculture provides livelihood to more than half the Indian workforce. A farmer is an entrepreneur who produces food, the most basic of all commodities. Although, it might not be academically fashionably and profitable to study Indian agriculture but as Sismondi notes: “We cannot consider them coldly and pass them over, without seeking some remedy.”

Recently, some students walked-out from the lecture of the exceedingly famous economist, Greg Mankiw, who teaches EC10, Introduction to (neoclassical!) Economics at Harvard University. He is, perhaps, more known for his best-selling textbooks. This post was drafted for a different purpose almost a year ago. However, given the relevance of the essay/post, I decided to publish it here.

***

“Students, economics is divided into microeconomics and macroeconomics,” says the professor. This classification dominates economics teaching at all levels – from schools to post graduate studies. What is not mentioned is that, this classification is a characteristic of a particular kind of economics – neoclassical economics. The introductory chapters of microeconomics textbooks teach us that there are two kinds of economics, namely, positive economics and normative economics. With this distinction students are led to believe that microeconomics is objective, scientific and apolitical. Such arbitrary and artificial characterization, I argue, is an important way in which neoclassical economics perpetuates its dominance both in academia and in the arena of policy making. However, the “politics” of microeconomics comes to the fore when one closely examines its history. This essay will closely examine the concepts of factors of production and marginal product.

The so-called objective and scientific microeconomics treats all factors of production (land, labour and capital) on an equal footing. In particular, the roles of labour and capital are depicted as symmetrical. No mention is made of their particular social and historical characteristics. Land, as we know, cannot be treated on par with labour in any unique way. At this juncture, let us recall the objective of economic theory and policy – to improve the conditions of human life. However, such a human-centric objective must not be taken to imply complete disregard for animals or for the environment. Given this, what is the rationale for employing the concept of factors of production in economic analysis? One wonders whether it is to depoliticize economic theory. The earlier economists (classical economists and Marx) had employed the concept of social classes to understand the working of the economy. In their analysis, society was divided into landowners, workers and entrepreneurs. This division was necessary to develop a theory of income distribution. That is, it is the division of the society into ‘social classes’ or ‘factors’ which provides the foundation on which the theory of income distribution is erected. In the former structure, landowners received rents, workers earned wages which were often at subsistence level and entrepreneurs received profits. Whereas, according to microeconomic theory, the rewards accruing to the factors of production are as follows: land earns rents; labour earns wages; capital earns interest and entrepreneur/organization earns profits.  In the latter case, one notices that a distinction has been made between the “agent” and the “factor” of production. Notwithstanding this, the apparent objectivity of microeconomic theory crumbles and arbitrariness enters once we ask: what are the units for measuring capital? Land, as we know, can be measured in hectares, acres, square feet, etc. Similarly, labour can be measured in head count, man hours, man days, etc. But, how is capital measured? In fact, even before posing this question, we need to ask: what is capital? Why is capital, which is produced by labour acting on raw materials, considered a a factor of production? There appears to be no clear reason or rationale behind this. It seems that such an arbitrary concept was introduced to remove “politics” and “conflicts” from economic theory. Even the nomenclature “factors of production” appear significantly distanced from society vis-a-vis that of social classes, which was conceptualised taking into account the conflicts, especially over the means of production, prevalent in the society. Employment of “factors of production” in economic analysis presented a harmonious view of the society as opposed to the conflicts in income distribution which was pointed out by the classical economists.

Next, we briefly discuss the role of the concept of marginal product in microeconomics. In simple language, marginal product measures the contribution of one unit of the factor of production to the production process. Marginal productivity theory is a widely taught concept in graduate programs in economics and business. It is this concept which links factors of production to a theory of income distribution in neoclassical economics. Clearly distinguished “factors” of production is a prerequisite for the theory of marginal productivity. As pointed out in the previous paragraph, the owners of means of production do not find any explicit mention. Microeconomics teaches us that, in conditions of perfect competition, labour and capital get (monetary) rewards in proportion to their contribution to the production process. In other words, wages paid to labour equals marginal product of labour and interest paid to capital equals marginal product of capital. But, note that marginal product can only be computed by considering ‘potential change’, which is computed with the aid of differential calculus. What we do not pay adequate attention to, is that the origins of marginal analysis are to be found in the differential rent theory of Ricardo. Land, owing to technological constraints generated output at a diminishing rate as more and more labour and machinery were applied. This was because of the characteristics particular to land. Neoclassical economists extended this notion of diminishing marginal returns in land to other “factors of production” such as labour and capital. Such a generalisation has been shown to be inadequate on logical and historical grounds. Today, microeconomics textbooks and microeconomics professors hardly mention the historical origins of marginal productivity theory.

Neoclassical economics, as we have seen, misguides economic policy making by projecting a harmonious view of the society, comprising financiers, rentiers, entrepreneurs, wage labourers, salaried workers, etc. This is mainly done through the conceptual apparatus of “factors of production”. The idea of symmetry is introduced through this manoeuvre. Neoclassical economics also teaches students that a state of perfect competition is desirable because each “factor of production” will get what they deserve (their marginal product) as incomes. This, as indicated above, is a misinformed generalization of the rent theory of Ricardo. In fact, through the theoretical apparatuses of factors of production and marginal productivity theory, neoclassical economics tries to be objective, scientific and apolitical. However, as this essay has shown, most concepts of neoclassical economics have been devised in order to mask the conflicts and politics involved in economic phenomena.

On October 14, 2011, heterodox economics (in particular, classical economics) lost one of its warriors. This post attempts to summarise some of his key contributions towards economic theory. First and foremost, he was an economic theorist par excellence. He contributed to the famous (now, almost forgotten) capital theory debates in 1960s along with Piero Sraffa and Joan Robinson on his side and Paul Samuelson and Robert Solow on the other. Alongside others, he pointed out logical flaws in the marginalist conception of capital and its devastating effects on equilibrium. Basically, marginalist theory of value and distribution (in modern parlance, microeconomic theory) was shown to be logically inconsistent. Today, these debates hardly ever appear in economics textbooks because marginalist or neoclassical economics invented inter-temporal equilibrium to take care of capital-theoretic issues. Moreover, history of economic thought has been sidelined – through famous graduate economic programs and by preaching that history of economic thought is of no use to a “practical” economist, both in academia and in business.

Garegnani made significant contributions to the revival of classical economics on the foundations laid down by Piero Sraffa. In particular, Garegnani, through various journal articles (in Italian and English) resurrected the works of old classical economists – mainly Smith, Ricardo and Marx. More than Sraffa, perhaps, it is Garegnani who has aided the revival and resurrection of classical economics. His command over the history of economic thought with a special focus on old classical economists and ‘old’ and ‘new’ neoclassical economists (Walras, Wicksell, Hicks, etc) is evident from his clear exposition of their analytical structure.

Like ‘old’ classical economists, Garegnani’s interest has been to explain growth dynamics of an economy. This, he believed and also demonstrated that it is possible by drawing insights from Keynes and working on a classical (Sraffian) foundation. In this regard, Garegnani and his friends-colleagues-students have been quite successful in their analysis of capacity utilization, supermultiplier, role of wages, profits being a monetary phenomenon and so on.

Given the massive contributions made by Garegnani, it has been an honour for me to have been introduced to his work during my Masters in Economics at University of Hyderabad. It is one of the few Universities, in India and possibly, in the world, which still teaches classical economics as a distinct approach to understanding contemporary economies. I hope that more Universities begin to recognise the benefits of a pluralist education and start teaching classical economics as a distinct subject.

Others

Robert Vienneau  Susan Pashkoff  Francesco Saraceno  Tyler Cowen  David Ruccio  Matias Vernengo