Xiaokai Yang & New Classical Economics (1)

Xiaokai Yang, Economics: Neoclassical Framework versus New Classical, Blackwell Publishers (2001)

This is not a review, since I’m not claiming to provide an authoritative critique of the work in question. What follows is my working out what Prof. Yang is trying to say.

Policy initiatives are predictable: the author makes familiar arguments on behalf of the free market (or “invisible hand of the market”) whenever possible, which is generally what economists do. His examples are abstract; there are no detailed examples, such as how to match a system of equations describing an economy to an actual economy or portion thereof. In some of his other works, e.g., Yang 🙵 Sachs (2008) he lists prominent economic historians as being conceptually allied with his opinions.

These opinions include a general institutionalist tilt, or yearning, that informs his thinking. In economics, “institutionalism” is usually described as focusing on the role of institutions, e.g., property rights and social norms, and of organizations, e.g., banks, firms, and governments. In the distant past, this would have meant that economic forces were included in efforts to evaluate historical causes, and the historical events would have been the development of economic (business, commercial, industrial) landscapes at certain times and places. Now, it includes mostly efforts to devise theories that explain the emergence of these institutions in certain times and places.

Yang took the position that neoclassical economics used mathematical models that disallowed for endogenous analysis of the division of labor, the formation of firms, the emergence of trade between communities of comparable size and material endowments, and so on. The reason was, according to Yang, that neoclassical economics treated economic actors as either pure consumers/workers or else firms.

In the neoclassical framework, pure consumers had a utility preference of x or y. They also had endowments of capital k and labor (time) l. They could sell their labor to a firm (it made no difference what the firm produced) and lend their capital to the firm as well. A general presumption was that models describing the economy were likely to feature different production functions, stimulating different outputs (but this was all “given” by the model-maker).

In the new classical framework, individuals were producers and consumers. They had a choice of producing both x and y for their own use, producing x and selling some to pay for y, and so on. The obvious rational choice was to specialize.

One reason why Yang’s version was a throwback to classical economics (i.e., a turning back from the Marginal Revolution that spawned neoclassical economics) was that classical equilibrium analysis regarded the economic equilibrum as reflecting the cost of production in terms of resources, which meant the price of things needed to be be expressed in terms of the price of its inputs. Neoclassical economists switched to a marginal analysis (meaning, general equilibrium was the outcome of a constrained maximization of utility), and value was derived from utility, not cost of inputs.

The advantage of neoclassical analysis was that it ignored any problem posed by the choice of numaire, or base unit of value. Classical economic analysis sought the natural price of commodities as the key to understanding equilibrium; the price and the quantity emerged from that. Oddly, the numaire survived in neoclassical general equilibrium (now with an actual name it didn’t have before), but it was just an arbitrary unit for solving a homogeneous system of equations. It was no longer the basis of value, and in fact its comparative price could shift with preferences, production methods, and substitute goods.

Yang “revived” neoclassical economics in response to the failure of neoclassical economics to make any predictions about the division of labor or the introduction of any new institutions.

In my sequels to this post, I want to discuss the ways in which Yang introduces new classical approaches to economic analysis.

(Part 2)

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SOURCES 🙵 ADDITIONAL READING

Allyn A. Young, "Increasing Returns and Economic Progress" (PDF), The Economic Journal, Vol. 38, No. 152. (Dec., 1928), pp. 527-542. This paper is cited often by Prof. Yang in his critique of the neoclassical framework. It’s a pretty easy-to-follow explanation of the aspects of the market Young thinks play an important role in the determination of output. In other words, Young thinks the market’s tendency to expand and specialize permits economies of scale to arise, whereas he thinks mainstream economists mostly assume economic expansion just happens. Yang interprets Young’s article as “endogenizing” (bringing into the theory itself) the process of economic expansion and specialization.

Xiaokai Yang 🙵 Jeffrey D. Sachs, Economic Development and the Division of Labor, John Wiley 🙵 Sons (2008). This is a more descriptive introduction to his methods. I think readers interested in real-world examples would like this more.