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Neo-classical Economics debunked.....by FT's Martin Wolf

by ChrisCook Tue Jul 13th, 2010 at 06:47:28 AM EST

Last week there was an excellent - if somewhat restrained by his standards - article by Professor Michael Hudson in the FT calling for the re-basing of the system of tax away from earned income and on to unearned income, particularly from land.

This was followed the next day by an article by Martin Wolf - the FT's most senior economic journalist, and a regular at the Bilderberg gathering. Wolf wrote of the role of land prices in 18 year economic cycles, and referred approvingly to the journalist Fred Harrison who predicted the property crash in 2005.

Property cycle: bust will follow boom - but when? - MoneyWeek: August 5th 2005

Many think that the global real-estate bubble has nearly run its course. Fred Harrison disagrees. He thinks it has another three years to run. Here he tells us why.

Wolf went on to convincingly make the case for a tax on land rental values and followed up today with an FT Diary post which demonstrates that he understands the case made by Mason Gaffney of the Corruption of Economics Neo-classical Economics as a Strategem against Henry George

NB: For those ET'ers unaware, Henry George was a proponent of what he called a 'Single Tax' on land values, and was for a time the second best known political figure in the US. His book 'Progress and Poverty' sold in the millions.


Wolf followed up today with this Diary post

Why were resources expunged from neo-classical economics? | Martin Wolf's Exchange | FT.com

Something strange happened to economics about a century ago. In moving from classical to neo-classical economics -- the dominant academic school today -- economists expunged land -- or natural resources. Neo-classical value theory -- based on marginalism and subjective valuation -- still makes a great deal of sense. Expunging natural resources from the way economists think about the world does not.

In classical economics, land, labour and capital were the three factors of production. With neo-classical economics, the standard production function had just two factors of production: capital and labour. Land -- by which we mean the totality of natural resources -- was then incorporated into capital.

All thinking about the world involves a degree of abstraction. Economics has taken this principle further than any other social science. This is a fruitful intellectual procedure. But it is also risky. The necessary process of abstraction may end up leaving essential aspects of the world out of the analysis. That can be intellectually crippling. I believe that that is exactly what has happened, in this case.

The idea that land and capital are the same thing is evidently ludicrous. It requires us to believe that the economic machine is self-sustaining -- a sort of perpetual motion machine.

I can see the objection that natural resources are necessary for the operation of capital and labour. Thus, the distinction between land, labour and capital is hard to draw. I agree with this. But there are two responses: first, from the point of view of economics, resource scarcity may mean diminishing returns, which are economically important; second, some natural resources are not appropriable and can be treated as free (sunlight, for example), but others are indeed appropriable.

Thus, for both economic and political reasons, we should put natural resources into the heart of economics, thereby remedying a neoclassical mistake.

Wolf is too charitable: this mis-classification was not a 'mistake' - it was a purely ideological distortion. As Gaffney said, this was the 'Corruption of Economics'.

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But there are two responses: first, from the point of view of economics, resource scarcity may mean diminishing returns, which are economically important; second, some natural resources are not appropriable and can be treated as free (sunlight, for example), but others are indeed appropriable.

Thus, for both economic and political reasons, we should put natural resources into the heart of economics, thereby remedying a neoclassical mistake.

There's another, more fundamental, point:

Capital can be produced by human industry. Raw materials cannot. They can be utilised more efficiently or more extensively, but they cannot be created, except through exceptional difficulty (yes, copper can be made from other metals if you have a linear accelerator, but that is unlikely to be economical...).

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Jul 13th, 2010 at 08:25:09 AM EST
Hudson has a current article on the use of proposed changes to land value taxation as a campaign platform in Latvia in New Economic Perspectives:

Latvia's Third Option: Neither Devaluation nor Austerity, but Tax Restructuring  By Michael Hudson.

Is a link now available to his FT piece?

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Jul 13th, 2010 at 10:04:04 AM EST
ARGeezer:
Is a link now available to his FT piece?

I haven't seen one. But you could probably get at it via Google News.....

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue Jul 13th, 2010 at 11:59:49 AM EST
[ Parent ]

Land -- by which we mean the totality of natural resources


"Life shrinks or expands in proportion to one's courage." - Ana´s Nin
by Crazy Horse on Tue Jul 13th, 2010 at 07:44:03 PM EST
It is fantastic that somebody in a paper like FT writes this. Bravo Martin Wolf!
by kjr63 on Wed Jul 14th, 2010 at 06:20:01 AM EST
[ Parent ]
I don't see what the fuss is really all about. When I look in the second chapter of my basic economics textbook it clearly states that there are three, not two, factors of production: labour, capital and land.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Wed Jul 14th, 2010 at 10:56:34 AM EST
[ Parent ]
That's pro forma. In the majority of microeconomic modelling, the land falls away. Open up an graduate intro math econ book and count the (L,K) models compared to the (L,K,R) models.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Thu Jul 15th, 2010 at 08:52:25 AM EST
[ Parent ]
Yes, they do say that. In one corner of one page. Then follows 300 pages of *BS* where land no longer exists.

Here is one example: according to Marx the reason for unemployment are monopoly profits. According to Henry George it's economic rent. So, the reason for unemployment is "simple." Unearned incomes.

This is what "Textbook of economics" 2008 by Matti Pohjola, prof. of Helsinki Business School of Economics, says about unemployment. In it's prologue (sorry my bad translation from finnish):

"Every one of us can name from every day life factors that can cause unemployment. These may be automation or social security. If both of them cause the unemployment together, there are 2^2 = 4 possible causes for unemployment. If there are 10 factors, then there are 2^10 = 1024 different explanations, if eleven then 2048. So, there are endless possibilities for public discourse about unemployment."

IMO there are 2048 reasons why these people should not teach economics.

by kjr63 on Thu Jul 15th, 2010 at 11:42:38 AM EST
[ Parent ]
Yeah but they have a great future teaching binary arithmetic!

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre
by ATinNM on Thu Jul 15th, 2010 at 11:48:24 AM EST
[ Parent ]
Rent is basically the terrible taxes that Adam Smith, Henry George and other classical economists were "raging" against.

Rent is determined by available alternatives to tenants, not by particular value of rented services. Therefore rentiers are in power to take away almost all productive surplus beyond the value of the least productive alternative. This was realized by Ricardo and explained by George. Also the modern "freakonomics" books explain soon that the higher coffee price at the London Waterloo station does not really benefit the coffee shop much more than other coffee shops; the surplus profit goes to rentiers, the owners of the station.

Those 300 years ago, governments were not busy with pensions, health care and social security. The governments represented top rentiers, hence the identification with taxes. Now we have a free reign of rentiers (and perhaps debt collectors) again, disguised behind "obstructive" governments.  

by das monde on Fri Jul 16th, 2010 at 04:51:33 AM EST
[ Parent ]
There was a good reason that land and raw materials fell out of economic analysis in the late 19th century - with advances in transportation, land and raw materials had become readily available to any power that had the ability to kill the people living on top of them. With the industrial powers being a comparatively small fraction of the world, and with the AK-47 still three quarters of a century from mass production, all industrial powers possessed, to a greater or lesser extent, this capacity.

Raw materials being abundantly available, the power to extract rent shifted to capital (labour, at the time, was still for the most part fairly crude, easily replaced and very abundant).

It is noteworthy that in those countries not yet industrialised, land reform (rather than tax reform or other means to redistribute capital) was and is the primary rallying cry of those who want to cut rentiers out of the economic loop. To take one example, in his Che Guevara's book on guerrilla strategy identifies a disenfranchised and economically desperate rural population as a cornerstone of any successful guerrilla war (as opposed to Marx who calls for mobilising the disenfranchised and economically desperate urban proletariat).

Then came the Fordist political economy in which capital became plentiful. Capital being readily available, and land and other raw materials still being available at will to any serious industrial power, control of the business enterprise shifted again. Not to labour per se, because blue-collar workers remained abundant relative to demand (partly because increasing capital commitments meant increasingly automating blue-collar functions). But to white-collar workers.

This is what Robert Reich calls "the not quite golden age," largely because the interests of the white-collar workers then in charge of the business enterprise were oriented more towards stability and security than towards rent-seeking: They were sufficiently well remunerated to become highly risk-averse, and rent-seeking increases the risk of systemic collapse (and systemic collapse would cost them not simply money but prestige and power as well, which further reduced the incentive for risk-taking). So in the Fordist political economy, the dominant factor of production was in the business of eliminating other people's rent-seeking largely without substituting their own. (Of course this was only golden for The WestTM - some of the rent seeking the white-collar technostructure eliminated with extreme brutality was the rent-seeking of developing countries seeking to regain control of the raw materials on or under their territory...)

Then you had the Raygun/Volker counter-revolution, which was basically about reasserting the primacy of capital, by creating an artificial scarcity of money to replace the scarcity of capital that had fallen by the wayside in the 1940s and by concentrating capital in fewer hands (through the establishment of pension trusts, reduction in top tax rates, etc.) so that it could create its own scarcity.

The effort to concentrate capital in fewer hands was particularly successful, and probably goes a large part of the way towards explaining the rise of modern managerial/financial capitalism (a.k.a. the Anglo Disease): When capital is made artificially scarce by restricting its large-scale, organised deployment to the members of an oligarchy, connections become more important than competence, and the power in the business enterprise switches to the members of the oligarchy (the financial sector, as opposed to the industrial sector) and the people who have regular business and social interaction with them (the executives and accountants, as opposed to the engineers and technicians). The oligarchs, as has been frequently noted on ET, did not inherit the technostructure's inhibition towards blatant and destructive rent-seeking...

The Raygun/Volker counter-reformation masks, to some extent, the increasing scarcity of a number of important raw materials - if capital is made artificially scarce compared to scarce white-collar workers, there is no reason that it cannot be made artificially scarce compared to raw materials instead, in the same way that a successful labour union can make labour artificially scarce for landlord and capitalist alike. But of course this only works up to a point - as the Americans are currently learning to their considerable discomfort, you cannot extract rents from economic activity that does not exist...

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Jul 16th, 2010 at 11:41:27 AM EST
[ Parent ]
Why is this not a diary?

By laying out pros and cons we risk inducing people to join the debate, and losing control of a process that only we fully understand. - Alan Greenspan
by Migeru (migeru at eurotrib dot com) on Fri Jul 16th, 2010 at 12:50:16 PM EST
[ Parent ]
Because in my head it started out as just the first two paragraphs. And then it sort of grew from there...

Also, I don't have to think of a title when I post it as a comment :-P

It is now, though.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Jul 16th, 2010 at 03:33:09 PM EST
[ Parent ]
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Wed Jul 14th, 2010 at 10:09:21 AM EST
Though praising econ for subjective valuation based on falsified psychology is not something I'd agree with.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Thu Jul 15th, 2010 at 08:54:24 AM EST
All thinking about the world involves a degree of abstraction. Economics has taken this principle further than any other social science.

It's not abstraction that is the problem.  

It's False-to-Fact abstraction that is the problem.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Thu Jul 15th, 2010 at 11:52:46 AM EST


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