Neoclassical Economics

Reviving the Smithian style of frequent references to social reality and reliance on analogies where deduction might fail, Alfred Marshall (1842-1924) assimilated Marginalism into the classical framework, reinterpreted the latter where necessary, and reinforced the theory of value and distribution by introducing the famous cross of demand and supply curves and analyzing in detail the various types of equilibria. The neoclassical school in economics symbolized the ultimate triumph of free enterprise Capitalism against its socialist detractors. The triumph of method over meaning, of means over purpose and of formal analysis over the content of what was being analyzed was now complete. The very debate on positive versus normative nature of economics indicated this triumph. Such a controversy did not arise a century earlier when analysis was a means to increase man's ability to manage his economy, not an end in itself. For this is what positive economics amounted to; its only social relevance was its ability to assure that what is, also ought to be. The analytical insights the neoclassical economics had to offer related to an imaginary world of perfect competition and perfect knowledge in which marginal techniques of analysis demonstrated maximization of utility and output, and the solution of the central economic problem as conceived by it, i.e., allocation of scarce resources. Neither time nor space disturbed this analysis, not to speak of the variety in culture and tradition and other features distinguishing man from man, society from society, region from region and one historical epoch from another. All these were irrelevant for the universal categories with which the system dealt.

One should not conclude that economists did not talk about anything other than the theory of value and distribution. They did discuss money but only as a numeraire, (because the marginal calculus could deal only with numbers not with speculation and expectation). International trade was taken care of by the assumption of perfect mobility and the real world complexities were confronted with only one option: free trade. Growth and development were concepts foreign to a system which envisioned maximization of production with optimum allocation of resources and which, having abstracted away time, as well as uncertainty, could not admit technological change in any real sense. Public finance could hardly deserve any notice in a regime of laissez faire. Labor and industrial relations could deal only with the pointlessness of any resort to unionism. What else is left?

Marshall's Principles was the standard text in economics even beyond the first quarter of the twentieth century. But already new and disturbing thoughts were surfacing. Schumpeter's characterization of the entrepreneur and Knight's insights into the all-pervading uncertainty hardly fit into the neoclassical wonder world. Flaws into the neoclassical theory of value (and distribution) appeared as the perfectly competitive equilibrium and a remainderless distribution of product were shown to depend on the assumption of constant returns to scale. The work of Piero Sraffa followed by those of Joan Robinson and Chamberlin shattered the harmonious edifice so diligently constructed over the last century. Goods were heterogeneous and indivisible, mobility imperfect, numbers not necessarily large, some prices were sticky, supplier could manipulate demand through advertisement and, above all, knowledge was always deficient. As a result of these fresh insights the belief in the automatism of the economic process was yielding to a recognition for the need to control this process in varying degrees. It was not, however, the academia which forced this realization upon the economists, but the rude reality intruding upon their peace in the form of the Great Depression in 1929. "The masses of the unemployed and the idle productive facilities, during the depression, made many economists realize that macroeconomic problems had been excluded from orthodox economic theory and that their micro-instruments of "the logic of choice" were completely inadequate to tackle the problems society then faced," to put rather mildly.

Source: Dr. Muhammad Nejatullah Siddiqi, Economics An Islamic Approach. Republished with permission.