The Construction of Early Neoclassical Economics

Neoclassical economics arose as the product of a theoretical approach called ‘marginalism’ in economic theory in the early 1870s. The prominent economists of the time were William S. Jevons (1835-1882), Léon Walras (1834-1910) and Carl Menger (1840-1921). At that time, marginalism was a new approach developed in economic theory together with the utility theory of value. Concepts of “marginal” and “utility” lie in the foundations of neoclassical economic theory. Since these two concepts (i.e., ‘marginal’ and ‘utility’) are the grounding concepts of neoclassical economics, ‘marginalism’ and ‘utilitarianism’ are also used to characterize neoclassical economics.

Austrian neoclassical economists particularly advocated pure subjectivism as British neoclassical economists (for example, Alfred Marshall) employed marginalism in keeping with the objective (material) foundations of economics.

According to Polanyi (2001), the ‘commodification’ process of three basic elements of the capitalist economy, namely money, land and labor, was completed in the 1830s. According to Polanyi, these three factors of production are not commodities in a real sense. In real terms, commodities are those produced to be sold. In this sense, soil is another name of nature, money is the means for buying and selling commodities, and labor is man himself. None of them are produced to be sold like other real commodities, and for this reason, Polanyi called this commodity form of labor, money and land “fictitious commodities” (Polanyi, 2001: 71-80).

According to Polanyi (2001), the ‘commodification’ process of three basic elements of the capitalist economy, namely money, land and labor, was completed in the 1830s.

The first period of neoclassical economics was between the 1870s and 1920s; the second began in the 1980s.

There were two important events that interrupted the development of neoclassical economics as an
orthodox theory. These were World War I (WWI) and the Great Depression of 1929, respectively.

Utilitarianism is a philosophical and existential concept that refers to the bodily, material, moral, reflexive and emotional aspects of human beings. In neoclassical economic theory, utilitarianism is employed to analyze the macro economic structure on the micro base of individuals’ (ir)rational preferences and behaviors in the light of its basic concepts such as happiness, pleasure, benefit, interest and utility.

In ethics three chief problems and questions are at issue: “1. The problem of the good or the highest good, 2. the problem of the right act, 3. the problem of will (free will)”. These fundamental problems of ethics are linked to three questions: “1. What should I choose?, 2. What should I do?, 3. What should I want?” (Özlem, 2004: 30). Utilitarianism is concerned with the first problem and its related question in ethics, that is, ‘what to choose?’. As such, utilitarianism is ‘the problem of the good or the highest good’, which produced various answers to the question of ‘what to choose/prefer’.

Neoclassical economics redefined utilitarianism in terms of hedonism with categories specific to the spiritual and bodily state of individuals, such as self-interest and pleasure.

In neoclassical economics, the key institutions of the economy, i.e., the market, the state and private property are taken for granted and they are not analyzed as part of the institutional social order. It is because of this fact, Veblen characterizes neoclassical economics as ‘taxonomic’ −a term that implies that the elements of the economy are stripped of an institutional character and classified without establishing relations between them.

The effect of Newton’s physics on Smith’s economic thought and the belief of classical tradition for the natural limits of economic growth, it becomes clearer that in classical tradition before Mill the driving forces and limits of the economy are the physical nature rather than the mind and behaviors of the economic man. Therefore, in classical tradition, the economy is a natural realm and the forces that set in motion the economic process are material forces like labor, not mental and psychological elements of the economic man like utility and pleasure. Therefore, the shift from labor to utility is linked to the transformation of economics from material science to mental science. This is the distinguishing feature of the marginal revolution that takes its inspiration from Mill’s economics paying attention to the mind. Jevons is the turning point that takes the mental orientation of economics to a higher level.

Menger developed another version of cost theory of value in accordance with subjectivism in economics, which is known as ‘alternative cost theory’ or ‘opportunity cost’ that explains prices and distribution of income as opposed to the objective theory of labor cost in the production process. Alternative cost theory stresses individuals’ mental
and psychological value imputations/attributions to things/goods and it also explains the material production process subjectively. Thus, utility as individuals’ attributions and preferences are not subject to the mathematical measurement that calculates and identifies them objectively. Subjective value attributions/evaluations are only made by
individuals in consumption and production. This theory, thus, emphasizes the psychological and mental side of the individualistic economic actions and interactions between individuals. Alternative/ opportunity cost theory not only explains the value and price of things, and the incomes of production factors and therefore the distribution of incomes but also the supply of public goods by the state and taxation as the consumer behavior.

Marshall’s most important contributions to neoclassical economics are his ‘partial analysis’ and ‘period analysis’.

Marshall's analysis was subject to constraints and he stated that his “method of partial equilibria” is only valid under certain conditions, which are rarely observed in reality. These are “(1) demand- and-supply curves need to be independent of each other, (2) only small changes in price or quantity are allowed for, and (3) adjustments triggered by some change must be restricted to the market under observation and must not influence noticeably the situation in other markets” (Kurz, 2013: 82).

Neoclassical economists, with very few exceptions, do not see the state as productive. As for government expenditures, they should be at a minimum because as in the state debt they are  another way of state intervention into the market that disrupts effective resource allocation.

Neoclassical public finance theory is the application of the marginalist premises and methodology to the state economy on the microeconomics base of the consumer choices, behaviors and interactions.

Neoclassical public finance theory interprets tax not in the context of law that forces its payment, but of the consumer’s sovereignty that pays taxes as the voluntary payment in return for the utility of public goods.

The English neoclassical economics is criticized because the measurement of utility surpasses the subjective aspect of marginalism and the fiscal policies depending on the calculations of utility and cost/sacrifice can press individualism in economics. If utility is subjected to calculations, then the government can calculate the marginal social cost and marginal social utility in a way to set the balance between the composition and amount of public good and taxes without recourse to the consumption decisions of individuals −this results in the state being the decision unit instead of
consumers (citizens), which is opposed to the basic idea of individualistic neoclassical economics (for an extensive debate see Kayaalp, 2004; Musgrave and Peacock, 1958).

Pluralism in economics is a movement that supports mixed methodologies and interdisciplinarity as knowledge order. It takes its root in the old tradition of classical political economy, institutional and
evolutionary economics, critical political economy as well as the Keynesian critique of neoclassical economics.

These principles are as follows: (1) “people face tradeoffs/there is no such thing as a free lunch”, (2) “the cost of something is what you give up to get it/opportunity cost”, (3) “rational people think at the margin”, (4) “people respond to incentives”, (5) “trade can make everyone better off”, (6) “markets are usually a good way to organize economic activity”, (7) “governments can sometimes improve market outcomes”, (8) “a country’s standard of living depends on its ability to produce goods and services, (9) “prices rise when the government prints too much money”, (10) “society faces a short-run tradeoff between inflation & unemployment”. According to this critical evaluation, these principles represent ten golden premises that govern real policies in the world in a way to  support “extreme and unwarranted bias towards unregulated markets” (see Campbell et. al, 2018 for the entire critical discussion on these neoclassical economics principles).