Growth theory advanced again with the theories of economist Paul Romer in the late 1980s and early 1990s. Other important new growth theorists include Robert E. Lucas and Robert J. Barro.
Unsatisfied with Solow's explanation, economists worked to "endogenize" technology in the 1980s. They developed the endogenous growth theory that includes a mathematical explanation of technological advancement. This model also incorporated a new concept of human capital, the skills and knowledge that make workers productive. Unlike physical capital, human capital has increasing rates of return. Therefore, overall there are constant returns to capital, and economies never reach a steady state. Growth does not slow as capital accumulates, but the rate of growth depends on the types of capital a country invests in. Research done in this area has focused on what increases human capital (e.g. education) or technological change (e.g. innovation). (Becker, 1976, 32-98)
Analysis Of Recent Economies' Success
Analysis of recent economies' success shows a close correlation between growth and climate. It is possible that there is absolutely no actual mechanism between the two, and the relation may be spurious. In early human history, economic as well as cultural development was concentrated in warmer parts of the world, like Egypt.
According to Acemoglu, Johnson and Robinson, the positive correlation between high income and cold climate is a by-product of history. Former colonies have inherited corrupt governments and geo-political boundaries (set by the colonizers) that are not properly placed regarding the geographical locations of different ethnic groups; this creates internal disputes and conflicts. Also, these authors contend that the egalitarian societies that emerged in colonies without solid native populations, and which could be exploited by individual farmers led to better property rights and incentives for long-term investment than those where native population was large, and together with the tropical climate, colonizers were led to plunder and run, and to create exploitative institutions, a situation which did not foster growth or private property rights. Colonies in temperate climate zones as Australia and USA did not inherit exploitative governments since Europeans were able to inhabit these territories and set up governments that mirrored those in Europe. It is important to note that Sachs, among others, do not believe this to be the case. (Dow, 1985, 56-98)
Neoclassical Economics
Neoclassical economics refers to a general approach in economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand. These are mediated through a hypothesized maximization of income-constrained utility by individuals and of cost-constrained profits of firms employing available information and factors of production. Mainstream economics is largely neoclassical in its assumptions, at least at the microeconomic level. There have been many critiques of neoclassical economics, often incorporated into newer versions of neoclassical theory as human awareness about economic criteria change. Neoclassical economics is often called the marginalist school. (Dow, 1985, 56-98)
Neoclassical Economic Theory
Neoclassical economic theory (which is also associated with neoliberal political policies) is grounded in the rejection of the Marxian notion of exploitation and the promotion of the idea that the distribution of social resources produced by market exchanges is innately fair and just (when it is allowed to work "without friction.") Although neoclassical theory dominates the economics discipline it is actually a psychological theory: at the core of the theory is a specific reductionist theory of human decision making and rationality that is then applied to economic (and other) phenomena. All human decision making is assumed to be driven by the pursuit of individual pleasure/happiness. This pleasure is defined, within the theory, as utility. Thus, the economic man (homo economicus) is a utility maximizer. Market exchanges are defined as simple trades between equally powerless economic men trying to maximize their individual pleasure. The wage labor relationship is such a market exchange. The wage is defined as equal to the value of the contribution of workers to the overall value of the commodity produced, such that workers are not cheated out of any “surplus value,” as defined within Marxian theory. Thus, neoclassical theory provides a clear alternative to the Marxian contention that workers are exploited by being cheated out of value that should rightly belong to them. (Mirowski, 1989, 43-78)
Neoclassical economic theory dominates the teaching and practice of economics in the United States and in many other countries, as well. It provides an analytical framework from which to argue in favor of the existing distribution of wealth: wealth is the result of the decisions that individuals make, not the result of processes of coercion, theft, colonization, etc. In neoclassical theory, those who become wealthy do so by hard work and frugality, while those who become poor do so by profligacy and laziness. Nevertheless, the best of all possible worlds (Pareto Optimality) can only come about by unfettered market exchanges, allowing individual decision-making to occur without governmental interference (the primary cause of the "friction" that John Bates Clark warned about). In many ways neoclassical (neoliberal) theory has become a tool for the dissemination of public policies and international agreements that reduce the role of government in shaping economic activities (including transactions) and promote the power of transnational firms in shaping these same economic activities. In this sense, neoclassical economic theory is a weapon in the extension of a transnational firm-led globalization process. (Mirowski, 1989, 43-78)
Economists publicly disagree with each other so often that they are easy targets for standup comedians. Yet noneconomists may not realize that the disagreements are mostly over the details—the way in which the big picture is to be focused on the small screen. When it comes to broad economic theory, most economists agree. President Richard Nixon, defending deficit spending against the conservative charge that it was "Keynesian," is reported to have replied, "We're all Keynesians now." In fact, what he should have said is "We're all neoclassicals now, even the Keynesians," because what is taught to students, what is mainstream economics today, is neoclassical economics.
But there were difficulties in this approach. Chief among them was that prices in the market did not necessarily reflect the "value" so defined, for people were often willing to pay more than an object was "worth." The classical "substance" theories of value, which took value to be a property inherent in an object, gradually gave way to a perspective in which value was associated with the relationship between the object and the person obtaining the object. Several economists in different places at about the same time (the 1870s and 1880s) began to base value on the relationship between costs of production and "subjective elements," later called "supply" and "demand." This came to be known as the Marginal Revolution in economics, and the overarching theory that developed from these ideas came to be called neoclassical economics. (The first to use the term "neoclassical economics" seems to have been the American economist Thorstein Veblen.) (Mirowski, 1989, 43-78)
The framework of neoclassical economics is easily summarized. Buyers attempt to maximize their gains from getting goods, and they do this by increasing their purchases of a good until what they gain from an extra unit is just balanced by what they have to give up to obtain it. In this way they maximize "utility"—the satisfaction associated with the consumption of goods and services. Likewise, individuals provide labor to firms that wish to employ them, by balancing the gains from offering the marginal unit of their services (the wage they would receive) with the disutility of labor itself—the loss of leisure. Individuals make choices at the margin. This results in a theory of demand for goods, and supply of productive factors.
Similarly, producers attempt to produce units of a good so that the cost of producing the incremental or marginal unit is just balanced by the revenue it generates. In this way they maximize profits. Firms also hire employees up to the point that the cost of the additional hire is just balanced by the value of output that the additional employee would produce. (Mirowski, 1989, 43-78)
The neoclassical vision thus involves economic "agents," be they households or firms, optimizing (doing as well as they can), subject to all relevant constraints. Value is linked to unlimited desires and wants colliding with constraints, or scarcity. The tensions, the decision problems, are worked out in markets. Prices are the signals that tell households and firms whether their conflicting desires can be reconciled. (Weintraub and Roy, 1985, 86)
Neoclassical theory has maintained its dominant position despite attacks upon its underlying assumptions from a wide range of perspectives and analyses, from the Cambridge critique and the work of Pierro Sraffa to the work of behavioral psychologists (who have demonstrated that human behavior is not in accordance with the neoclassical notion of rationality).
Conclusion
The value of neoclassical economics can be assessed in the collection of truths to which we are led by its light. The kinds of truths about incentives—about prices and information, about the interrelatedness of decisions and the unintended consequences of choices—are all well developed in neoclassical theories, as is a self-consciousness about the use of evidence. In planning for future electricity needs in my state, for example, the Public Utilities Commission develops a (neoclassical) demand forecast, joins it to a (neoclassical) cost analysis of generation facilities of various sizes and types (e.g., an 800-megawatt low-sulfur coal plant), and develops a least-cost system growth plan and a (neoclassical) pricing strategy for implementing that plan. Those on all sides of the issues, from industry to municipalities, from electric companies to environmental groups, all speak the same language of demand elasticities and cost minimization, of marginal costs and rates of return. The rules of theory development and assessment are clear in neoclassical economics, and that clarity is taken to be beneficial to the community of economists. The scientificness of neoclassical economics, on this view, is not its weakness but its strength.
References
Becker, Gary. The Economic Approach to Human Behavior. 1976.
Dow, Sheila. Macroeconomic Thought: A Methodological Approach. 1985.
Mirowski, Philip. More Heat Than Light. 1989.
Weintraub, E. Roy. General Equilibrium Analysis: Studies in Appraisal. 1985
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