I take neoclassical economics to be more the branch of modern economics that renews emphasis on the foundational thoughts of Adam Smith and David Ricardo, than on the synthesis that gives government a role in the economy such as the Keynesian thought so popular the last decades. Hence, I see the Austrian economists Ludwig von Mises and Friedrich von Hayek as better representatives of neo-classical thought than government interventionists like Keynes or Marxists. But, while I believe in the central economic truths about supply and demand and property ownership, neoclassical economics is inadequate for explaining the entirety of today’s economy.
I recently read an excerpt from Ludwig von Mises, titled “The Problems of External Costs and External Economies,” on Ron Paul’s website. This is a brilliant economic talk for its time, and most of the principles von Mises discusses in that article apply today. However, more recent developments in the financial sector are not addressed by this article because ownership of money, rather than ownership of property (land) is a level of abstraction from a neoclassical economy.
Many people miss the fact that Wall Street, like government, does not conform to these principles. Unlike the family farmer worried about destroying his land because he has to hand it over to his children, or James Hill’s willingness to invest in a dike to protect his railroad tracks, Wall Street speculators are an order removed from the ownership of property and the incentives that account for external costs.
External costs are those not directly related to economic exchanges. For example, pollution of land, air, or water is an external cost. Critics of neoclassical economics and Keynesian economics frequently argue that the focus on exchanges is only an analysis of part of the entire system. The exchange system is dependent on outside environmental factors and upon human well-being and development. It ignores such factors external to transactions that are important for the maintenance of an economic system. This is why we are destroying our environment and creating an unstable society.
In the above-mentioned article, von Mises argues quite forcefully that the externals are covered by the concept of property ownership. If land on a frontier is owned by no one, people will go there to exploit its resources and not care whether they destroy it. However, if an individual or firm owns the land it will keep it environmentally sustainable because it has to serve him or his descendants for many lifetimes. I believe history bears out von Mises’ argument if the individual or firm is directly engaged in the use of the land for long-term livelihood.
Von Mises argues that with bureaucratic government ownership, a bureaucrat does not have the same interest in considering external factors, and therefore governments notoriously fail to care for people or resources in a personal way. I agree, in an earlier article in my blog and in Life, Liberty, and the Pursuit of Happiness, Version 4.0, I explain why bureaucracies cannot care.
But this neo-classic analysis fails to address bureaucratic management of property in the private sphere, namely Wall Street. In an effort to produce a short-term profit through the stock market, mergers, acquisitions, and even dismantling of competitor’s companies, it is ownership of money, not property (land) that is the primary capital of economic action for financial bureaucracies. Care for land and the external factors related to the environment becomes secondary, perhaps even less important than for a government bureaucracy.
I believe neo-classical economic thought, while superior to Keynesian ideas about the role of government generally, is not up to the task of addressing this second-order financial economy that becomes largely external to traditional property ownership. Wall Street has become more removed from neo-classical economic assumptions about ownership of land than has Washington. But, in neither case is ownership of property—the driving force of caretaking and stewardship—as essential as for the person or family firm that must live in the environment and preserve it for its own economic resource and for posterity.
We cannot blame von Mises for not addressing problems that largely flowered after his lifetime, but we must warn our contemporaries not to take his teachings as a closed canon of economic scripture the way Biblical and Muslim fundamentalists or Marxists believe all answers to salvation today are contained in fixed ancient texts. We must realize that we have to build on von Mises, not worship him.
An integral perspective is one that considers something as a system, or subsystem, with internal relationships and external relationships. In addition to the natural environment, globalization is yet another factor that is often left out of neo-classical economic analyses. For example, “free trade” is not free just because tariffs are eliminated. Countries’ tax structures add burdens to the cost of labor and production differently, so that people in a low tax state have greater opportunity to compete on a world market than citizens of a high-tax state. While, the classical notion of supply and demand is operative here, it involves many factors external to the economic transaction itself.
I believe that neither neoclassical economics nor Keynesian economics are adequate to describe our current economic system and its problems. The arguments we witness between these groups are largely irrelevant. They each apply to a subset of our economy, but neither are adequate to explain the economy as a whole and massive problems, such as “too big to fail.” Neoclassic economics is pretty good at explaining government economic failure, but not Wall Street’s failure to serve the economic well-being of those on “main street.”
Keynesian economics can only serve to create a modicum of economic justice when there is already an overwhelming amount individual wealth in a vast consumer population that can generate enough taxes out of its surplus to sustain a small percentage of government jobs and welfare. It has reached its limit when it goes beyond this point and advises governments to borrow against the future, simply delaying economic collapse. And, that is where the United States is today.
With neither neoclassical nor Keynesian economics up to the task, and with socialism relegated to the garbage heap of history, we need an economic philosophy that recognizes the importance of fundamental classical and neoclassical arguments for wealth creation, but also a systems analysis that creates checks and balances against the usurpation of wealth for personal gain through any scheme of redistribution, whether in the public or private sector. In Life, Liberty, and the Pursuit of Happiness, Version 4.0, I have developed an outline of principles, and the laws that would follow from them, that would regulate both Washington and Wall Street.