Criticisms of Neoclassical Economics - Equilibrium Theory

Equilibrium Theory

Problems exist with making the neoclassical general equilibrium theory compatible with an economy that develops over time and includes capital goods. This was explored in a major debate in the 1960s—the "Cambridge capital controversy"—about the validity of neoclassical economics, with an emphasis on the economic growth, capital, aggregate theory, and the marginal productivity theory of distribution. There were also internal attempts by neoclassical economists to extend the Arrow-Debreu model to disequilibrium investigations of stability and uniqueness. However a result known as the Sonnenschein-Mantel-Debreu theorem suggests that the assumptions that must be made to ensure that the equilibrium is stable and unique are quite restrictive.

Neoclassical economics is also often seen as relying too heavily on complex mathematical models, such as those used in general equilibrium theory, without enough regard to whether these actually describe the real economy. Many see an attempt to model a system as complex as a modern economy by a mathematical model as unrealistic and doomed to failure. Famous answer to this criticism is Milton Friedman's claim that theories should be judged by their ability to predict events rather than by the realism of their assumptions. Mathematical models also include those in game theory, linear programming, and econometrics.

For a detailed critique of mathematical modeling, as used in the academic and political practice of neoclassical economics, see Pitfalls of Economic Models.

In the "Concluding Remarks" (p. 524) of his 2001 Nobel Prize lecture, Joseph Stiglitz examined why the neoclassical paradigm—and models based on it—persists, despite his publication, over a decade earlier, of some of his seminal results showing that Information Asymmetries invalidated core Assumptions of that paradigm and its models:

"One might ask, how can we explain the persistence of the paradigm for so long? Partly, it must be because, in spite of its deficiencies, it did provide insights into many economic phenomena. ...But one cannot ignore the possibility that the survival of the paradigm was partly because the belief in that paradigm, and the policy prescriptions, has served certain interests."

In the aftermath of the 2007-2009 global economic meltdown, the profession's attachment to unrealistic models is increasingly being questioned and criticized. After a weeklong workshop, one group of economists released a paper highly critical of their own profession's unethical use of unrealistic models. Their Abstract offers an indictment of fundamental practices:

"The economics profession appears to have been unaware of the long build-up to the current worldwide financial crisis and to have significantly underestimated its dimensions once it started to unfold. In our view, this lack of understanding is due to a misallocation of research efforts in economics. We trace the deeper roots of this failure to the profession's focus on models that, by design, disregard key elements driving outcomes in real-world markets. The economics profession has failed in communicating the limitations, weaknesses, and even dangers of its preferred models to the public. This state of affairs makes clear the need for a major reorientation of focus in the research economists undertake, as well as for the establishment of an ethical code that would ask economists to understand and communicate the limitations and potential misuses of their models."

The assumption of rational expectations which has been introduced in some more modern neoclassical models (sometimes also called new classical) can also be criticized on the grounds of realism.

In general, allegedly overly unrealistic assumptions are one of the most common criticisms towards neoclassical economics. It is fair to say that many (but not all) of these criticisms can only be directed towards a subset of the neoclassical models (for example, there are many neoclassical models where unregulated markets fail to achieve Pareto-optimality and there has recently been an increased interest in modeling non-rational decision making).

Economists tend to focus on markets or aggregate outcomes instead of observing individual behavior. Neoclassical economists have argued that evolutionary or "market forces" tend to select naturally the most “fit“ actors. Hence, neoclassical economic theories are based on assumptions that (competitive) markets provide an environment that involves incentives for economic actors to learn optimal behavior, on average, in the long run. In this line markets are thought to “heal“ the cognitive imperfections of actors through evolutionary forces, compelling most of them to behave "as if" they were rational. According to Joseph Stiglitz, “(Economics as taught) in America’s graduate schools .... bears testimony to a triumph of ideology over science.” Recently more and more critics have raised their voices against the way Economics is being taught. On the subject Mark Blaug says: "Economics has increasingly become an intellectual game played for its own sake and not for its practical consequences for understanding the economic world. Economists have converted the subject into a sort of social mathematics in which analytical rigour is everything and practical relevance is nothing.”