From: thompson@atlas.socsci.umn.edu (T. Scott Thompson)
Subject: Re: Problems with Neo-Classical Economics
Reply-To: thompson@atlas.socsci.umn.edu
Organization: Economics Department, University of Minnesota
Date: Mon, 28 Sep 1992 22:34:20 GMT

garry@monarch.eng.ufl.edu (Garry Peterson) writes:

>The problems with neo-classical economics

>(1)  Perfect Rationality.  People are not perfectly rational.  Perhaps in 
>simple situations, but definitely not in complex ones.

>(2)  Perfect Information.  All people do not have access to all 
>information.  Again, in simple situations this approximation may be 
>valid, but most situations are not simple.

>(3)  Externalities.  Environmental good and services are either not 
>valued or are undervalued.  In general, the problem of the commons.

1.  It is possible to show that some conclusions of neoclassical
equilibrium theory do not require rational behavior.  Other
conclusions stand essentially unchanged under minor deviations from
rationality.  George Akerlof has written papers showing how small
deviations from rationality generate only second order small
deviations in observed aggregate equilibrium outcomes.  Other
conclusions are possible depending on the model.

2.  The economics of information (including imperfect and asymmetric
information) are standard fare in virtually all graduate economics
programs today.  Perhaps you do not think that these departments are
part of the neoclassical tradition.

3.  The economics of public goods and externalities are also standard
fare in virtually all graduate (and undergraduate) economics programs.

>Attempts by economics to deal with these problems:

>(1) & (2) are being dealt with by people applying ideas from chaos, 
>game, and adaptation theory to conventional economics.  (For 
>example 'The Economy as an Evolving Complex System, ed. by 
>Kenneth Arrow).

>(3) Ecological economics and to a lesser degree environmental and 
>resource economics. (Eg. Ecological Economics ed. by Robert Costanza).

>Here is one topic relating to these points which I think is interesting.
>-To me this looks like three reasons why free trade is not necessarily 
>a good thing.

>Comments anyone?

4.  While information asymmetries might lead to a rational argument
for trade restrictions, no such complications are needed.  It is well
recognized by economic theorists that (even under the standard
assumptions) free trade is not necessarily the socially optimal
policy.  This has been well known for at least 40 years, and probably
longer.

5.  Likewise, neoclassical trade theory has considered the role of
externalities in international trade theory for at least 40 years.  (I
routinely teach this topic to undergraduates.)  There has been
extensive analysis of the fact that externalities can make free trade
suboptimal.  In order to get this conclusion, however, you must appeal
to trade restrictions as "second best" policies under the assumption
that first best policies are not available.  I have yet to see an
example where trade restrictions are the first best policy response to
an externality.  In other words, free trade is usually a scapegoat for
other kinds of problems in the economy.

6.  You avoid the real question, namely whether or not the mechanisms
by which free trade is _potentially_ suboptimal are empirically
important enough to upset the general validity of the theory.

The assumptions made by Newtonian physics are also "wrong".
Nevertheless, I have never observed an obvious violation of them in my
daily life, and find it useful to plan my life as if they were true.
If I were designing microelectronic circuits I might take a different
view.
--
T. Scott Thompson              email:  thompson@atlas.socsci.umn.edu
Department of Economics        phone:  (612) 625-0119
University of Minnesota        fax:    (612) 624-0209