The theory of capitalism: A two-legged stool
By Leonard Hitchcock
If you believe that the best kind of economic system is one based upon free markets and competition — one in which every individual is free to sell his or her labor, rent his or her property, and buy whatever he or she thinks will provide the most satisfaction — then you believe, whether you know it or not, in some version of a theory called “neoclassical economics.”
The basic tenets of that theory were laid down at the end of the nineteenth century and, despite some radical changes proposed by John Maynard Keynes in response to the great depression, have continued to enjoy the allegiance of many economists up ‘til the present day and are regularly taught in that Microeconomics 101 class that you may have taken.
Neoclassical economic theory serves not only to provide explanations of how markets operate, but also to sustain the political viability of capitalism. It does so by assuring people that capitalism is a rational way to run an economy, one which utilizes resources and labor with maximum efficiency and responds to changing circumstances through an inherent mechanism for self-correction. This latter alleged propensity, which is essentially the ability to restore a balance, or equilibrium, between “supply” and “demand” whenever forces threaten to push an economy off-center, is devoutly believed in by those who oppose any and all government interference in the workings of the market.
Unfortunately for those devotees, there is good reason to regard one of the foundational premises of neoclassical theory as almost certainly false.
The mainstream account of neoclassical theory usually begins with an account of the behavior of an individual who participates in a marketplace exchange. The assumptions of the theory are these: in making a choice in the marketplace, an individual is motivated entirely by self-interest. That self-interest is pursued by the use of reason and aims at the maximization of “utility,” a word that essentially means the satisfaction of the choice maker.
If the choice involves the selection of goods to consume, an individual is assumed to bring to the choice a ranked ordering of preferences that encompasses all possible bundles of goods on the market, and does not change over time. The chooser is assumed to possess complete information regarding all the goods vying for purchase. If, in an individual’s ranking of preferences, product A is preferred to B, and product B preferred to C, then that individual will always prefer A to C. And , finally, no one, in making market choices, is influenced by others.
The individual so described is the neoclassical version of Adam Smith’s “Homo Economicus,” i.e. economic man, and it is only choices made under the specified circumstances that can legitimately be called “rational.”
I venure to guess that anyone who is even minimally aware of how he or she makes choices in the marketplace will recognize that this Homo Economicus is no more real than Mr. Pickwick – in fact, is a good deal less real since Dickens takes considerable trouble to make Mr. Pickwick a believable human being.
The fact is that the economist’s portrait of Homo Economicus is not drawn from life. It represents an entirely theoretical concept, a concept formulated not because of its resemblance to how people actually behave, but because it is only if economic man is so characterized that the theory in its totality can deliver a positive assessment of how market economies function. In other words, neoclassical economics is a top-down theory. It pretends to begin with an account of individuals’ behaviors and build to a description of an economic system as a whole, but in fact it begins with the assumption that capitalism is a rational, equilibrating system and describes the individual market participant in the only way which is consistent with that conclusion.
What is Homo Economicus like in the real world? It is someone who very often comes to a market choice un-equipped with a predetermined ranking of preferences and rarely possesses (or even seeks) adequate information about those products upon which to base a choice. It is someone whose choices are not consistent over time and is heavily influenced by what others’ choices have been.
The real Homo Economicus is capable of using reason to make choices, but does so only occasionally. An average person makes thousands of decisions a day and most are made through habit, whim or by means of subconscious inclinations. Bringing rational reflection to bear of a choice is time-consuming and effortful and, in an affluent society, many market choices are relatively trivial.
Even when reason is invoked in choice-making , it is influenced by a host of biases that skew the results and operate without our conscious awareness. We imagine ourselves to have conducted an objective appraisal of our options when, in fact, mental dispositions common to our species have disrupted the logic of our deliberations.
Finally, it is simply false that self-interest is the only motivation for our economic choices. Humans have empathy and concern for one another that, fortunately for us all, enter into market decision-making.
Surely the world would be considerably more miserable than it is already if my only aim in buying a glass of lemonade from the neighbor kids’ stand was to maximize my utility.
Leonard Hitchcock of Pocatello is a professor emeritus at Idaho State University.