AnarWiki/markdown/C.1.2_(An_Anarchist_FAQ).md

**C.1.2 Is economics a science?** is the third chapter of [Section
C](Section_C:_What_are_the_myths_of_capitalist_economics?_\(An_Anarchist_FAQ\) "wikilink")
of [An Anarchist FAQ](An_Anarchist_FAQ "wikilink").

## Transcript

In a word, no. If by “[scientific](Science "wikilink")” it is meant in
the usual sense of being based on empirical observation and on
developing an analysis that was consistent with and made sense of the
data, then most forms of economics are not a science. Rather than base
itself on a study of reality and the generalisation of theory based on
the data gathered, economics has almost always been based on generating
theories rooted on whatever assumptions were required to make the theory
work. Empirical confirmation, if it happens at all, is usually done
decades later and if the facts contradict the economics, so much the
worse for the facts.

A classic example of this is the neo-classical theory of production. As
noted previously, neoclassical economics is focused on individual
evaluations of existing products and, unsurprisingly, economics is
indelibly marked by “the dominance of a theoretical vision that treats
the inner workings of the production process as a ‘black box.’” This
means that the “neoclassical theory of the ‘capitalist’ economy makes no
qualitative distinction between the [corporate](Corporation "wikilink")
enterprise that employs tens of thousands of people and the small family
undertaking that does no employ any [wage
labour](Wage_Labour "wikilink") at all. As far as theory is concerned,
it is technology and market forces, not structures of social power, that
govern the activities of corporate capitalists and petty proprietors
alike.” \[William Lazonick, Competitive Advantage on the Shop Floor, p.
34 and pp. 33–4\]

Production in this schema just happens — inputs go in, outputs go out —
and what happens inside is considered irrelevant, a technical issue
independent of the social relationships those who do the actual
production form between themselves — and the conflicts that ensure. The
theory does have a few key assumptions associated with it, however.
First, there are diminishing returns. This plays a central role. In
mainstream diminishing returns are required to produce a downward
sloping demand curve for a given factor. Second, there is a rising
supply curve based on rising marginal costs produced by diminishing
returns. The average variable cost curve for a firm is assumed to be
U-shaped, the result of first increasing and then diminishing returns.
These are logically necessary for the neo-classical theory to work.

Non-economists would, of course, think that these assumptions are
generalisations based on empirical evidence. However, they are not. Take
the U-shaped average cost curve. This was simply invented by [A. C.
Pigou](Arthur_Cecil_Pigou "wikilink"), “a loyal disciple of \[leading
neo-classical Alfred\] Marshall and quite innocent of any knowledge of
industry. He therefore constructed a U-shaped average cost curve for a
firm, showing [economies of scale](Economy_of_Scale "wikilink") up to a
certain size and rising costs beyond it.” [\[Joan
Robinson]([Joan_Robinson "wikilink"), Collected Economic Papers, vol. 5,
p. 11\] The invention was driven by need of the theory, not the facts.
With increasing returns to scale, then large firms would have cost
advantages against small ones and would drive them out of business in
competition.

This would destroy the concept of perfect competition. However, the
invention of the average cost curve allowed the theory to work as
“proved” that a competitive market could not become dominated by a few
large firms, as feared. The model, in other words, was adjusted to
ensure that it produced the desired result rather than reflect reality.
The theory was required to prove that markets remained competitive and
the existence of diminishing marginal returns to scale of production did
tend by itself to limit the size of individual firms. That markets did
become dominated by a few large firms was neither here nor there. It did
not happen in theory and, consequently, that was the important thing and
so “when the great concentrations of power in the multinational
corporations are bringing the age of national employment policy to an
end, the text books are still illustrated by U-shaped curves showing the
limitation on the size of firms in a perfectly competitive market.”
\[Joan Robinson, Contributions to Modern Economics, p. 5\]

To be good, a theory must have two attributes: They accurately describe
the phenomena in question and they make accurate predictions. Neither
holds for Pigou’s invention: reality keeps getting in the way. Not only
did the rise of a few large firms dominating markets indirectly show
that the theory was nonsense, when empirical testing was finally done
decades after the theory was proposed it showed that in most cases the
opposite is the case: that there were constant or even falling costs in
production. Just as the theories of marginality and diminishing marginal
returns taking over economics, the real world was showing how wrong it
was with the rise of [corporations](Corporation "wikilink") across the
world. So the reason why the market become dominated by a few firms
should be obvious enough: actual corporate price is utterly different
from the economic theory.

This was discovered when researchers did what the original theorists did
not think was relevant: they actually asked firms what they did and the
researchers consistently found that, for the vast majority of
manufacturing firms their average costs of production declined as output
rose, their marginal costs were always well below their average costs,
and substantially smaller than ‘marginal revenue’, and the concept of a
‘demand curve’ (and therefore its derivative ‘marginal revenue’) was
simply irrelevant. Unsurprisingly, real firms set their
[prices](Price "wikilink") prior to sales, based on a mark-up on costs
at a target rate of output.

In other words, they did not passively react to the market. These prices
are an essential feature of capitalism as prices are set to maintain the
long-term viability of the firm. This, and the underlying reality that
per-unit costs fell as output levels rose, resulted in far more stable
prices than were predicted by traditional economic theory. One
researcher concluded that administered prices “differ so sharply from
the behaviour to be expected from” the theory “as to challenge the basic
conclusions” of it. He warned that until such time as “economic theory
can explain and take into account the implications” of this empirical
data, “it provides a poor basis for public policy.” Needless to say,
this did not disturb neo-classical economists or stop them providing
public policy recommendations. \[Gardiner C. Means, “The
Administered-Price Thesis Reconfirmed”,The American Economic Review, pp.
292–306, Vol. 62, No. 3, p. 304\]

One study in 1952 showed firms a range of hypothetical cost curves, and
asked firms which ones most closely approximated their own costs. Over
90% of firms chose a graph with a declining average cost rather than one
showing the conventional economic theory of rising marginal costs. These
firms faced declining average cost, and their marginal revenues were
much greater than marginal cost at all levels of output. Unsurprisingly,
the study’s authors concluded if this sample was typical then it was
“obvious that short-run marginal price theory should be revised in the
light of reality.” We are still waiting. \[Eiteman and Guthrie, “The
Shape of the Average Cost Curve”, The American Economic Review, pp.
832–8, Vol. 42, No. 5, p. 838\]

A more recent study of the empirical data came to the same conclusions,
arguing that it is “overwhelming bad news ... for economic theory.”
While economists treat rising marginal cost as the rule, 89% of firms in
the study reported marginal costs which were either constant or declined
with output. As for price elasticity, it is not a vital operational
concept for corporations. In other words, the “firms that sell 40
percent of GDP believe their demand is totally insensitive to price”
while “only about one-sixth of GDP is sold under conditions of elastic
demand.” \[A.S. Blinder, E. Cabetti, D. Lebow and J. Rudd, Asking About
Prices, p. 102 and p. 101\]

Thus empirical research has concluded that actual price setting has
nothing to do with clearing the market by equating market supply to
market demand (i.e. what economic theory sees as the role of prices).
Rather, prices are set to enable the firm to continue as a going concern
and equating supply and demand in any arbitrary period of time is
irrelevant to a firm which hopes to exist for the indefinite future. As
Lee put it, basing himself on extensive use of empirical research,
“market prices are not market-clearing or profit-maximising prices,
but rather are enterprise-, and hence transaction-reproducing prices.”
Rather than a non-existent equilibrium or profit maximisation at a given
moment determining prices, the market price is \<em\>“set and the market
managed for the purpose of ensuring continual transactions for those
enterprises in the market, that is for the benefit of the business
leaders and their enterprises.” A significant proportion of goods have
prices based on mark-up, normal cost and target rate of return pricing
procedures and are relatively stable over time. Thus “the existence of
stable, administered market prices implies that the markets in which
they exist are not organised like auction markets or like the early
retail markets and oriental bazaars” as imagined in mainstream economic
ideology. \[Frederic S. Lee, Post Keynesian Price Theory, p. 228 and p.
212\]

Unsurprisingly, most of these researchers were highly critical the
conventional economic theory of markets and price setting. One viewed
the economists’ concepts of perfect competition and monopoly as virtual
nonsense and \<em\>“the product of the itching imaginations of
uninformed and inexperienced armchair theorisers.”\</em\> \[Tucker,
quoted by Lee, \<strong\>Op. Cit.\</strong\>, p. 73f\] Which
\<strong\>was\</strong\> exactly how it was produced. No other science
would think it appropriate to develop theory utterly independently of
phenomenon under analysis. No other science would wait decades before
testing a theory against reality. No other science would then simply
ignore the facts which utterly contradicted the theory and continue to
teach that theory as if it were a valid generalisation of the facts.
But, then, economics is not a science. This strange perspective makes
sense once it is realised how key the notion of diminishing costs is to
economics. In fact, if the assumption of increasing marginal costs is
abandoned then so is perfect competition and \<em\>“the basis of which
economic laws can be constructed ... is shorn away,”\</em\> causing the
\<em\>“wreckage of the greater part of general equilibrium
theory.”\</em\> This will have \<em\>“a very destructive consequence
for economic theory,”\</em\> in the words of one leading neo-classical
economist. \[John Hicks, \<strong\>Value and Capital\</strong\>, pp.
83–4\] As Steve Keen notes, this is extremely significant: <quote>
\<em\> “Strange as it may seem ... this is a very big deal. If marginal
returns are constant rather than falling, then the neo-classical
explanation of everything collapses. Not only can economic theory no
longer explain how much a firm produces, it can explain nothing
else.\</em\> \<em\>“Take, for example, the economic theory of employment
and wage determination ... The theory asserts that the real wage is
equivalent to the marginal product of labour ... An employer will employ
an additional worker if the amount the worker adds to output — the
worker’s marginal product — exceeds the real wage ... \[This\] explains
the economic predilection for blaming everything on wages being too high
— neo-classical economics can be summed up, as \[John Kenneth\]
Galbraith once remarked, in the twin propositions that the poor don’t
work hard enough because they’re paid too much, and the rich don’t work
hard enough because they’re not paid enough ...\</em\> \<em\>“If in fact
the output to employment relationship is relatively constant, then the
neo-classical explanation for employment and output determination
collapses. With a flat production function, the marginal product of
labour will be constant, and it will \<strong\>never\</strong\>
intersect the real wage. The output of the form then can’t be explained
by the cost of employing labour... \[This means that\] neo-classical
economics simply cannot explain anything: neither the level of
employment, nor output, nor, ultimately, what determines the real wage
...the entire edifice of economics collapses.”\</em\>
\[\<strong\>Debunking Economics\</strong\>, pp. 76–7\] \</quote\> It
should be noted that the empirical research simply confirmed an earlier
critique of neo-classical economics presented by Piero Sraffa in 1926.
He argued that while the neo-classical model of production works in
theory only if we accept its assumptions. If those assumptions do not
apply in practice, then it is irrelevant. He therefore \<em\>“focussed
upon the economic assumptions that there were ‘factors of production’
which were fixed in the short run, and that supply and demand were
independent of each other. He argued that these two assumptions could be
fulfilled simultaneously. In circumstances where it was valid to say
some factor of production was fixed in the short term, supply and demand
could not independent, so that every point on the supply curve would be
associated with a different demand curve. On the other hand, in
circumstances where supply and demand could justifiably be treated as
independent, then it would be impossible for any factor of production to
be fixed. Hence the marginal costs of production would be
constant.”\</em\> He stressed firms would have to be irrational to act
otherwise, foregoing the chance to make profits simply to allow
economists to build their models of how they should act. \[Keen,
\<strong\>Op. Cit.\</strong\>, pp. 66–72\] Another key problem in
economics is that of time. This has been known, and admitted, by
economists for some time. Marshall, for example, stated that \<em\>“the
element of \<strong\>time\</strong\>”\</em\> was \<em\>“the source of
many of the greatest difficulties of economics.”\</em\>
\[\<strong\>Principles of Economics\</strong\>, p. 109\] The founder of
general equilibrium theory, Walras, recognised that the passage of time
wrecked his whole model and stated that we \<em\>“shall resolve the ...
difficulty purely and simply by ignoring the time element at this
point.”\</em\> This was due, in part, because production
\<em\>“requires a certain lapse of time.”\</em\> \[\<strong\>Elements
of Pure Economics\</strong\>, p. 242\] This was generalised by Gerard
Debreu (in his Nobel Prize for economics winning \<strong\>Theory of
Value\</strong\> ) who postulated that everyone makes their sales and
purchases for all time in one instant. Thus the cutting edge of
neo-classical economics, general equilibrium ignores both time
\<strong\>and\</strong\> production. It is based on making time stop,
looking at finished goods, getting individuals to bid for them and, once
all goods are at equilibrium, allowing the transactions to take place.
For Walras, this was for a certain moment of time and was repeated, for
his followers it happened once for all eternity. This is obviously not
the way markets work in the real world and, consequently, the dominant
branch of economics is hardly scientific. Sadly, the notion of
individuals having full knowledge of both now and the future crops up
with alarming regularly in the “science” of economics. Even if we ignore
such minor issues as empirical evidence and time, economics has problems
even with its favoured tool, mathematics. As Steve Keen has indicated,
economists have \<em\>“obscured reality using mathematics because they
have practised mathematics badly, and because they have not realised the
limits of mathematics.”\</em\> indeed, there are \<em\>“numerous
theorems in economics that reply upon mathematically fallacious
propositions.”\</em\> \[\<strong\>Op. Cit.\</strong\>, p. 258 and p.
259\] For a theory born from the desire to apply calculus to economics,
this is deeply ironic. As an example, Keen points to the theory of
perfect competition which assumes that while the demand curve for the
market as a whole is downward sloping, an individual firm in perfect
competition is so small that it cannot affect the market price and,
consequently, faces a horizontal demand curve. Which is utterly
impossible. In other words, economics breaks the laws of mathematics.
These are just two examples, there are many, many more. However, these
two are pretty fundamental to the whole edifice of modern economic
theory. Much, if not most, of mainstream economics is based upon
theories which have little or no relation to reality. Kropotkin’s
dismissal of \<em\>“the metaphysical definitions of the academical
economists”\</em\> is as applicable today. \[\<strong\>Evolution and
Environment\</strong\>, p. 92\] Little wonder dissident economist
Nicholas Kaldor argued that: <quote> \<em\> “The Walrasian \[i.e.
general\] equilibrium theory is a highly developed intellectual system,
much refined and elaborated by mathematical economists since World War
II — an intellectual experiment ... But it does not constitute a
scientific hypothesis, like Einstein’s theory of relativity or Newton’s
law of gravitation, in that its basic assumptions are axiomatic and not
empirical, and no specific methods have been put forward by which the
validity or relevance of its results could be tested. The assumptions
make assertions about reality in their implications, but these are not
founded on direct observation, and, in the opinion of practitioners of
the theory at any rate, they cannot be contradicted by observation or
experiment.”\</em\> \[\<strong\>The Essential Kaldor\</strong\>, p.
416\] \</quote\>