A History of Development Economics Thought: Challenges and Counter-challenges

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Paul Samuelson 's Foundations of Economic Analysis contributed to this increase in mathematical modelling. The interwar period in American economics has been argued to have been pluralistic, with neoclassical economics and institutionalism competing for allegiance. Frank Knight , an early Chicago school economist attempted to combine both schools.

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But this increase in mathematics was accompanied by greater dominance of neoclassical economics in Anglo-American universities after World War II. Some [17] argue that outside political interventions, such as McCarthyism , and internal ideological bullying played an important role in this rise to dominance. Hicks' book, Value and Capital had two main parts. The second, which was arguably not immediately influential, presented a model of temporary equilibrium. Hicks was influenced directly by Hayek's notion of intertemporal coordination and paralleled by earlier work by Lindhal.

This was part of an abandonment of disaggregated long run models. This trend probably reached its culmination with the Arrow—Debreu model of intertemporal equilibrium. Many of these developments were against the backdrop of improvements in both econometrics , that is the ability to measure prices and changes in goods and services, as well as their aggregate quantities, and in the creation of macroeconomics , or the study of whole economies.

The attempt to combine neo-classical microeconomics and Keynesian macroeconomics would lead to the neoclassical synthesis [18] which has been the dominant paradigm of economic reasoning in English-speaking countries since the s. Hicks and Samuelson were for example instrumental in mainstreaming Keynesian economics. Macroeconomics influenced the neoclassical synthesis from the other direction, undermining foundations of classical economic theory such as Say's law , and assumptions about political economy such as the necessity for a hard-money standard.

These developments are reflected in neoclassical theory by the search for the occurrence in markets of the equilibrium conditions of Pareto optimality and self-sustainability. Neoclassical economics is sometimes criticized for having a normative bias. In this view, it does not focus on explaining actual economies, but instead on describing a theoretical world in which Pareto optimality applies. Perhaps the strongest criticism lies in its disregard for the physical limits of the Earth and its ecosphere which are the physical container of all human economies.

This disregard becomes hot denial by neoclassical economists when limits are asserted, since to accept such limits creates fundamental contradictions with the foundational presumptions that growth in scale of the human economy forever is both possible and desirable. The assumption that individuals act rationally may be viewed as ignoring important aspects of human behavior. Many see the " economic man " as being quite different from real people. Thorstein Veblen put it most sardonically that neoclassical economics assumes a person to be:.

Non-rational decision-making is the subject of behavioral economics. Large corporations might perhaps come closer to the neoclassical ideal of profit maximization, but this is not necessarily viewed as desirable if this comes at the expense of neglect of wider social issues. 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 s—the " Cambridge capital controversy "—about the validity of neoclassical economics, with an emphasis on 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 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. A 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. Some [24] see mathematical models used in contemporary research in mainstream economics as having transcended neoclassical economics, while others [25] disagree.

Critics of neoclassical economics are divided into those who think that highly mathematical method is inherently wrong and those who think that mathematical method is potentially good even if contemporary methods have problems. 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.

It has been argued within the field of ecological economics that the neoclassical economic system is by nature dysfunctional since it holds the destruction of the natural world through the accelerating consumption of non-renewable resources as well as the exhaustion of the "waste sinks" of the ecosphere as "externalities" that are nowhere taken into account in the theory. From Wikipedia, the free encyclopedia. Not to be confused with New classical macroeconomics. Index Outline Category.

History Branches Classification. History of economics Schools of economics Mainstream economics Heterodox economics Economic methodology Economic theory Political economy Microeconomics Macroeconomics International economics Applied economics Mathematical economics Econometrics.

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Glossary of economics. This section does not cite any sources. Please help improve this section by adding citations to reliable sources. Unsourced material may be challenged and removed. August Learn how and when to remove this template message. Main article: Criticisms of neoclassical economics. What is Heterodox Economics? Key Takeaways Heterodox economics refers to all the theories and schools of thought that are outside the mainstream, market-based approaches.

Heterodox economists are interested in power dynamics and historical context when approaching economic problems. Heterodox economics plays an important role in challenging established schools of economic thought to continually prove their worth as a policy framework for the real world. Compare Investment Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. Related Terms Mainstream Economics Definition Mainstream economics is a term used to describe schools of economic thought considered orthodox.

Everything You Need to Know About Macroeconomics Macroeconomics studies an overall economy or market system: its behavior, the factors that drive it, and how to improve its performance. What Is Ceteris Paribus? Ceteris paribus is a Latin phrase usually rendered as "all other things being equal. Milton Friedman Definition Milton Friedman was an American economist and statistician best known for his strong belief in free-market capitalism. Is Economics Really a Dismal Science?

Classical Economics and the Evolutions of Capitalism Classical economics refers to a body of work on market theories and economic growth which emerged during the 18th and 19th centuries. Partner Links. Related Articles. Our regulations could be better designed and maintained to promote a more vibrant, innovative, and productive economy. Many researchers and research organizations U. Those 12 recommendations are quoting, with emphasis added :. Commit at the highest political level to an explicit whole-of-government policy for regulatory quality.

The policy should have clear objectives and frameworks for implementation to ensure that, if regulation is used, the economic, social and environmental benefits justify the costs, distributional effects are considered and the net benefits are maximised. Adhere to principles of open government, including transparency and participation in the regulatory process to ensure that regulation serves the public interest and is informed by the legitimate needs of those interested in and affected by regulation.

This includes providing meaningful opportunities including online for the public to contribute to the process of preparing draft regulatory proposals and to the quality of the supporting analysis. Governments should ensure that regulations are comprehensible and clear and that parties can easily understand their rights and obligations. Establish mechanisms and institutions to actively provide oversight of regulatory policy procedures and goals, support and implement regulatory policy, and thereby foster regulatory quality.

Integrate Regulatory Impact Assessment RIA into the early stages of the policy process for the formulation of new regulatory proposals. Clearly identify policy goals, and evaluate if regulation is necessary and how it can be most effective and efficient in achieving those goals. Consider means other than regulation and identify the tradeoffs of the different approaches analysed to identify the best approach.

Conduct systematic programme reviews of the stock of significant regulation against clearly defined policy goals , including consideration of costs and benefits, to ensure that regulations remain up to date, cost-justified, cost-effective and consistent and [deliver] the intended policy objectives. Regularly publish reports on the performance of regulatory policy and reform programmes and the public authorities applying the regulations.

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Such reports should also include information on how regulatory tools such as Regulatory Impact Assessment RIA , public consultation practices and reviews of existing regulations are functioning in practice. Develop a consistent policy covering the role and functions of regulatory agencies in order to provide greater confidence that regulatory decisions are made on an objective, impartial and consistent basis, without conflict of interest, bias or improper influence.

Ensure the effectiveness of systems for the review of the legality and procedural fairness of regulations, and of decisions made by bodies empowered to issue regulatory sanctions. Ensure that citizens and businesses have access to these systems of review at reasonable cost and receive decisions in a timely manner. As appropriate apply risk assessment, risk management, and risk communication strategies to the design and implementation of regulations to ensure that regulation is targeted and effective. Regulators should assess how regulations will be given effect and should design responsive implementation and enforcement strategies.

Where appropriate promote regulatory coherence through co-ordination mechanisms between the supra national, the national and sub-national levels of government. Identify cross cutting regulatory issues at all levels of government, to promote coherence between regulatory approaches and avoid duplication or conflict of regulations. Foster the development of regulatory management capacity and performance at sub national levels of government. In developing regulatory measures, give consideration to all relevant international standards and frameworks for co-operation in the same field and, where appropriate, their likely effects on parties outside the jurisdiction.

In their most recent October reports on regulatory policy Regulatory Policy in Perspective55 and OECD Regulatory Policy Outlook , the OECD catalogs the knowledge to date on best regulatory practices and continued challenges, with special focus on the use of regulatory impact assessment, stakeholder engagement, and ex-post or retrospective evaluation. They conclude that the ex-ante evaluation of regulatory costs and benefits is well developed in the United States, with the degree of evaluation efforts proportional to the anticipated impacts of the regulatory proposals. The scope of current U.

The federal government guidance on U. For the current fiscal year , each agency recommending a new regulation must identify at least two to be repealed. Furthermore, the total incremental cost of all new regulations for this fiscal year must be no more than zero including the reduction of cost from regulations that are repealed , as determined by guidance issued by the Director of OMB. The Executive Order makes no reference to the benefits that accrue from any regulations, including those that are recommended for imposition or repeal.

Logically, if only costs are considered, then every existing regulation should be eliminated, and no new regulations should be imposed. Presumably, this logical inconsistency will somehow be dealt with in the guidance issued by the OMB Director. Because such a resolution would be subject to a presidential veto, and with a presumption that a president would support his own regulation with a veto, the CRA garnered little attention. However, the CRA also requires each agency issuing a regulation to submit a report to the Congress, and the deadline for a resolution of disapproval occurs after the report is filed.

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Because the requirement for a report may have been ignored in some instances, a new administration hostile to such a regulation could file a report on a regulation issued at any time after the CRA was enacted, and thereby empower the Congress to pass a resolution of disapproval. The Omnibus Consolidated and Emergency Supplemental Appropriations Act of section a requires OMB to report to Congress yearly on the costs and benefits of regulations and to provide recommendations for reform.

The Truth in Regulating Act of gives Congress authority to request that the GAO conduct an independent evaluation of economically significant rules at the proposed or final stages. The Information Quality Act of requires OMB to develop government-wide standards for ensuring and maximizing the quality of information disseminated by federal agencies. On the former:. The legislation:. Revises provisions relating to congressional review of agency rulemaking to require a federal agency promulgating a rule to publish information about the rule in the Federal Register and include in its report to Congress and to the Government Accountability Office GAO a classification of the rule as a major or non-major rule and a complete copy of the cost-benefit analysis of the rule, including an analysis of any jobs added or lost, differentiating between public and private sector jobs.

But we conclude that there has been disproportionate emphasis on greater scrutiny of new regulations based on the common presumption that there is too much regulation overall , at perhaps the price of too little effort toward expanding the practice of retrospective review and too little recognition that regulations may be suboptimal in a variety of ways in the variety of cases that evolve over time.

As the world changes including, but not limited to, advances in technology , regulations, even those based on principles rather than narrow, specific rules, can become obsolete and even counterproductive. It is not surprising that scholars of regulation around the world have cited retrospective review as one of the areas where other nations have made advances, and the United States, while still a world leader, has lost some of its comparative edge.

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We believe that our nation must invest more in continuing review of its stock of regulations, and in the data and other resources to support it. That does not determine precisely what organization should perform such review. We are skeptical that an analytical body of a sufficient size and strength could be created within the Congress.

Retrospective review must rely heavily on the street-level body of knowledge and information already resident within the executive agencies, and with the associated leadership resources in OIRA.

Neoclassical economics

However, we also are concerned that the instincts of self-justification within those agencies—the reflex to defend the judgments taken by those same executive offices in the past—could prevent objective retrospective review. One way to circumvent any tendencies of agencies to be closed-mindedly defensive about their own regulations in any review process would be either to expand the resources of OIRA so that it could have a separate shop that focuses of retrospective review. Alternatively, a new and independent office could take on that responsibility.

What would not work is requiring existing staff at OIRA or the agencies, already required to assure the quality of new regulations, also to take on the responsibility for retrospective review. Both functions would suffer, beyond any self-protective instinct in the retrospective review function. The office charged with retrospective review could select existing regulations for the earliest review, guided by priorities set by the Congress.

The Congress must play a stronger role in regulation. There is always the potential for a costly Catch dilemma for the executive, should a less-than-fully-informed Congress mandate the creation of a new regulation that must pass a cost-benefit test, while imposing conditions such that the creation of such a regulation is impossible.

The Congress does need more expertise to ensure that the legal foundations that it builds for future regulations are sound. So, better creation and ex-post review of regulation will cost money. It is important that the nation not swallow whole the fallacy that more resources for regulators mean more regulation. It must be made to mean better regulation. It can mean better data to facilitate stronger and more-frequent review, and therefore the cleaning-out or improvement of obsolete or deficient regulations that otherwise would evade scrutiny.

All that is needed is the leadership and the understanding to make that happen. It is imperative for a dynamic, prosperous economy. We largely agree with the recent conclusions of the Council on Foreign Relations: proposals for regulatory reform should continue to emphasize better ongoing evaluation and oversight of regulatory policy that might be directed, guided, and even conducted outside the executive-branch regulatory agencies themselves. A deeper discussion of regulatory governance is included in Appendix 3.

Who in the executive branch and who in the legislative branch would best be given the responsibility for unbiased evaluations of regulations, and how can we best keep cronyism and special interests away from regulatory analyses and decision-making? At the same time, policymakers will need to devote adequate resources to whichever entities are charged with conducting these impartial analyses, to make sure that such evaluations can be done in a comprehensive, systematic, effective, and yet timely and cost-efficient manner.

We find some of the ideas in the literature highly promising, others less so. At the headline level, we have already noted that approval of any regulation is at least an implicit assertion that its benefits exceed its costs. We believe that to the greatest possible degree, comparison of costs and benefits should be explicit. We recognize that cost-benefit analysis can be extraordinarily challenging and believe that sound cost-benefit analysis in a world of uncertainty should make all of its assumptions explicit and should provide alternative upper- and lower-bound estimates of its key components.

We also believe that our proposed retrospective review should allow reconsideration on the basis of those sensitivity analyses. We believe that such cost-benefit analysis is the gold standard of the regulatory process. We fear that some alternative decision rules, however well meaning, might yield inferior outcomes. For example, an aggregate regulatory budget or regulatory cost cap could yield perverse results. A new regulation with benefits exceeding costs could be rejected by an aggregate regulatory cost cap or budget.

But at the same time, old regulations whose costs exceeded their benefits would be protected against a cost cap or budget solely because of their incumbency.

We fear that a well-meaning mandatory sunset requirement would soak up considerable resources to reimpose justified and uncontroversial regulations—resources that would better be devoted to the difficult and more important issues. If we were assured that those basics were unattainable, we would consider falling back on the second-best alternatives. But we see no reason to declare pre-emptive surrender on the most-sound options available to our regulatory system.

There are other recommendations that we find highly appealing. We believe that even statutorily independent regulatory agencies should be subject to the same process and review requirements as the line executive regulatory agencies. We also align ourselves with the governance principles in the OECD report.

This CED review of U. The problem of biased, inefficient, and outdated regulations could be better avoided if policymakers would pursue an overarching strategy of favoring principles-based over rules-based regulation which would be more immune to special interest hijacking and manipulation. Measurement challenges and resource constraints continue to prevent adequate levels and quality of both ex-ante and ex-post retrospective evaluation of regulations to ensure that policies are beneficial and optimal.

The United States is doing better at ex-ante justification but could and should strive to do more monitoring and evaluation of regulations after they are put in place. Some other countries have surpassed the United States in regulatory management in this regard. The independent body in charge of reevaluation of regulations could be charged with criteria to order the existing stock of regulations for review. But we believe this to be a permanent function of looking for regulations that have fallen behind the changing times—not a once-for-all housecleaning.

Toward the goal of more regular scrutiny of regulations, a reinvigoration of the congressional reauthorization process is needed. Legislators need more resources so that they can develop realistic standards for new regulations, and can pay better attention to the function and performance of regulations after they are put in place, too.

More and better data on the effects of regulatory policies are needed. This has been recommended for decades, but we really should be doing better now that the costs of collecting, maintaining, and analyzing data in real time have come down and will continue to decline rapidly. At the same time, funding for the statistical agencies should be preserved and enhanced to take advantage of the increasing productivity of investments in data.

More sharing and disclosure of information with stakeholders and the public—more transparency—is needed. Regulatory policy making should involve other parts and levels of government and the public, not just the federal executive agencies. Increased stakeholder participation will shed light on and help avoid inefficient regulations that benefit special interests over the public interest. These recommendations continue the spirit of our recommendations. Unlike our recommendations in , however, we now put less emphasis on Congress doing the heavy lifting.

We also conclude that no matter who is in charge of developing and maintaining regulations, the regulations will be more supportive of the economy and the public interest—as well as more sustainable over time—if based on broadly defined, commonly agreed-upon economic principles rather than narrowly defined technical rules. If we are to improve the regulatory policymaking process and the ultimate quality and effectiveness of the regulations themselves, we will need to determine which entities are best able to consider, construct, administer, and review regulations in ways that help businesses, the economy, and our society.

See a more detailed discussion of issues of stakeholder involvement in Appendix 4. Reorienting our approach to regulation in this way will help to achieve our goal of regulations that are better justified and regularly monitored, reevaluated, and scrutinized to be economically smarter, not just administratively simpler. Following are some valuable contributions from the recent literature. Frantz and Instefjord 72 present an academic, theoretical paper on rules- versus principles-based financial regulation. We study the relative strengths and weaknesses of principles based and rules based systems of regulation.

In the principles based systems there is clarity about the regulatory objectives but the process of reverse-engineer[ing] these objectives into meaningful compliance at the firm level is ambiguous, whereas in the rules based systems there is clarity about the compliance process but the process of forward-engineer this into regulatory objectives is also ambiguous. The ambiguity leads to social costs, the level of which is influenced by regulatory competition. Regulatory competition leads to a race to the bottom effect which is more harmful under the principles based systems.

Regulators applying principles based systems make dramatic changes in the way they regulate faced with regulatory competition, whereas regulators applying rules based systems make less dramatic changes, making principles based regulation less robust than rules based regulation. Firms prefer a rules based system where the cost of ambiguity is borne by society rather than the firms, however, when faced with regulatory competition they are better off in principles based systems if the direct costs to firms is sufficiently small.

We discuss these effects in the light of recent observations. When we think of regulation, we think of specific rules that spell out the boundaries between what is approved and what is forbidden. I call this bright-line regulation BLR. What I want to propose is an alternative approach, called principles-based regulation PBR. With PBR, legislation would lay out broad but well-defined principles that businesses are expected to follow.

Administrative agencies would audit businesses to identify strengths and weaknesses in their systems for applying those principles, and they would punish weaknesses by imposing fines. Finally, the Department of Justice would prosecute corporate leaders who flagrantly violate principles or who are negligent in ensuring compliance with those principles. The banks will always be savvier than the consumers and nimbler than the regulators, so bright-line regulation is bound to fail. As with any regulatory approach, principles-based regulation must be well executed in order to work.

A key element is that the principles should have clear meaning. They are just glittering generalities that offer no concrete guidance to a firm. Businesses often use internal mission statements and lists of principles as a tool to align employees with the goals of top management.