I LOVE JAPAN. Kazuhiro Arai

The Nature of Economics (7) Neoclassical economics does not consider efficiency of the whole economy because the production function and utility function are exogenously given. Since I do not think that this point is made clear in books or papers, I would like to discuss it in some detail. Consider two economies E1 and E2. The workers in E1 are more cooperative and hard-working. Those in E2 are selfish and lazy. Hence, the labor productivity in the firm in E1 is higher for equally given levels of physical inputs. However both economies are efficient in neoclassical economics! Both E1 and E2 are efficient as far as all firms maximize their profits subject to exogenously given (different) production functions! It is obvious that E1 is more affluent than E2. I would like to emphasize that efficiency differs from affluence in neoclassical economics. Next consider two economies E3 and E4. The people in E3 are more harmonious and other-regarding within the household. Those in E4 ar...

The Nature of Economics (6) The household is an equally important part of the economy as the firm. But neoclassical economics has similarly avoided serious economic analyses of this economic unit by assuming that the utility function is exogenously given. This has caused many serious problems. The household is important in the economy because it determines labor supply and labor quality. It also determines consumer demand. Indeed, a typical individual in the real world feels much of happiness in the household rather than in the firm or market. Nevertheless, neoclassical analyses of this problem is insufficient, biased, and harmful. G. Becker has done some detailed analyses of the household but we do not know how they are incorporated into general equilibrium theory or if such incorporation generates efficient equilibrium. The whole system of economics needs to be considered. As in the case of the firm, neoclassical economics lacks a theory of efficient human relations within ...

The Nature of Economics (5) We see here a good example for the fact that the values researchers possess affect their choice of the topic and method of research generating bias in ‘scientific works.’ 　 Researchers who want to support individualism do not analyze firms or households seriously. They simply introduce exogenously given production functions and utility functions. Economists tend to ignore or distort social aspects that are inconvenient to build models with conclusions they like. It is really hard to establish social sciences that are value-free. Researchers need to recognize this. On the other hand, a unified theoretical model may be formed to explain the cultural difference mentioned in the example given in the above third reason. It may be done by introducing a measure of the degree of cooperativeness as an exogenous variable. In such a model different types of equilibrium may arise for different values of the measure. If we can endogenize the variable for that m...

The Nature of Economics (4) Why does not neoclassical economics seriously analyze the firm? There are a few related reasons. First, as mentioned before, human behavior in the firm is different from that in the market. Individualism cannot be supported in the firm. Although one of the implicit ideological goals of neoclassical economics is to spread this Western ideology around the world, a fuller analysis of the firm would make it impossible because individualism can be supported loosely only in organized markets. A second reason is that human behavior in the firm is not simple. It cannot be described by a simple principle of price mechanism with pursuit of self-interest. In fact, a raison d'être of the firm is for the employees to refrain from pursuit of self-interest to some extent in order to have cooperation among employees. Thus analyzing both market and firm seriously would make the theory complex. Neoclassical economics avoids this difficulty by focusing only on the ...

The Nature of Economics (3) A crucial defect of neoclassical economics related to the above discussion is that it analyzes seriously only markets, more specifically organized markets. It does not seriously analyze firms or households. It ignores government, the environment, and international relations. Although the real economy has a variety of market types, it treats all markets as the same type. Can the demand-supply analysis (with auctioneers) be applied to medical markets or education markets? This implies that neoclassical economics analyzes only a limited part of the economy. Although it deals with firms, it does not seriously analyze them in the sense that it fails to explain how a particular set of input levels achieves the level of output given by the production function. In other words, it does not describe the process of production or how production is carried out. Firms in the real economy try hard to improve their technologies. They also try to invent new products ...

The Nature of Economics (2) When a contract is incomplete as in the real world, the agents have discretion and face interdependence or a game situation. Each can influence the welfare of the other. Pursuit of self-interest in this situation is generally inefficient. This discretion includes many commonplace behaviors such as providing wrong information, doing shoddy work, and working slowly. They will surely decrease the welfare of the partners such as employers, employees, and consumers. The game situation can be described as the prisoner's dilemma game. It shows that pursuit of self-interest under contract incompleteness with discretion leads to inefficiency. For example, telling a lie is a strictly dominating strategy* in it but both players being honest is more efficient than both telling a lie. The above story suggests that individualism or unrestrained pursuit of self-interest cannot be justified in general. It may be loosely justified only in organized markets, suc...

The Nature of Economics (1) Many people believe that economics is a science that promotes the welfare of all human beings. However it is actually used to justify strategies of particular groups as in the case of free trade. Today’s economics is an ideology. The basis of an ideology is formed first intuitively and then the whole is justified by cleverly applying logic. A widely used method of clever application of logic is to use only facts or assumptions that are convenient for justification. Neoclassical economics or mainstream economics is an ideology that justifies individual freedom or individualism to the maximum. Because of its mathematical nature, we can easily know what assumptions are used in it. We can know further that it ignores many inconvenient facts. One of the most important assumptions of neoclassical economics is contract completeness, which means that all transaction contracts are sufficiently detailed. Otherwise it cannot justify Western individualism. But...

Summing up, I have mentioned that neoliberalism is harmful because of the following reasons: (1) It considers only partial efficiency. It does not consider the efficiency of whole society. (2) In particular it does not discuss organization efficiency since the production functions are exogenously given, even though firms are its object of analysis. (3) Hence, it claims that the economy is efficient however lazy or untrustworthy the individuals are. (4) Similarly, it does not consider how family members can become happy. (5) Even the markets in the real economy are very likely to be inefficient because complete contracts are impossible due to astronomically high transaction costs. (6) It does not consider many factors that make the consumer happy such as her good human relations with others, her kindness to others, or the happiness of her descendants. (7) Therefore policies based on neoliberalism tend to generate inefficient firms (organizations), households, communities,...

There is also a pathological aspect in the very concept of market efficiency in neoclassical economics. Consider an economy where all people are lazy. They are poor since their productivity is low. However, this economy is efficient in the sense of neoclassical economics if those people act from self-interest. The same is true of an economy where all people are untrustworthy and cooperation is hard to be achieved. These pathologies arise because efficiency is considered under the assumption that the production functions are exogenously given. However low the productivity is, the economy is efficient in neoclassical economics so far as each individual acts from self-interest! As mentioned, market efficiency in neoclassical economics requires complete contracts, but they are impossible in almost all transactions in the real economy because of high transaction costs. For instance, complete contracts between employer and employee would entail astronomical costs and be virtually impossib...

Neoclassical economics has firms and households but does not consider their efficiency. Its object of analysis is market efficiency only. What a narrow worldview it is! Relying on neoliberalism, therefore, implies regarding the world as made up of only markets. Our society is made up not only of markets but also of households, firms (organizations), schools, hospitals, governments, communities, social & natural environments, and so forth. Neoclassical economics, however, has a systematic theory only about markets. It can teach in its own way how one should behave in markets but it cannot do so for households, firms (organizations), schools, hospitals, governments, communities, or environments since it has no theories about these. Therefore, neoclassical economics considers only partial efficiency, i.e. the efficiency of the markets only. We need to consider, however, total efficiency, i.e. the efficiency of whole society including households, firms (organizations), schools,...

               Neoliberalism is the most influential ideology in today’s world. It relies theoretically on neoclassical economics, which has the following proposition: If all individuals act from self-interest, the resource allocation of the economy will be efficient. This is called the first proposition of welfare economics. Here I would like to show that it has many theoretical defects. Most people in the world are obsessed with a harmful ideology.               Each firm in neoclassical economics is simply an exogenously given production function, which relates the amounts of inputs to the amount of output. If something is exogenously given in economics, it does not discuss how that has become the present form. Thus neoclassical economics does not analyze how production efficiency is achieved through innovations in organization structure, human relations, physical capital, and ...