Category: Piero Sraffa

Some Logical Fallacies in Economics

Economic theory of various kinds are often employed to formulate policies in the real world. Often, certain conclusions of a particular economic theory are utilised in policy making. For instance, some of the insights/conclusions arising from mainstream economics are: fiscal deficits are inefficient and inflationary; a perfectly competitive economy is desirable because it is efficient; increase in money supply causes inflation and increase in investment (domestic and foreign) will create employment. Hence, we are regularly advised to lower fiscal deficits, encourage ‘efficiency’, etc.

Broadly, two kinds of logical fallacies are committed by economists and policy makers. Firstly, there are logical fallacies in the domain of economic theory. Secondly, a logical fallacy is committed when real-world policy decisions are derivatives of conclusions from a particular economic theory. This blog post makes use of Stephen F Barker’s’book‘The Elements of Logic‘(1965) to illustrate some of the logical fallacies in economics.

According to Barker, a ‘fallacy is a logical mistake in reasoning.’ He identifies three broad categories of logical fallacies: (1)’non sequitur, (2)’petition principia‘and (3) inconsistency. Fallacies of’non sequitur‘(Latin: ‘it does not follow’) occur when there is an’insufficient link‘between premises and conclusion. ‘If the premises are related to the conclusion in such an’intimate way‘that the speaker and his hearers could not have less reason to doubt the premises than they have to doubt the conclusion, then the argument is worthless as a proof, even though the link between premises and conclusion may have the most cast-iron rigor,’ logical fallacy of’petition principia‘(Latin: ‘begging the question’) occurs. Lastly, fallacies of inconsistency occur ‘when someone reasons from a set of premises that’necessarily‘could not all be’true.’

Logical fallacies in economic theory

An economic theory like any scientific theory begins from a set of premises. These premises can be based on observation, fact, other theories, (reasonable) assumptions, etc. Obviously, these premises have to be sufficiently’general‘for it to be a ‘theory.’ From these premises, through the process of (deductive) reasoning, we arrive at certain conclusions. Note that unrealistic assumptions do not render an economic theory fallacious. However, their utility in real-world policy making is contingent on how ‘approximate’ the assumptions are to the particular context.

Hence, given the premises, if the conclusions do not follow, the economic theory under consideration is said to be logically fallacious. This, in fact, happened to the marginalist theory of value and distribution. In the 1960s, it was demonstrated bySraffa,’Garegnani‘and others that marginalist theory of value and distribution is logically fallacious. This was shown so clearly that defenders of the theory, notably,’Paul Samuelson, admitted this defect. The main reason for this logical fallacy was/is that prices (value) and distribution are interdependent and hence are simultaneously determined. Therefore, the distribution theory in neoclassical economics (marginal productivity theory) cannot be logically prior and independent of the theory of prices (value). In other words, capital cannot be treated as a distinct factor of production, independent of prices. This is because, at an aggregate level, capital is comprehensible only as a value magnitude. Therefore, the construct of the aggregate production function breaks down and with it the whole neoclassical edifice of value and distribution crumbles. In any case, to circumvent such logical critiques, the concept of inter-temporal equilibrium was constructed. So far, it seems to have been ‘successful’ in warding off capital-theoretic critiques. But, this shift towards inter-temporal equilibrium from long period equilibrium has seriously compromised the relevance of such economic theory. For, ‘anything goes’ in temporary equilibrium. The capital theoretic fallacy is of the’non sequitur‘type as there is an insufficient link between the premises and conclusion.

Marginalist economics studies human behaviour. It is a science of choice thanks to Lionel Robbins who presented a clear definition of neoclassical economics (which originated in the works of Jevons, Walras and Menger in 1870s). Hence, the theory assumes scarcity of both factors and commodities. The central problem in economics becomes that of ‘ allocation. The theory starts with specifying endowments to agents and concludes’ that there is full employment of resources. After all, if the issue is that of allocation, there will necessarily be a full-employment of resources both before’and‘after the process of allocation (carried out by the market forces of demand and supply). In this case, the premises and the conclusion are connected in such an intimate manner that it seems to commit the fallacy of’petition principia.

Consumers maximize utility. Producers maximize profits. This gives us equilibrium. However, is there a clear line of demarcation between a producer and a consumer’ What if an agent is both a consumer and a producer’ In the language of set theory, what if the intersection between consumers and producers in an economy is not a null set’ If so, is it logically consistent to have a’strict‘demarcation between producers and consumers’

Logical fallacies in economic policy

Economists, policy makers and journalists argue for a particular economic policy based on certain premises. These premises are nothing but an admixture of various economic theories. Note the emphasis on ‘theories’, for there is not just one economic theory but multiple economic theories. Most of them are competing paradigms, i.e., they ask similar questions but provide dissimilar answers. Examples include Austrian economics, Marxian economics, Classical economics and Keynesian economics. The dominant paradigm, of course, is the marginalist one; variants of this include New Classical Macroeconomics, Monetarism, New Keynesian Macroeconomics, Microeconomics, etc.

The question we are interested in asking is: what is the basis on which a particular economic policy is favoured. A few examples are provided below.

I

Premise: Increase in money supply causes inflation.

Conclusion: Therefore, increase interest rates to reduce inflation.

II

Premise: Inflation is determined by inflation expectations.

Conclusion: Therefore, the Central Bank should target inflation expectations.

III

Premise: Given full-employment of all resources, an increase in expenditure will raise prices.

Conclusion: Fiscal deficits are inflationary. Therefore, reduce fiscal deficits.

The premise in the first example is from a Monetarist paradigm; the premise in the second one is a New Keynesian perspective and the premise in the third example is a typical neoclassical/marginalist view. Are these kinds of policy conclusions logically correct’ Do the conclusions follow from the premises’ Or, are we taking a leap of faith’ For, the economies which the premises talk about and describe aretheoretical worlds‘which (hopefully) have certain characteristics of the real-world. In any case, hasty conclusions should not be made. This is especially important for policy making in an economy like India which is very distinct from the theoretical worlds mentioned above.

Yet another commonly used argument is to favour a policy based on its success in another economy. For a long time, India followed economic doctrines which were promoted in the advanced economies of the West. Today, we see a similar trend where examples and case-studies from ‘other emerging economies’ are used to argue for a particular policy recommendation in India. But, India is structurally ‘ socially, culturally, politically and economically different from these other economies. Hence, we again take a leap of faith. I end with such a’claim which was made‘to argue that FDI is favourable: ‘in Indonesia 10 years after allowing 100 per cent FDI, 90 per cent of the retail sector is controlled by the small shopkeepers.’

Pierangelo Garegnani (1930 – 2011)

On October 14, 2011, heterodox economics (in particular, classical economics) lost one of its warriors. This post attempts to summarise some of his key contributions towards economic theory. First and foremost, he was an economic theorist par excellence. He contributed to the famous (now, almost forgotten) capital theory debates in 1960s along with Piero Sraffa and Joan Robinson on his side and Paul Samuelson and Robert Solow on the other. Alongside others, he pointed out logical flaws in the marginalist conception of capital and its devastating effects on equilibrium. Basically, marginalist theory of value and distribution (in modern parlance, microeconomic theory) was shown to be logically inconsistent. Today, these debates hardly ever appear in economics textbooks because marginalist or neoclassical economics invented inter-temporal equilibrium to take care of capital-theoretic issues. Moreover, history of economic thought has been sidelined ‘ through famous graduate economic programs and by preaching that history of economic thought is of no use to a ‘practical’ economist, both in academia and in business.

Garegnani made significant contributions to the revival of classical economics on the foundations laid down by Piero Sraffa. In particular, Garegnani, through various journal articles (in Italian and English) resurrected the works of old classical economists ‘ mainly Smith, Ricardo and Marx. More than Sraffa, perhaps, it is Garegnani who has aided the revival and resurrection of classical economics. His command over the history of economic thought with a special focus on old classical economists and ‘old’ and ‘new’ neoclassical economists (Walras, Wicksell, Hicks, etc) is evident from his clear exposition of their analytical structure.

Like ‘old’ classical economists, Garegnani’s interest has been to explain growth dynamics of an economy. This, he believed and also demonstrated that it is possible by drawing insights from Keynes and working on a classical (Sraffian) foundation. In this regard, Garegnani and his friends-colleagues-students have been quite successful in their analysis of capacity utilization, supermultiplier, role of wages, profits being a monetary phenomenon and so on.

Given the massive contributions made by Garegnani, it has been an honour for me to have been introduced to his work during my Masters in Economics at University of Hyderabad. It is one of the few Universities, in India and possibly, in the world, which still teaches classical economics as a distinct approach to understanding contemporary economies. I hope that more Universities begin to recognise the benefits of a pluralist education and start teaching classical economics as a distinct subject.

Others

Robert Vienneau”Susan Pashkoff”Francesco Saraceno”Tyler Cowen”David Ruccio”Matias Vernengo

Krishna Bharadwaj: The Ideal Economist

Krishna Bharadwaj is an economist who made lasting contributions to economic theory. She is especially known for her understanding of the classical theories of value and distribution. In particular, she has successfully traced out the history of classical as well as neoclassical economics. This kind of conceptual history writing is important, especially for the economist who wants to apply these theories in understanding the socio-economic reality. And because of her firm grasp of various theoretical approaches in economics, she was able to judiciously analyse problems of the Indian economy. She was, in fact, the first economist to point out the exploitative nature of inter-linked markets which are prevalent in Indian agriculture. She also placed emphasis on the power relations which dominated the production structure of agriculture in India.

Apart from struggling to show the distinct and superior nature of classical economics over neoclassical economics, Bharadwaj also relentlessly worked on Indian economic issues. In particular, Bharadwaj analysed the structural linkages between agriculture and industry in India and also examined the production conditions which characterise Indian agriculture. In her latter study, she pointed out the inadequacies of neoclassical economics in understanding Indian agriculture. She particularly criticised the application of production functions. In addition, Bharadwaj explained the origin of neoclassical economics and how it suffers from various logical as well as other methodological issues.

For Bharadwaj, theory was only a tool to understand the questions and problems which arose from the social reality. This is why, she promoted the teaching of different economic approaches in Centre for Economic Studies and Planning (CESP) at Jawaharlal Nehru University (JNU), such as classical, Marxian, Keynesian as well as Walrasian. As Prabhat Patnaik writes in a foreword of The Krishna Bharadwaj Memorial Lecture, ‘according to her [Bharadwaj]…we had to evolve a research-cum-teaching agenda of our own. No centre in India could flourish, by international standrads, merely by mimicking what was happening abroad, merely by showing proficiency in solving problems which were posed abroad. The problems has to be rooted in the social reality of our own country, and the effort to grapple with them had to be, very consciously, located within the intellectual endeavour of our country…[However] Her emphasis on taking up problems rooted in the Indian social reality was not a plea for turning one’s back upon theory or theoretical struggles. On the contrary, her plea for investigating our real problems, was simultaneously a plea for a richer theory, a theory with a body to it, one which is all the more powerful because it has been used for investigating real problems facing economies like ours.’

From her work on economic theory and its applications to the Indian economy, what becomes clear is her philosophy that economic theory should be based on concepts which can be observed and be amenable to measurement in reality. This is one of the reasons why she criticised the demand and supply theories; for, values were determined by subjective utilities. Another quality worth mentioning is her firm belief that economic theories are not mere intellectual constructs; rather, they arise out of a particular socio-historical situation, often to promote a certain ideology. In her R C Dutt Lecture, which was later published as a book in 1986, she makes it clear that the emergence of demand and supply theories were primarily a reaction against Ricardo and Marx. For, in both Ricardo and Marx, a conflict of interest is visible between social classes. In order to promote the ‘idea’ of a just and harmonius system, the theories (especially the labour theory of value) of Ricardo and Marx were criticised as being limited, and an alternative was proposed. This new theory completely did away with social classes. Individuals were chosen as the primary unit of analysis. Social classes, actually was modified into ‘factors of production’. A very interesting and important methodological shift, with powerful political implications! All the factors of production were assigned equal importance, and it was also shown how both labour and capital recieved incomes according to their contribution to the production process. That is, a capitalist system, with free mobility of labour and capital and with clear property rights (contracts), is essentially a just and stable system.

To conclude, the following are the reasons why Krishna Bharadwaj is an ideal economist. (1) She had an in-depth understanding of the various theoretical approaches in economics, be it, Marxian, Classical, Neoclassical, Austrian or Keynesian. (2) She did not blindly apply these theories (mainly Classical and Marxian) to understand the Indian economy; instead, her inquiry was based on extensive empirical observations, which made the theory richer. (3) She considered it very necessary to understand the history of economic theory, especially because of the historical specificity of all theories. Also because, most theories are responses to certain socio-political events or interests. (4) Lastly, she applied all her experience in setting up a new centre, which paid close attention to both economic theory and its application to the Indian economy, in close connection with other disciplines.

References

Bhaduri, Amit (1992), Krishna Bharadwaj, Economic and Political Weekly, Vol. 27, No. 10/11 (Mar. 7-14, 1992), p. 490.

Bharadwaj, Krishna (1963), ‘Value Through Exogenous Distribution’, The Economic Weekly, August 1964.

Bharadwaj, Krishna (1986), Classical Political Economy and the Rise to Dominance of Supply and Demand Theories, Calcutta: Universities Press.

Harcourt, G C (1993-94), ‘Krishna Bharadwaj, August 21, 1935 – March 8, 1992: A Memoir’, Journal of Post Keynesian Economics, Vol. 16, No. 2 (Winter, 1993-1994), pp. 299-311.

Patnaik, Utsa (1991), ‘Krishna Bharadwaj: 21 August 1935 – 8 March 1992,’ Social Scientist, Vol. 19, No. 12. (Dec., 1991), pp. 63-67.

Patnaik, Prabhat (1996), Foreword, in Time as a Metaphor of History: Early India, by Romila Thapar, The Krishna Bharadwaj Memorial Lecture, New Delhi: Oxford University Press.

Roncaglia, Alessandro (1993), ‘Krishna Bharadwaj, 1935-1992. In Memoriam’, Metroeconomica, Vol. 44, No. 3, pp. 187-194.

Sraffa: The Origins of ‘Marginal’ Analysis

Since the advent of the ‘marginal’ method, the doctrines of the old classical economists have been submerged and forgotten. It is this standpoint that Sraffa revives in his 1960 book Production of Commodities by Means of Commodities. Being third in the series of posts [Post 1; Post 2] on Sraffa, this post examines the origin of the ‘marginal’ method and its subsequent (mis)use by the neoclassical economists. The posts concludes with a brief mention of how history of economic thought is important so as to place theories in a proper context.

In the preface of his book, Sraffa points out that in a system of production where the scale of an industry or proportions of factors of production remained unchanged, one would not be able to locate marginal product and marginal cost. To put it differently, marginal analysis is done by considering ‘potential change’. That is, we try to find out variations in equilibrium quantities and prices with respect to infinitesimal changes in the neighbourhood. [Bharadwaj 1986, p 39]

What we do not pay adequate attention to, is that the most familiar case of ‘marginal analysis’ is that of the product of marginal land (also known as no rent land) in agriculture, when lands of different qualities are cultivated side by side. This refers to the well known differential rent theory of David Ricardo. In fact, it is the case of diminishing marginal returns on land which is at the junction of the ‘fundamental methodological shift from classical to equilibrium theory’. [Bharadwaj 1986, p 40] This can be understood only through a discussion of ‘extensive’ and ‘intensive’ margins.

Cultivation on lands of different qualities is visualised as the outcome of a process of ‘extensive’ diminishing returns. On the other hand, successive use of more output producing techniques refers to the process of ‘intensive’ diminishing returns. [Sraffa 1960, p 76] In the case of ‘extensive’ margins in cultivation, ‘the rents can directly worked out on the basis of the single observed situation.’ [Bharadwaj 1986, p 41] Whereas, in the case of ‘intensive’ margins, the calculation of rent requires a quantitative change in the situation. That is, successive doses of labour and ‘capital’ need to be added to the land. And, a further assumption is made on the nature of these ‘doses’. These ‘doses’ are considered to be homogeneous. As Krishna Bharwadwaj explains: ‘At any moment of observation, no dose is distinguishable from each other. No ‘marginal product’ can, therefore, exist in this case without introducing potential change.’ [Bharadwaj 1986, p 42]

Thus, it is the Ricardian theory of rent which provided the basis for the neoclassical theory of distribution by providing an inverse relationship between successive doses of labour and ‘capital’ and their remuneration. This theory of Ricardo was intended to explain the origin of rents. In the hands of later authors, this was generalised to labour and ‘capital’. Hence, we see the inverse relation between ‘capital intensity’ and rate of profit in microeconomics textbooks of today.

From this excursion into the Ricardian theory of rent, two aspects are very clear. First, the concept of ‘marginal’ or ‘margins’ was used exclusively in the domain of cultivation. In ‘intensive’ cultivation, it is obvious that the output would increase only until a certain point, owing to the quality of that piece of land. Whereas, in the case of ‘extensive’ cultivation, the output would increase till all the acres of land are cultivated- notice the scarcity element here. What is not clear is the rationale of extending such an analysis into the area of manufacturing! Also, it is well accepted that land is scarce; but, is ‘capital’ or produced commodities scarce in a similar way’

No book of microeconomics mentions the origins of the famous ‘marginal’ analysis. And this method is so entrenched in the profession, that it is almost impossible to throw it away. It is in this context that other conceptual frameworks, that pay more attention to the changing historical conditions, assume importance. Probably, we need to revisit earlier theories and theorists not just for their own sake but for our sake as well in throwing light on contemporary issues. Sraffa’s work has inspired a lot of work on the history of economic thought, which will be summarised in a later post.

References

Bharadwaj, Krishna (1986), ‘Classical Political Economy and Rise to Dominance of Supply and Demand Theories‘, Universities Press: Calcutta.

Sraffa, Piero (1960), ‘Production of Commodities by Means of Commodities: Prelude to a Critique of Economic Theory‘, Cambridge University Press: Cambridge.