Economic Schools of Thought

‘Economics’, in general, is the study of our economy. Many students believe that what they are taught at university is simply ‘economics’, as if it is a neutral science and do not have any particular frames of values or specific methodology. The truth is that there are many different schools of thought within the discipline of economics, each of them often having different assumptions, methodology and sometimes even goals and ethical values. 

Today, most Universities teach what is called neoclassical economics. We believe that this is an important school of thought. But we also believe that it is insufficient and too narrow to learn only about neoclassical economics. We think undergraduate students should be taught that the economic discipline contains a plurality of theories and schools, and know the main features of the most important ones. The awareness of these different theories will equip students with a better understanding of the economy and will lead to a more dynamic development of the economic discipline. 

Below is a brief introduction of some of the most important schools. Useful web pages are Exploring Economics and ‘The History of Economic Thought’.

Austrian school

The Austrian school of economics often propose policies matching those of right-leaning neoclassicalists; a reliance on the free-market and an avoidance of government intervention, except to maintain law and protect property rights. However, this school arrives at such conclusions from assumptions which are almost opposite to neoclassical ones. Austrian economics, unlike Neoclassical economics, see individuals as irrational and possessing little knowledge; when they are able to make logical decisions it is because unquestioned social norms have limited the choices of individuals. The world is highly uncertain, unpredictable and largely unknowable.

From such Austrian understandings, economists will argue that any sort of central planning or other government intervention is more or less bound to worsen society, as such actors are inherently unable to fully grasp situations or predict outcomes. It is impossible for them to acquire enough information to make good decisions. Austrian economics, therefore, propose that only through spontaneous, decentralised decisions and reactions to unpredictable events can the plans of numerous economic agents be reconciled. Friedrich Hayek is one of the most famous Austrian economists, and also very famous for his writings in political science and philosophy.

Read more on Exploring Economics and ‘The history of economic thought’.

Classical School

Classical Economics dominated economic thought throughout much of the 18th and 19th centuries. It was developed by several of the “fathers of economics” such as Smith, Malthus and Ricardo as an alternative to the previous paradigm of government-heavy mercantilist policy in Europe. Classicalism as its own school lost its dominance in the 20th century, when ideas grown within it became incompatible and new schools split off.

In the Classical school there also exists the underlying assumption that all economic agents act rationally, and out of pure self-interest. Collectively, the vast number of decentralised, private decisions create a working market system which generates positive outcomes for society as a whole. From this idea stems a generally laissez-faire attitude; the Classical school joins others in suggesting that government interference will usually produce a less beneficial outcome than free markets.

Classical economics looks at economics primarily through the lens of production, rather than consumption. It suggests that the value of a product is determined by conditions within its supply, i.e. costs of production, often referred to as the labour theory of value: a good’s value is determined by the amount of labour put into producing it. As this theory of value encountered very essential contradictions, this was one of the main areas in classical economics which was later neglected by the neoclassical school. Neither Smith, Ricardo or Marx could resolve the question of value properly. Nevertheless, some argue that the neoclassical school has now instead entirely rejected production as having any impact on the value of a good, and only speak about subjectively determined value by consumers. It is suggested that a consideration of both sides would perhaps produce a more accurate understanding of what “value” actually entails.

One of the Classical economic theories and principles which still are in use today in mainstream economics is Ricardo’s theory of Comparative Advantage, as well as other pivotal concepts which are often taken for granted today such as the benefits of specialisation, trade and the division of labour.

Read more on ‘The history of economic thought’.

Ecological Economics

Ecological economics often tries not to present itself as a school of economics at all, rather a cross-disciplinary fusion, primarily between ecology and economics but also anthropology, psychology and other fields. Economic principles from other schools remain part of ecological economics but the movement’s key criticism of traditional economic thought is that it doesn’t recognise the importance of scale. Ecological economics proposes that mainstream economics suffers from a chronic fallacy of composition in its models and that the base of thinking should be that all human systems (i.e. economics) are part of a finite global environment.

Ecological economics distinguishes itself from environmental economics as seeking to expand and change the principle’s foundations, whilst the latter applies (usually neoclassical) concepts to environmental issues, although inevitably there is a degree of crossover. Ecological economics is also generally very critical of GDP as the goal for the economy, suggesting that economic activity that destroys or depletes natural capital shouldn’t be counted as a positive contribution, sometimes favouring instead the Genuine Progress Index (GPI).

Read more on Exploring Economics.

Institutionalist Economics

The Institutionalist School’s core principle is that individuals are social beings and hence economic analysis should include analysis of the institutions and social rules that guide their actions. The “Old” version of Institutional economics enjoyed a pinnacle of popularity under the USA’s 1935 New Deal, which can sometimes be inaccurately described as Keynesian policy but was implemented prior to Keynes’ pivotal work.

The institutional bounds on guiding rationality and actions can have crossovers with the Austrian school and in the 1980s Institutional economics had a resurgence from this direction. “New Institutionalism” incorporates the notion of significant transaction costs, which are defined most broadly as costs of running a market system and can be used in Institutional economics to explain why much economic activity does not occur in a free market, but within firms and without a market transaction per se.

Read more on Exploring Economics and ‘The history of economic thought’.

Keynesian School

John Maynard Keynes is often argued to be the most important 20th-century economist and essentially the founder of macroeconomics; acknowledging that the whole economy is different from the sum of its individual actors. He also gave rise to the Keynesian school of thought which was very influential in government policy-making during the height of its popularity.

For full employment of all resources (the state which we’d like the economy to be in), total savings must equal total investment to continue a complete circular flow of income; this is thus where we have an “equilibrium” in the macroeconomy. Whilst the neoclassical school argues this state will naturally to approached, Keynes argues that there is a glitch in the system: uncertainty. This glitch was traditionally more or less ignored by other mainstream schools, but as Keynes explains, when uncertainty exists companies may not want to invest all savings, causing a fall in employment and incomes. Assuming household consumption remains similar, savings will, therefore, contract and settle at the new level of investment; the economy hasn’t tended back to the same equilibrium but to a new, lower level of income.

The natural extension followed by Keynesian economics is thus that the government should actively intervene and use its own spending to prop up demand and maintain employment/income levels in the economy.   

Read more on Exploring Economics and ‘The history of economic thought’.

Marxist School

Like Neoclassical economics, Marxist economics arose initially from the Classical school and retains its focus on production rather than consumption in the economy, as well as a view of society as comprising of distinct classes, rather than individuals per se. Marxist economics furthermore places much emphasis on the differing economic institutions and their structures; capitalist firms, for example, being islands of order and structure within an anarchic and chaotic market system.

Perhaps the crux of Marxist economic thinking is the concept that social and economic systems inevitably will evolve in form through historic stages, beginning with tribalism before developing over time into slavery-based production, feudalism and capitalism, before reaching the ultimate state of communism. The school proposes that as capitalist economies become increasingly complex, firms become ever-more interdependent and therefore the need for close coordination greatly rises. However, private ownership makes the necessary coordination practically impossible, leading to an internal contradiction of the capitalist system which can and will only be resolved by a progression to communism. History has generally witnessed such a progression into the capitalist state but none successfully have completed to transformation suggested in Marxist economics, for which it is oft-criticised.

Read more on Exploring Economics and ‘The history of economic thought’.

Neoclassical School

Stemming from Classical notions of the price mechanism acting as an “invisible hand”, the neoclassical school emphasised and developed the scientific method in economic thinking. Neoclassicism was the first major movement to attempt to transform economics into a pure science, referred to today as the Marginalist Revolution around the late 1800’s. Economics was to use the scientific method to develop general rules and principles of producer and consumer behaviour. Neoclassical economics accordingly enjoys strength in precision and logical clarity.

The school assumes that consumers will act to maximise utility and firms to maximise profits, acting out of rationality and sound judgement. From these ideas the principles of supply and demand are derived. Extending these notions leads naturally to the neoclassical notion that, in the long run, such rational action will lead to economic equilibria; a state in which supply and demand, production and consumption, is in perfect balance.

The large shift between the classical and neoclassical school was from a focus almost solely on production to consumption. Instead of trying to derive the prices of goods and services from the labour put into producing it, price was now being derived from the value the good had to potential consumers. “Value” went from being objectively to subjectively measured, very much influenced by the philosophical school of utilitarianism.

A popular idea in the neoclassical school is the Pareto Condition: an action should only be considered if it will increase the welfare of some without making anybody worse of. This has lead to a highly conservative bias in the neoclassical school, as almost any choice will arguably make somebody worse off.

Whilst initially equated with supporting unfettered free markets, in the 20th century neoclassicalism adopted the concept of market failure and externalities which can dampen the free market approach within neoclassical models and justify intervention by government. However, a counter to these concepts within the school also stem from government failure; to paraphrase Ha-Joon Chang, a clever economist can justify almost any action by a firm, economy or individual using some sort of neoclassical economics.

Read more on Exploring Economics.