Criticism and Reconstruction 1918

Criticism and Reconstruction, 1918-World War II

Then beginning about 1918, came a period of criticism; that is, of effective criticism. It came in the troubled period following World War I and was characterized, as to economic theory, by the "Institutional approach." The names of Wesley C. Mitchell and John R. Commons became more prominent, and the thought of Veblen was influential. This brought attacks on hedonism in marginal utility, on ethical implications in marginal productivity, and on static economics. The conditions of equilibrium were more critically examined, preparing the way for theories of imperfect competition and attempts at "dynamic" analysis.

But before the twenties were over, the period of criticism developed into attempts at reconstruction, and positive studies began. One can find in this period, down to say 1936, at least four elements: (1) attempts at quantitative analysis by sta­tistics, focusing on business cycles (e.g., Mitchell's work);
(2) the development by younger Institutionalists out of impa­tience with existing institutions into planning new institutions;
(3) the attempt of mathematical economists to use "econo­metrics," (4) the lapse into a sort of agnosticism concerning economic values which sometimes resulted in the extreme abstraction of "ivory-tower" economics. (The last two tend­encies had in common a high degree of subjectivism — tend­ing to ignore technological conditions, and assuming that goods exist. Perhaps Fisher may be mentioned as a representative of the third group; Knight, of the fourth.)

These four elements seem to have been most influential until the advent of Keynes's General Theory soon after 1936.

During the years 1930-1939, under the influence of the stock market crash and the Great Depression, there arose disillusion­ment and distrust concerning both democracy and competition, as these had been working. The result was a growing interest in "imperfect-competition theory" and a tendency to accept more "social planning." Monopolistic-competition theory broke out in 1933. And at about the same time, Professor Tugwell carried " the experimental approach" of the younger Institutionalists to Washington: Less competition, more central planning, an entirely different approach to economic theory—"social values" and "social justice."

To this condition is to be added the failure of the monetary policies based upon the quantity theory. The recognized failure of orthodox attempts to control prices by manipulating the quantity of currency ("open market operations") or discount rates, tended to discredit much Neo-Classical thought.

But, as the thirties wore on, unemployment continued abnor­mally great. When, therefore, in 1937 there came an extraordi­narily sharp recession, a highly significant change occurred in the thought of those who favored central control. For this change, the way was being prepared not only by the failure of Institu-tionalist "social planning," but also by the rise of "monopolistic-competition" theory. Following Chamberlin's book in 1933, interest in the monopoly approach grew, reaching a peak perhaps about 1937 when A. R. Burns's The Decline of Competition appeared.

But the change referred to was the change of style in thinking from Veblen to Keynes, marked by the swing to Keynesian policies at Washington. This change meant three important developments in American economic thought: (1) income eco­nomics according to which attention became directed toward controlling incomes and forcing circulation, rather than control­ling mere quantities of money and levels of interest rates; (2) macro-economics, or the management of aggregates; (3) "monetary economics," which replaces "real" economics by assuming the value and constant purchasing power of "money" regarded as a mere unit of account, or bank credit. With the ascendancy of Keynesian thought in 1937 came the "national income approach."

This worked with the "holistic" tendencies of Institutional-ism; but was opposed in part to the Veblenian antipathy to "pecuniary" motives.

Hardly had the Keynesian "pump-priming" era begun, before the general-equilibrium school of thought gained influence. Hicks's Value and Capital came out in England in 1939, and by that time the indifference-curve, mathematical economics, and "econometrics" were well established in America. The earlier work of Fisher, Schultz, and others was succeeded in the forties by the budgetary studies of Smithies, Hart, and others, and by the general-equilibrium models of Leontief, Tintner, Klein, and the rest. These characterized the World War II period.

To be associated with this phase is the movement to make economic theory "dynamic." In the years since 1940, have come such men as Samuelson, Klein, Metzler, Smithies, Tintner, and Lange. Mostly they rely very heavily upon mathematical procedures.

Thus out of distrust of democracy and competition came systems of "political arithmetic," for planning and controlling national aggregates. They were able to work with the American "institutionalism" in that (1) both had "the experimental approach," and (2) both were "holistic."

This represents a phase of subjectivism in economic theory that stands opposed to Austrian marginal-utility theory, as appears in the difference between marginal-utility theory and the indifference-curve approach. It may be taken to free the central authority from the limitations imposed by individual desires for any particular good, as well as from the "real" costs of production. It leads to the "new welfare school" idea of an "optimum" of some sort based either on some concept of well-being or on full employment.